Yardeni Research | The Hire-No-Fire AI Economy

💡The S&P 500 fell 2.7% last week following the Democrats' midterm election victory, yet the selloff was not broad-based. Five of its 11 sectors rose, with Consumer Discretionary leading at 2.7%, followed by Communication Services (2.3%), and Real Estate (1.9%). Conversely, Energy experienced the largest decline at -11.9%, Information Technology fell by -6.9%, and Industrials lost -2.8%. This indicates a rotation within equities rather than a complete abandonment, driven by resilient earnings, as the S&P 500's blended Q3 EPS growth rate increased to 25.9% year-over-year.

💡Wall Street's reaction to the midterm election results unfolded in three distinct stages. First, on Wednesday, a relief rally characterized by short covering occurred, with the S&P 500 jumping 1.6% and the Dow Jones Industrial Average surging 3.0%, as risks of a constitutional crisis and Iran war escalation receded. Second, on Thursday, the S&P 500 plunged 4.4% due to concerns over potential roadblocks to the AI investment boom, specifically investor frets about local opposition to data centers. Third, on Friday, the S&P 500 recovered 0.3% as investors reconsidered these concerns as

💡The S&P 500 plunged 4.4% on Thursday after the midterm elections because investors became concerned that the new political landscape could impede the AI investment boom, particularly regarding data center development. This fear stemmed from striking backlash against data centers, evidenced by NBC exit polls showing 76% of voters opposed new facilities in their communities, and local ballot propositions restricting data center development winning in 40 out of 41 cases. Goldman Sachs estimates that states facing potential restrictions account for approximately 45% of planned US data center capacity, including about one-quarter in Texas, leading investors to worry about the US economy's AI-driven growth.

💡Investor concerns regarding the AI data center buildout eased on Friday as investors reconsidered whether the political backlash would halt or merely slow the expansion, viewing potential roadblocks as

💡The AI investment boom faces three intensifying constraints: financial, political, and physical, with the first two becoming particularly acute. Financial constraints involve increasing costs as investors demand clearer returns on large commitments, alongside the need for expanding financing toolkits. Political constraints are evident in rising local opposition to data center construction, requiring developers to shoulder more infrastructure costs and deliver greater community benefits. Physical constraints include power shortages, interconnection delays, and equipment bottlenecks, which prolong project timelines and extend the wait for positive free cash flow, collectively adding friction and delaying projects.

💡The speed of the AI investment boom will slow down because political opposition is making data center construction more conditional, requiring developers to increasingly fund grid upgrades, protect local resources, and deliver tangible benefits to host communities. Additionally, financing is becoming costlier as investors demand clearer returns on hyperscalers’ enormous commitments. Finally, physical limitations such as power shortages, interconnection delays, and equipment bottlenecks cannot be resolved quickly. These three constraints collectively add friction, delay projects, and extend the wait for positive free cash flow, thus decelerating the boom without necessarily ending it.

💡The S&P 500's forward P/E ratio, which has fallen to 17.6, below its Liberation Day level of 18.1, indicates that stock investors are discounting speed bumps in the AI investment boom. This suggests that investors increasingly recognize that financial, political, and physical constraints make earnings harder to forecast and existing forecasts more challenging to achieve. The decline reflects a more cautious sentiment, implying that while the AI boom is expected to continue, its pace and profitability might be affected by these growing limitations, leading to a more conservative valuation of future earnings.

💡The Treasury market appears to anticipate a potential economic slowdown following a cooling of the AI investment boom, as indicated by falling yields. The 10-year Treasury yield declined 8 basis points last week to 4.84%, and the 2-year yield fell 5 basis points to 4.46%. This narrowing of the spread relative to the effective federal funds rate of 3.88% suggests bond investors are starting to consider that mounting constraints on the AI investment boom could weigh on overall economic growth. Additionally, the futures market's expectations for Federal Reserve tightening dropped, anticipating only 1.4 quarter-point hikes over the next six months and 1.9 over the next 12 months.

💡The AI investment boom contributed to job growth in October through several sectors. Manufacturing added 19,000 jobs, including 6,700 in computer and electronic products, 3,300 in semiconductors and electronic components, and 3,900 in machinery. Additionally, nonresidential specialty-trade contractors, a category that includes workers involved in data center construction, contributed another 7,900 jobs. This indicates that the buildout of AI infrastructure and related industries is directly creating employment opportunities, making a notable mark on the US labor market's resilience.

💡Strong consumer spending will continue in the US economy due to a robust labor market and a surge in household net worth. The US labor market is resilient, with accelerating jobs growth, declining unemployment, and rising wages, as evidenced by a 0.5% month-over-month increase in the Earned Income Proxy in October. Concurrently, household net worth surged to a record $185.6 trillion in Q2, marking the largest quarterly gain on record at $12.5 trillion, with Baby Boomers commanding the majority of this wealth. These factors collectively provide a solid foundation for sustained consumer expenditure.