The Bull’s Wild Ride: What We Have Here Is A Worrywart Market

It was a curiously unsettled week on Wall Street as investors spent the first few days either fretting or selling as they waited for the mother of all bellwethers, Nvidia , to report earnings on Wednesday night, and for the September jobs report—not a typo, it was delayed by the government shutdown—on Thursday.

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Mohamed El-Erian: ‘AI Is In a Rational Bubble’Play video: Mohamed El-Erian: ‘AI Is In a Rational Bubble’

Once the news had dropped by Thursday morning, buyers rushed in, giving the all-clear sign, it seemed, after Nvidia’s boffo earnings and a robust job report. But fear soon enough took hold, and just like that, as Sarah Jessica Parker might say, the market rolled over.

Then, on Friday, the market took solace in New York Federal Reserve President John Williams being down with a December interest-rate cut.

Still, the causes for the agita are pretty clear. As mind-blowing as Nvidia’s P&L is, it wasn’t enough to dispel the concerns that surround the artificial-intelligence trade: fundamentally, too much money being spent—up to $7 trillion of borrowing alone, estimates J.P. Morgan —and not enough return. And as for the jobs report, it wasn’t quite as rosy as it seemed.

To be more precise, the underlying fear that had the S&P 500 index spiraling down since its late-October peak didn’t seem to be ameliorated by Nvidia reporting record earnings and CEO Jensen Huang assuring investors that there was no AI bubble and that business was booming, even accelerating. And though the U.S. economy added 119,000 jobs in September versus an expected 50,000, that strong growth could be fodder for interest-rate bears at the Fed, who are against a December rate cut. Meanwhile, the rest of the report read hinky, in that unemployment ticked up to 4.4%, the highest rate in nearly four years, and payrolls were revised downward for July and August.

It all goes to show that traders will find news to fit their mood. So, what we’ve got here is a failure to be bullish. Instead, we have a worrywart market.

This even applies to Nvidia, which, as Barron’s Tae Kim writes, is hard to believe, given the numbers the world’s most valuable company (some $4.5 trillion) posted. “Nvidia blew out revenues and earnings, showing they can execute even with sky-high expectations,” says Brian Casey, CEO of asset manager Westwood Holdings Group in Dallas. “Nearly 90% of total sales came from data centers, showing their dominance as the backbone of AI infrastructure. Guidance for the fourth quarter at $65 billion revenue suggests that the ongoing buildout of the AI infrastructure is not just growing; it is accelerating at a breakneck pace. Gross margins of 75% speak to their pricing discipline at a time that sales are surging. Just a spectacular moment in the history of technology.”

And yet fear is just around the corner.

“It feels like guys are terrified that they are going to give the year away and have taken down exposure hard,” a Wall Street trader we’ll call Big Cat wrote to me. “My instinct is we have a bumpy ride through Thanksgiving weekend and then we get a little Santa rally, but that might be wishful thinking. Crypto guys have been shelled, but no one likes or cares about them. Gonna be an interesting last six weeks of the year.”

Leaving aside the catty, ad hominem attacks on our crypto friends (who truly have been shellacked, with Bitcoin now down 30% from its record high on Oct. 6), it’s probably healthy to remain wary. The S&P 500, after all, has slipped only 5% from its all-time high of 6890 on Oct. 28. Consider, too, that the eight biggest stocks (all of them techies)— Alphabet, Apple , Amazon.com , Broadcom, Meta Platforms, Microsoft, Nvidia, and Tesla —now account for nearly 40% of the index’s valuation (with No. 1 Nvidia at 8%).

Is there any way to justify those relative valuations?

“AI is in a rational bubble,” says Allianz Chief Economic Advisor Mohamed El-Erian, whom I spoke with recently as part of our At Barron’s interview series. “It makes sense to overinvest in it, to overspend on it, because the payoff is enormous.” But, he says, there will be a small number of winners: Be wary of “companies that simply put an AI label on what they do and suddenly attract investment that’s going to end up in tears.”

El-Erian says that AI has pulled up the stock market in two ways—and it can unwind it, too. “One is indexes,” he says. “The bigger that the technology names get in the indexes, the more the indexes react, the more they attract money into it. The second one has to do with ‘risk compression.’ When things start going up, you look for those that haven’t gone up yet, foreign stocks, the [small-cap] Russell [2000] index. In credit, you go all the way up the high-yield curve. So, AI has pulled everybody up with them. Some names don’t deserve the valuations they have right now. Others do.”

To that point, note there is some dispersion among the AI names. A new study by Bank of America shows subgroups of AI stocks moving independently to a degree. (Asian-Pacific AI infrastructure stocks held up well over the past month, while U.S. AI infrastructure underperformed.)

Adam Grossman, global equity chief investment officer of RiverFront Investment Group, says that AI opportunities extend beyond Nvidia and Microsoft, including network security companies like Palo Alto Networks, CrowdStrike, Fortinet, and Zscaler, which are “crucial as AI proliferates,” as well as businesses involved in building, powering, and cooling data centers like Caterpillar, Eaton, and GE Verona.

What about the other 492 stocks in the S&P 500 besides the Exuberant Eight mentioned above? Plenty of them are undervalued, says Westwood’s Casey, who also points to Eaton, as well as Knife River, which produces construction materials like asphalt and builds roads; Packaging Corp. of America, which makes corrugated packaging; and electrical components producer Hubbell. He acknowledges that they have been painfully underperforming. But Casey is resolute: “When the times get tough, people generally look to find quality.” That day may be coming soon.

As of now, though, AI is to the rest of the market what Marcia was to Jan on The Brady Bunch. (“Marcia! Marcia Marcia!”) All we hear about these days is how pervasive AI is. And it’s true to a degree.

Even the slow-burn fall from grace of Larry Summers, the besieged Harvard professor (and, lest we forget, a former president of Harvard, U.S. Treasury secretary, and director of the National Economic Council), thanks to revelations in the newly released Epstein files—tawdry on any number of levels—contains an element of AI-itis. Note that this past week Summers had to step down from the board of OpenAI, to which he had been appointed two years earlier as the grown-up in the room to stabilize the mega-start-up and restore CEO Sam Altman after the company went sideways and the previous board fired Altman. (Summers didn’t return a request for comment.)

It appears that AI, even with this market uncertainty, has grown up a bit more than Summers has.

Sure, AI is having a big impact, but in the broader U.S. economy, other factors still hold sway. “We’ve thrown absolutely everything at it, including a government shutdown, and yet [it] doesn’t skip a beat,” El-Erian says. “If you had told me at the beginning of the year, with all the shocks we’re going to get, we would deliver 3.8% growth in the second quarter, I would say, ‘Well, maybe one quarter.’ I suspect we did 3% in the third quarter, so it’s an incredibly resilient economy, and it speaks to the entrepreneurship and the dynamism of the private sector.”

When I asked El-Erian about the Fed, I was gratified to hear him address one of my pet peeves: the dim-bulb types who proudly declare themselves to be data-dependent, full stop.

“Think of how absurd that statement is,” El-Erian says, relating it specifically to the Fed. “Monetary policy acts with long and variable lags. That’s what we’ve learned. Data captures the past. So, you’re telling me that I’m setting policy for some outcome in the future based on data of the past. Unless I complement that with some strategic view of where we’re going, I am going to be continuously late. And I think that we’ve seen the Fed continuously late. They were so late in responding to the inflation surge of 2021, it is a miracle that we didn’t fall into recession. I remember Chair [Jerome] Powell in August 2022 warning about pain. I remember Bloomberg going with a headline that said ‘100% probability of recession in 2020,’ and that didn’t happen.”

It’s like driving while looking in the rearview, I say to him. “Correct,” he replies. “On a curvy road.”

El-Erian has long been critical of the Fed sticking with a 2% target for inflation. I asked him if he was going to get a T-shirt that says, “Change the Dang Rate!”

“I’m not going to do that, because that would be a waste of money, because this Fed will not change it,” he says, pointing out that this is the fifth year of exceeding the 2% target and that the Fed has said it would exceed that for at least another two years. “I don’t believe 2% is the right target for an economy that’s going through such fundamental structural change. I think that the equilibrium inflation rate for this economy is 2.5% to 3%, and we’re seeing the inflation rate come around there.”

So, what should investors look for? El-Erian says the macro is fluid because we are in a world of geoeconomics. “For a very long time, economics was driving the bus,” he says. “Now, economics is lucky to be in the back seat. Decisions are being made according to national security, geopolitics, and domestic politics. What investors have to realize is that economic outcomes will have less to do with economic logic and commercial logic. For example, if the administration decides to take ownership in a company, suddenly this company has a lot more partners and its competitors are worse off.”

All of this is squarely on El-Erian’s radar these days. After a five-year stint as president of Queens’ College of Cambridge University in England, he is now happily ensconced in Connecticut, that much closer to his beloved New York Jets, as well as Wall Street and the world’s biggest economy. Not that El-Erian was particularly removed anyway, as the former CEO of Pimco and head of Harvard Management was very much on top of all things economic and football (U.S. and British) during his time in the United Kingdom.

Speaking of football, how could a logical economist like El-Erian root for the hapless Jets, who have the worst record in the NFL over the past decade? “I fell in love with the Jets in 1969, so it’s loyalty,” he says. “The more interesting question is, why do I hope? I need a psychiatrist for that.”

Write to Andy Serwer at andy.serwer@barrons.com. Follow him on X and subscribe to his At Barron’s podcast