Risk sentiment improves, but can the AI trade fully recover?

After Tuesday’s decline, the mood seems to have improved as we wait for the European session to open. European futures are pointing to a mildly lower open for European stocks, which managed to stage a mini recovery and pare losses at the end of the Tuesday session. In the US, future prices are also recovering.

Gold rises alongside stocks, as safe haven status under threat

Gold, which sold off sharply on Tuesday as the market punished all fast-moving asset prices, is also in recovery mode on Wednesday. The gold price is higher by $32 so far, and is edging back towards $4,000 per ounce. This suggests that the gold price is mirroring the market mood, rather than acting as a safe haven. Bitcoin is also higher by more than 1%.

Stock markets in Asia sold off heavily and followed the US markets lower on Wednesday. There was a 2.8% decline in the Nikkei. This is testing the ‘Takaichi’ rally, which saw the Nikkei surge more than 7% on a currency adjusted basis in the past month, after Japan elected its first female conservative leader.

Market has new-found prudence over AI stock valuations

The fact that the Nikkei has sold off alongside US tech stocks, the IT sector was the weakest on the S&P 500 on Tuesday and fell 2.27%, suggests that this is a sell off focused on stretched valuations. A 2% decline in the US tech sector is not a rout, but it does suggest that the market is less complacent about valuations as we move into the final months of the year. This also means that any sell off comes with a buying opportunity, as investors wait to buy the dip.

The weakest performers on the S&P 500 on Tuesday included Palantir, the big data firm with a 12-month forward price to earnings ratio of over 200 times, which fell more than 7%. This is a meaningful decline, and we will be looking for any dip buying as we move through Wednesday’s session.

AMD struggles to impress with earnings

The broader AI pullback included AMD, which dropped more than 3% after it reported earnings on Tuesday. Although the company reported stronger sales in Q3, and a decent Q4 outlook, including a GPU outlook that remains above expectations, the market wanted more. The guidance left some investors underwhelmed, which triggered the sell off. While there is nothing wrong with AMD’s results, the market has a new-found prudence when it comes to the AI trade.

Seasonality factors drive markets higher

However, we would point out that stocks tend to rally in the last two months of the year. Seasonality can have a big impact on markets, so the impulse for a stock market recovery and a general risk rally could be strong.

Travel stocks in the spotlight

The biggest decliners on the S&P 500 on Tuesday can tell us a lot about market sentiment. They included cruise liners, with Norwegian cruise lines dropping 15% on Tuesday. This came after weaker than expected Q3 earnings. Although its forecast for Q4 saw a slightly higher than expected occupancy ratio, margins were weaker than expected. This dragged down the entire sector, as travel-related anxiety hits stock prices.

US shutdown reaches milestone and could add to market volatility

Although there may be a broader stock market rally on Wednesday, airlines and travel-related stocks could get hit in the US. The US  government shutdown is now the longest ever and has lasted for over a month. This could disrupt air travel in the US, as air traffic controllers are Federal workers who could miss their second paycheck. If air traffic controllers walk out of their jobs, then this could cause chaos to the air travel sector in the coming days.

As the effects of the shutdown become real, the market could focus on how well negotiations are going in Congress to end the shutdown. In the past month, risk assets have broadly ignored the shutdown, but if this leads to economic disruption then it could be another factor that pushes up volatility.