There’s no doubt that the growing adoption of artificial intelligence (AI) is one of the biggest drivers of the market rally that began early last year, but countering that bullish sentiment are lingering concerns about the ongoing battle with inflation and its impact on the economy.
The Fed has maintained it won’t cut interest rates until inflation improves significantly, leaving them at 22-year highs, though the latest inflation reading came in higher than expected, raising hopes of a rate cut and sparking a broad market rally.
On this backdrop, chip designer Arm Holdings (NASDAQ: ARM) rose 3.2%, semiconductor giant Broadcom (NASDAQ: AVGO) rose 4.9% and memory and storage chipmaker Micron Technology (NASDAQ: MU) was up 6.5% as of 1:06 p.m. on Thursday.
After checking all the usual sources of information, such as regulatory filings, earnings results, and analyst ratings and price target changes, we found very little company-specific news that drove AI stock higher (more on this shortly). Today’s market bounce is likely due primarily to improving economic conditions and their implications for the future.
Image source: Getty Images.
Persistent and stubborn inflation
The monthly inflation report from the U.S. Bureau of Labor Statistics, released yesterday, offered some good news on the inflation front. Prices continue to fall, providing some much-needed relief for price-weary consumers. The most closely watched inflation measure, the Consumer Price Index (CPI), rose 2.9% year-over-year in July. Month-over-month, it rose just 0.2%. This is the lowest rate since the beginning of 2021.
The monthly reading was in line with expectations, but the annual reading was better than expected. Economists had been expecting inflation to rise 3% year-on-year and 0.2% quarter-on-quarter. The “core” reading, which excludes volatile food and energy prices, was 3.2% higher than the same period last year and 0.2% higher quarter-on-quarter, both in line with expectations.
The Fed remains committed to its 2% inflation target, but a growing number of economists are predicting the central bank will cut interest rates by 0.25% in September, with some suggesting a 0.5% cut is possible.
Despite progress, challenges remain, with home prices (mainly rents) being the biggest driver of the increase and consumers continuing to bear the burden of rising housing-related costs.
Interest rates have been trending upward since March 2022, and investors and businesses alike are eagerly awaiting the first of many rate cuts to spur further business and consumer spending and ultimately boost the economy. With inflation hitting its lowest level in more than three years, Wall Street is increasingly hopeful that rate cuts will start sooner rather than later.
The story continues
The only other catalyst
Yesterday was the deadline for hedge funds to file their quarterly portfolio disclosures with the Securities and Exchange Commission (SEC), and stock prices have been known to move when it becomes clear that prominent investors have made changes to their holdings.
To close out the second quarter, Paul Singer’s Elliott Investment Management disclosed in a regulatory filing that it had acquired a small stake in Arm Holdings. The billionaire investor bought about 150,000 Arm shares worth $24.5 million. Incidentally, this represents just 0.24% of Elliott’s overall portfolio, so it’s unlikely to have had a major impact.
AI has been getting a lot of attention since the beginning of last year, mainly due to heavy investments by hyperscale cloud providers and large technology companies eager to profit from the technology. But other companies have been reluctant to invest in a new and still largely unproven technology, especially in the face of rising borrowing costs. That said, as interest rates fall and generative AI proves its value, more companies may be willing to take the plunge.
Frankly, expectations about the potential of this breakthrough technology are driving valuations in the sector. Shares of Micron Technology, Arm Holdings, and Broadcom are selling at staggering 332, 71, and 52 times earnings, respectively. That said, price-to-earnings (P/E) ratios are of little use in valuing high-growth stocks. A more appropriate price-to-earnings growth (PEG) ratio takes into account high-growth trajectories and suggests multiples of 0.1, 0.2, and 0.8, respectively. Anything below 1 indicates an undervalued stock.
This suggests that for investors with the right investment timeline and the ability to tolerate volatility, these AI stocks may be worth keeping an eye on.
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Danny Vena has no position in any of the stocks mentioned. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
The article Why Arm Holdings, Broadcom and other artificial intelligence (AI) stocks surged Thursday morning was originally published by The Motley Fool.