The US stock market declined 1.6% last week, led by a 4.1% drop in technology stocks and a 1.8% drop in communications services, as investors appeared to lose confidence in the prospects for the artificial intelligence trade and specifically the sustainability and profitability of the current level of capital investment. The change in investor sentiment was also evident in the 1.8% decline in the Morningstar PitchBook Modern Market 100 index that combines the largest public and venture capital-backed private companies into a single index.

Tesla TSLA, a poster-child for the high expectations associated with AI investment fell 6% last week as shareholders approved a potential $1 trillion pay package for Elon Musk. This staggering award is predicated on the business reaching a market capitalization of $8.5 trillion, from roughly $1.5 trillion today, alongside several other targets over the next decade. Although it would be easy to focus on the potential upside for Musk, it seems more likely that shareholders are concerned about the current valuation of Tesla if he were to leave. Despite the decline last week, the stock remains priced 43% above Morningstar’s estimate of its fair value and so needs to deliver growth ahead of already high expectation to justify its current price.

The downside of the tech-stock concentrated market

The high concentration of large technology-oriented companies in benchmark indexes was demonstrated last week as six of the eleven sectors rose, led by energy, despite the overall decline at a market level. This ongoing bifurcation can be seen most clearly by comparing the movements in large growth stocks—down 3.7%—with those in small value, which rose 0.7%.

Although the market decline may appear significant, it merely takes the market back to the level of a few weeks ago and into slightly undervalued territory. As with previous declines, this may encourage investors to buy the dip. However, there is considerable uncertainty surrounding the fair value of individual stocks and markets, as illustrated by Morningstar’s Star Rating for stocks, and therefore price movements within a narrow band around fair value are more likely manifestation of market noise rather than a clear buy or sell signal.

Technology stocks also weighed on Morningstar Emerging Markets Index, which fell by 1.4%, led by Korea and Taiwan. Developed markets outside the US fared a little better but also appeared to suffer from negative sentiment, falling 0.9% and continue to offer some attractive opportunities for investors.

The boom in AI (experts)

This dominance of AI in the minds of investors has been accompanied by confident technological analysis that is reminiscent of the sudden emergence of virology expertise during the covid pandemic or geopolitical knowledge that accompanied Russia’s invasion of Ukraine.

It is natural for those with capital risk to seek to understand as much as possible about a topic that is dominating investing flows. However, this rapid accumulation of knowledge can create overconfidence that leads to poor investment performance due to the Dunning-Kruger effect. (For an excellent discussion of investing amid uncertainty and Dunning-Kruger, check out this episode of The Long View podcast.) Successful investing, especially during periods of rapid change, is underpinned by acknowledging what one does not know and cannot be known so forecasts must be probabilistic encompassing a range of possible outcomes.

Investors await US government reopening—and US economic data

Jobs Friday failed to live up to is name again last week as the US employment report was delayed due to the ongoing shutdown. In the absence of economic data from the Federal government, market commentators are drawing inferences from what is available such as the ADP employment report on Nov. 5. While this indicated the that the private sector added 45,000 jobs in October, marking the first gain in three months, it is worth noting that the ADP measure varies from the BLS report and is regarded as less influential on the Federal Reserve, evidenced by the lack of movement in the expectations of an interest rate cut in December following the report.

As the reopening of the Federal government appears closer following negotiations over the weekend, boosting investor sentiment, it is worth remembering that the link between economic growth and asset price movements is weak over the short term and so the former is a poor guide use when making investment decisions.

Company earnings remain in focus

The focus this week would normally be on inflation and the discussions at COP30. However, in the absence of a breakthrough in the shutdown negotiations or surprising unity at COP, it seems likely that company earnings, the ongoing debate about technology investing and the search for further “cockroaches” in the credit markets are likely to dominate the financial news. The latter two have the potential to establish a narrative in our minds that needs to be guarded against if we are to make successful long-term decisions.

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