October has been perilous for investors positioned in the AI trade. Many of the companies that led the rally—including semiconductor, hardware, and data center infrastructure names—have fallen sharply. Some semiconductor indexes are nearly 30% below their June highs, while individual stocks have suffered drawdowns approaching 50%.

We anticipated a handoff from the first phase of infrastructure buildout to the companies benefiting from it. We did not anticipate declines this broad. So, what happened, and what might bring investors back?

Simply put, it comes down to capital availability and cost. Several forces are affecting both.

First, interest rates and inflation raise the cost of capital, putting pressure on companies at the margin. This brings to mind the dot-com era of the late 1990s. During that boom, companies with weak business models could still go public. Today, companies with access to capital can present themselves as data center builders, including some neocloud providers. But ultimately, the likely winners will be those with strong balance sheets and a visible path to positive cash flow.

Second, the federal government’s enormous financing needs may be crowding out private borrowers.

Third, surging energy prices have added to inflationary pressure and, in turn, interest-rate concerns. Geopolitical factors—including the Russia-Ukraine war and conflict in the Middle East—are contributing to energy-market uncertainty.

Fourth, the midterm elections add political uncertainty. The administration’s timeline for resuming the war with Iran may also be affecting investor sentiment, particularly if investors expect the conflict to remain on hold until after the elections.

Meanwhile, AI adoption continues. Consumers are beginning to use agents for everyday tasks, while businesses are moving from pilot programs to production. The midterms and the Iran conflict are near-term uncertainties. The Fed is unlikely to raise rates just ahead of the election, and a credible resolution to geopolitical conflicts could bring energy prices down, ease inflation pressure, and lower rate expectations. That could shift investors from “risk off” to “risk on,” especially if valuations have fallen to more palatable levels.

In retrospect, this may prove to have been an attractive buying opportunity within a correction, rather than the end of the AI trade. We believe the opportunity is still in its early stages.

Michael P. DeSantis
Managing Member

Bruce M. Lupatkin
Managing Member