The Rotation Toward Fundamentals
The market has been rotating this week, with heavy trading questions around the AI trade. A move into a focus on valuation and fundamentals is good for the market. It helps active managers, who care about these things rather than just spotting trends and buying momentum. A reset or rotation like this can lead to steadier, more lasting market gains instead of the boom-and-bust swings the stock market sometimes shows.
AI is a transformational technology, but the story now comes down to AI fundamentals. Many people piled into the story. The focus should shift to revenue growth and cash flow conversion, meaning whether these companies actually make money, plus volume and pricing. Supply chains face constraints, but these usually clear over time as more capacity gets built.
Memory is a good example. The industry raised prices on higher demand and tight supply, then built out capacity and prices came down. So this is not a valuation bubble. From a price-to-earnings view, these stocks look very cheap. It is an earnings bubble instead. You can still make money in these stocks, but you have to time your trades, which makes focusing on valuation important. Many of these stocks have blue-sky scenarios priced in. We saw that in this week's earnings, where companies posted phenomenal numbers but stock prices sold off, because the real question is whether this is as good as it gets. Hyperscaler PE ratios sit at 11-year lows right now, worth weighing going into Q2 earnings.
The Bloom Case
Framed as a World Cup game, AI has just reached its first hydration break, one of many to come. The four years since ChatGPT launched brought a lot of innovation and some anxiety. Comparing AI to how the internet evolved, the early phase is finished and the best is yet to come. Across the broader age of AI and society, the story will be mostly bloom, not gloom and doom.
The core reason: AI is reimagining society in a very fundamental way, bringing a modern renaissance. It will free people from specialized assembly-line labor, an idea that started roughly 100 years ago with Henry Ford and the manufacturing assembly line. For most of civilization, humans were generalists. In the Renaissance, one person could be a sculptor, an artist, and a painter. AI will free all 7 billion of us to be generalists, doing the specialization itself while humans fall back on their natural skills. Everyone shifts from being an employee to being an entrepreneur. In the long run, AI should reduce inequality rather than make it worse.
Engage or Pause
Every new technology, going back to fire and electricity, offers two choices: pause your engagement with it, or use it more so you learn to handle it safely and put guardrails around it.
Self-driving cars show this. In California, the local government chose to engage with self-driving technology. As a result, San Francisco has seen self-driving cars cut fatalities and serious accidents by a factor of 90%. That is engaging with something new that might seem dangerous. We teach kids in high school to drive safely; pausing that would not help society. A moratorium on data centers is like pausing driver's education for high schoolers. Engaging with data centers and learning to make them safer is the better route.
The Capex Question
Not everyone on Main Street feels the general effects of AI. The market feels it, and wealthier people feel it through their stock portfolios. A recent Charles Schwab chart showed hyperscaler capex running far ahead of hyperscaler profits across the S&P 500.
This is a big market concern: what is the return on all this capex spending? The most profitable companies in the world are pouring their capex into building out artificial intelligence. If the ROI does not justify these capex numbers, spending could pull back. There is growing recognition of both the opportunities and the risks in the AI path, and that is already showing in the market's wobbles, especially in semiconductor stocks. Some hyperscalers report as soon as next week.
