Momentum Works in Both Directions — And Now It’s the Bear’s Turn
Buckle up. Worries about interest rates and valuations are weighing heavily on speculative and AI-related names.
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Following brutal action in AI, technology, and speculative stocks on Thursday, the market is indicated lower again early Friday morning. Overseas markets were weak, and dip buyers are scared to jump in as leading stocks crack support levels.
Two interrelated issues are driving the action. The first is concern about valuations, and the second is worry about Fed interest-rate cuts. Lower interest rates help to support higher valuations, but when rates stay elevated, that causes P/E ratios to contract, and it becomes more difficult to justify stocks trading at very high multiples.
Even without the issue of interest rates, the bears have been loudly declaring that valuations are at bubble levels in many of the AI names. They were ignored for quite a while, but after third-quarter earnings reports from key Magnificent Seven (MAGS) names and the "sell the news" reaction to Palantir (PLTR) , valuation now matters.
If the only issue were the valuation of some mega-cap technology names, then this corrective action would not be much of a crisis. However, the problem is that this reevaluation spills over into many speculative stocks leveraged to AI in various ways. Aggressive traders favor these fast-moving stocks, and when they exit, momentum reverses.
One of the most obvious victims of the shift in aggressive retail trading is Bitcoin (IBIT) , which is now in a technical bear market after a drop of about 23% from its October 6 highs. Groups such as quantum computing and nuclear power don’t have fundamentals to justify their extreme valuations, which renders technical support levels meaningless.
The big problem for many leading stocks is that they still have to fall significantly before they will be viewed as good values. A stock like Apple (AAPL) with a P/E of 37 and forward EPS growth of 10% is certainly not cheap. If that valuation is questioned, there is a huge air pocket before value buyers will believe it is a value.
The good news is that this is normal cyclical market action. The market has gone through this process many times before. Eventually, valuations and technical conditions will become more favorable, and investors who have been badly wounded will sort through the wreckage and find great opportunities.
The immediate question is how much deeper this corrective action goes. There is no way to know. It is looking very nervous early on Friday, and selling is already accelerating. There isn’t any news flow on the agenda that is likely to help right now. Buckle up, it is going to be a rocky ride.
At the time of publication, Rev Shark had no positions in any securities mentioned.
