Last week reminded us that periods of strong market returns can include uncomfortable days. On Thursday, the S&P 500 fell more than 4%, while technology and semiconductor stocks experienced significantly larger declines. Concerns following the election, particularly around future data-center development, contributed to the selloff. Profit-taking and a large reduction in leverage by hedge funds also amplified the move.
We believe it is important to put this volatility in perspective.
The Election and Policy Outlook
The election has changed the policy environment. With Democrats controlling Congress and Republicans maintaining the White House, significant federal legislation will be difficult to pass. As a result, some of the more meaningful policy changes over the next two years may occur at the state and local level. This could include greater scrutiny of technology and privacy, as well as policies affecting utilities, power generation, and data-center development.
There are also implications for consumers and the broader economy. Democrats may have greater leverage to delay or reduce proposed cuts to Medicaid and SNAP during future budget negotiations. This would provide support to healthcare providers serving Medicaid populations and could have a modest positive impact on consumer spending, particularly among lower-income households.
Treasury rates have also fallen from highs reached last quarter. If there is less AI build-out and spending, fewer AI-related bonds will come to market, which could help drive rates lower by removing the new issuance that is contributing to higher rates. If lower rates persist, they would provide some relief to housing, businesses, and other borrowers, although the future direction of rates remains uncertain.
Energy prices are another potentially positive development. Oil prices have fallen sharply from recent highs. President Trump on Monday commented that “Iran, militarily, is effectively over,” which is hopefully an indication that the conflict is winding down. Geopolitical outcomes remain highly uncertain. However, if the trend of falling oil prices persists, it would reduce costs for consumers and businesses and help ease an important source of recent inflation pressure.
AI and Data Centers
Data centers received considerable attention following the election as investors considered whether state and local restrictions could slow future development. We expect regulation to influence where and how quickly some new projects are built. However, projects that have already been approved or started are unlikely to be halted, and current construction is already absorbing the entirety of the available supply of chips, memory, power equipment, and other critical inputs. Significant capacity constraints were already limiting the pace of the build-out.
This gives governments and developers time to establish rules for the next phase of construction. Some communities may make future development more difficult, while others will inevitably welcome investment, jobs, and tax revenue. The result may be a shift in where projects are built rather than an end to the broader investment cycle. Ultimately, a slowdown in AI infrastructure investment may be healthy, allowing adoption and usage to catch up with the rapid pace of the buildout.
The importance of this investment to the economy also makes an abrupt stop unlikely. Roughly half of the economy’s 3.4% third-quarter growth can be attributed to AI-related investment, depending on how that investment is defined. This economic importance should help support continued investment, even if the pace of spending moderates from today’s elevated levels.
There are questions about whether AI-related valuations and spending have moved too far, too quickly. However, real revenue and profit growth underpin many of these companies. Major cloud businesses are growing at exceptionally strong rates, with Amazon Web Services revenue increasing 39% in the most recent quarter and Microsoft Azure growing 48%. Investors are paying higher valuations in some areas of the market, but they are also getting substantially higher growth. Risks remain, including whether current levels of investment will ultimately generate adequate returns and the increasing use of off-balance-sheet financing structures to support AI infrastructure. These are important issues to watch, but they need to be weighed against the underlying growth in demand, revenues, and earnings.
Non-AI Economic Strength
The U.S. economy outside of data-center development also remains healthy. Consumer spending increased 3.8% in the third quarter. Consumer loan defaults and household balance sheets also look healthy overall. The labor market has also remained resilient, with October payrolls increasing by 165,000 and unemployment declining to 4.1%.
Corporate earnings have been particularly strong. With most S&P 500 companies having reported third-quarter results, earnings are running more than 30% above last year. FactSet currently expects S&P 500 earnings to grow 33.3% for full-year 2026, followed by another 16.1% in 2027. AI-related companies are a driving force behind the fantastic earnings growth this year, but it is not the entire story. JP Morgan estimates that if AI technology and energy companies are excluded, the remaining companies in the index grew earnings 13% year over year in the third quarter, a strong growth figure.
Last week’s volatility should also be viewed in the context of an otherwise strong year. The S&P 500 had generated an 11.8% total return through October 30, the final Friday before the election. Even after Thursday’s sharp selloff, its total return through November 9 remains approximately 11.3%. Semiconductor stocks experienced a much larger correction, but they have also generated significant returns this year.
Looking Ahead
As we look toward 2027, we expect the market’s focus to gradually shift away from the election and back to the factors that ultimately drive longer-term returns: economic growth, corporate profits, inflation, and interest rates.
The outlook is not without risks. Markets will continue to debate the return on AI spending and how this investment is being financed. Inflation remains above the Federal Reserve’s target, geopolitical uncertainty remains elevated, and policy changes could affect certain industries.
At the same time, the underlying economic picture remains constructive. Growth is solid, employment remains resilient, oil prices have moved lower, and corporate earnings are expected to continue growing in 2027. Lower energy prices, if sustained, could also provide additional support to consumers and businesses.
Markets have already absorbed tariffs, higher energy prices, the conflict with Iran, and significant changes in interest-rate expectations this year. Periods of volatility are likely to continue, but we believe continued economic growth and rising corporate profits provide a solid foundation as we look toward 2027.
