The market ended the week on a somber note as the economy once again took center stage. Investors were digesting a surprisingly robust jobs report that highlighted the Federal Reserve's ongoing battle with inflation, the potential for future interest rate cuts, and what it means for the overall economy. To add insult to injury, a decision by the Biden administration regarding advanced semiconductors used for artificial intelligence (AI) sent a ripple through the semiconductor industry.
With that as a backdrop, database and AI chipmaker Oracle (ORCL 2.20%) dropped 4.4%, chip architect Arm Holdings (ARM 1.54%) tumbled 3.4%, and semiconductor specialist Broadcom (AVGO 2.96%) fell 2.8% as of 1:10 p.m. ET on Friday.
A check of all the usual suspects -- financial reports, regulatory filings, and changes to analysts' price targets -- revealed no company-specific news to explain the swoon. This suggests the economy and developments in the semiconductor industry stole the spotlight.
Image source: Getty Images.
A tightrope walk
The monthly jobs report, courtesy of the U.S. Bureau of Labor Statistics, showed that total nonfarm payrolls increased by 256,000 on a seasonally adjusted basis during the month of December, which far outpaced economists' forecasts of 153,000.
This report highlights not only the incredible resilience of the job market, but the difficult tightrope walk the Fed faces between curbing inflation and cutting interest rates. In normal circumstances, a strong job market is a good thing, but red-hot growth continues to keep inflation elevated. Wall Street and Main Street alike are eager for rates to come down, but the data makes it unlikely the Fed will be able to lower rates any further until it gets a handle on inflation.
Fed officials are scheduled to meet later this month to discuss the issue, but the chances of a rate cut are slim, with the likelihood now standing at just 2.7%, according to the CME FedWatch tool.
Further exacerbating matters in the chip industry, the Biden administration is set to introduce another wave of export restrictions related to high-performance and AI-centric processors, a move aimed at keeping this advanced technology away from U.S. adversaries, including China and Russia.
This plan involves a three-tiered system that would allow sales of these chips to U.S. allies, while sales to many other countries would be strictly regulated. Countries in the final tier would be ineligible to buy these advanced processors at all. This will mark the third round of such restrictions, designed to keep third-party countries from acting as go-betweens and bypassing U.S. export restrictions.
The news wasn't all bad, as Broadcom earned a couple of price target increases. Analysts at Mizuho increased their price target to $260, while Goldman Sachs boosted its price target to $255. This would represent potential upside for investors of 13% and 11%, respectively, compared to Wednesday's closing price. Unfortunately, the bullish sentiment for Broadcom wasn't enough to overcome the market's otherwise dour mood.
Taking a step back
This marks something of a one-two punch for our AI stocks. Wall Street is eager to see interest rates come down, as this will likely spur borrowing and capital investment among businesses -- which will likely include investment in AI. Furthermore, any restrictions impacting the semiconductor industry will likely weigh on the overall adoption of AI, ultimately impacting these key players:
- Broadcom provides many of the semiconductors and supplemental technology used in data centers and cloud computing, where much of AI processing occurs.
- Arm Holdings creates and licenses many of the designs for high-end processors that are integrated into larger and more complex semiconductors and AI chips.
- Oracle is a provider of database and cloud infrastructure services, but it also designs and engineers AI chips.
On the subject of valuation, beauty is in the eye of the beholder. Arm, Broadcom, and Oracle are currently selling for 90 times, 35 times, and 27 times forward earnings, respectively, which suggests that Oracle is the best bargain.
However, the most widely used valuation metrics tend to fall short when measuring high-growth stocks. Applying the more appropriate forward price/earnings-to-growth (PEG) ratio, which takes into account their accelerating growth rates, Oracle, Arm, and Broadcom sport multiples of 0.38, 0.21, and 0.09, each below the threshold of 1, which is the standard for an undervalued stock.
Today's downturn aside, AI is expected to continue to grow rapidly. The technology is expected to contribute $15.7 trillion to the global economy by 2030, according to Big Four accounting firm PwC. This illustrates the magnitude of the opportunity in the coming years.
If our trio of AI companies can command even a small part of that windfall, today's declines will be a drop in the bucket -- despite the day-to-day volatility. That helps illustrate why investors should focus on the long term.
