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The increasingly narrow market breadth in recent months, combined with high valuations—especially among those benefiting from the artificial intelligence (AI) boom—has once again become apparent. At first glance, such markets appear robust: the US S&P 500 stock index has often delivered very attractive risk-adjusted returns over the course of the year. However, on closer inspection, they prove to be remarkably fragile when the few pillars of the bull market begin to falter. In the current environment, two factors have exposed this vulnerability: growing doubts about the AI boom, particularly the profitability of the enormous AI investments, and the pricing out of the hoped-for interest rate cut by the US Federal Reserve in December. The end of the US government shutdown only briefly lifted the mood.
Even if the current nervousness among market participants could persist, there is little to suggest a real trend reversal on the stock markets – the fundamental environment is too robust for that. Corporate earnings are developing solidly, as the past reporting season has impressively demonstrated. There are currently few signs of global recession risks. In addition, key interest rate cuts are prevailing worldwide. Even if it remains unclear whether the Fed will cut interest rates in December, further monetary easing is very likely in the medium term. Geopolitically, too, the signs point to a détente. The trade dispute between the US and China has been defused for the time being by a small deal and is unlikely to weigh on the markets for the time being.
Finally, it should be noted that the large data center operators, known as hyperscalers, generate very high returns in their core businesses – and thus have sufficient cash flow to appease their investors in case of doubt. If investor concerns become too great in view of the continuing rise in AI investments, companies could scale back their investment plans at any time, thereby significantly increasing their free cash flow.
However, developments in recent weeks are likely to be a preview of what investors should expect in the coming investment year. The AI supercycle is still in a relatively early phase, with widespread adoption and comprehensive use of the technology still to come. Accordingly, only a few “AI superstars” are benefiting for now. The weak market breadth and high valuations are therefore likely to persist – and with them the latent vulnerability of the markets. Against this backdrop, investors should factor temporary phases of AI disillusionment and associated setbacks into their investment strategy.
