Why Markets Don't Trust AI

What Is Going on in Markets?

July has been an absolutely terrible month for AI markets, the worst in the industry's record by a long shot.

In fact, most of the “AI stocks” are now considerably down from all-time highs, an interesting situation considering most of them are posting their best economic results in history.

Which is to say:

For some reason, markets don’t trust AI.

We already went into my reasons why I believe markets simply misunderstand AI, in particular with respect to its inability to turn a profit, which we already disproved.

But markets aren’t totally stupid, and they “see” things that are, indeed, pretty dramatic. And worse, they aren’t yet seeing what’s to me the real danger.

This newsletter will explain in full detail what went wrong with AI markets this month and point you directly to my biggest worries. Simply put, AI is amazing and full of potential, but there are very worrying signs.

Let’s dive in.

WTF happened?

The story begins before July. Semiconductor stocks had just completed one of the most extraordinary quarters in market history. The Philadelphia Semiconductor Index rose close to 90% during Q2, its best quarter on record.

Several companies doubled in a matter of months, while memory, semiconductor equipment, networking, power, cooling, and almost anything connected to AI infrastructure became part of the same trade.

At the same time, the trade had become extremely crowded. Semiconductor funds received approximately $12 billion of inflows over two weeks in June. Unbeknownst to many, the event was led by “smart money,” which came pounding into global semis and hardware like Winnie the Pooh on honey.

Source: Morgan Stanley, JP Morgan

These times were like the calm before the storm. And then came July 1st.

The not-so-calm calm before the storm

A report claimed that Meta was considering selling some of its data-center capacity to external customers through a cloud business.

While Meta later said compute remained scarce and that third parties had offered to pay premiums for access to its infrastructure, markets obviously did not wait for that clarification.

Instead, what they actually heard was this:

“Meta, the company with 3.65 billion active users and gigawatts upon gigawatts of AI compute, enormous off-balance commitments, and an annual budget larger than Germany’s annual defense budget, still has no idea how to monetize its user case using AI.”

The Philadelphia Semiconductor Index fell 6.3% in one session. KLA fell approximately 12%, Applied Materials 10%, Lam Research close to 10%, and Micron and SanDisk more than 10%.

All these are WFE (wafer fab equipment) and memory/storage stocks, all very important semiconductor companies central to the AI trade.

The selloff continued the following day. Global markets were relatively stable, and European stocks even rose, but semiconductor stocks fell another 5.5%. South Korea’s market also suffered one of its worst sessions in years.

The next warning came from Samsung. On July 6, Samsung estimated that its quarterly operating profit had increased approximately nineteenfold. Under normal circumstances, that would…

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