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Key takeaways
- Concerns about potential restrictions on new U.S. data centers contributed to a sharp sell-off in AI-related stocks.
- U.S. economic growth and corporate earnings remain supportive, even as market sentiment moves toward oversold levels.
- Prolonged market weakness could create risks for highly leveraged AI companies and consumer spending.
Why did stocks fall after the U.S. midterms?
Our Director and Senior Portfolio Manager Alex Cousley sees this week's sharp equity sell-off as a test of market sentiment, with the U.S. midterm elections raising new questions about the outlook for AI infrastructure investment.
Markets initially responded positively to Tuesday's election results, although semiconductor stocks faced some pressure. That changed dramatically on Thursday as selling accelerated across equities.
The S&P 500 fell roughly 4%, the Nasdaq declined around 6%, and the equal-weighted S&P 500 lost approximately 3% during Thursday's session.
For Cousley, much of the concern centers on the future of U.S. data-center development, particularly following Democratic victories in Georgia, Ohio and Texas.
Could data-center restrictions slow AI investment?
Proposals to restrict new data-center development have gained attention in several states, reflecting public concerns about the rapid expansion of AI infrastructure.
Some newly elected governors have supported slowing or placing additional conditions on new development. Although these proposals do not necessarily affect facilities already operating, they could change the outlook for future projects.
That matters for companies across the AI supply chain. A slower pipeline of new data centers could reduce future demand for semiconductors, non-residential construction and the heating, ventilation and air-conditioning systems required to support large computing facilities.
Investors have responded aggressively to the prospect of slower growth in these industries, even though the eventual scale and timing of any restrictions remain uncertain.
Is the market sell-off creating investment opportunities?
Despite the sharp decline in equities, Russell Investments' broader investment outlook remains relatively constructive.
Our investment framework considers three factors: cycle, valuation and sentiment. Cousley believes the economic cycle remains in a healthy position. U.S. economic activity continues to show resilience, while corporate earnings have generally been strong.
Sentiment, however, is beginning to change. Thursday's selling has pushed market sentiment closer to oversold territory, although Russell Investments' indicators have not yet reached the more extreme levels associated with investor pessimism.
For long-term investors, those extremes can sometimes create opportunities when market prices move further than underlying fundamentals justify.
Our investment team is closely monitoring sentiment for signs of potential tactical opportunities as the sell-off develops.
What risks could prolong the AI sell-off?
There are two risks Cousley believes investors should watch particularly closely.
The first is credit risk within the AI ecosystem. If negative sentiment continues, highly leveraged companies involved in AI infrastructure could face greater difficulty accessing capital markets. For some lower-quality borrowers, that could place pressure on business models and potentially affect companies elsewhere in the AI supply chain.
The second is the wealth effect on U.S. consumers. Equities represent a substantial share of American household wealth. As share prices rise, households may feel more comfortable spending and saving less. A prolonged market downturn could have the opposite effect.
Cousley emphasizes that both the magnitude and duration of a sell-off matter. A brief decline may have a limited economic impact, while deeper and more persistent losses could eventually weigh on consumer confidence and spending.
For now, Russell Investments continues to see a relatively healthy economic cycle. The focus is on whether market sentiment moves into more extreme territory, potentially creating investment opportunities, or whether weakness begins to affect credit conditions and the broader economy.