If the AI Bubble Bursts, These Stocks Will Be Winners

Jitters about the AI trade are spreading across the market again.

CoreWeave has plunged in recent weeks, reaching its lowest level since shortly after its IPO, after its bond yields jumped to as high as 15%. The Nasdaq Composite plunged 2.6% on Thursday, hitting its lowest level in more than a month. Meta Platforms tumbled 7% in spite of a strong earnings report as investors were spooked by its first quarter of negative free cash flow in its history, reflecting the surge in spending on AI infrastructure capital expenditures.

While there’s no sign of demand issues in AI, investors are clearly skeptical that companies like Meta and CoreWeave will see a return on investment, especially as interest rates have surged.

However, something surprising has happened with interest rates over the past couple of weeks. After investors bid them up on concerns about inflation, the war in Iran, AI spending, and new Fed chief Kevin Warsh’s promise to raise the benchmark Fed funds rate, treasury yields have started to come down.

The benchmark 10-year yield fell by 3.8% to 4.95%, its first time below 5% in a month, and it’s down by 7% over the last two weeks. That could reflect a rotation out of stocks into bonds to take advantage of high yields, and worries about a sell-off in AI stocks are likely to accelerate that shift.

Image source: Getty Images.

A sign of things to come

While tech stocks were plunging on Thursday, one sector was soaring, and it could be a sign of things to come.

Homebuilder stocks jumped Thursday, due to the decline in interest rates, tech investors looking for opportunities elsewhere, and attractive valuations in many of these stocks, even as the housing sector has struggled.

The State Street SPDR S&P Homebuilders ETF (XHB +3.77%) finished the day up 3.8% as stocks like Pool Corporation, RH (Restoration Hardware), and Lennar finished up 14.4%, 9.5%, and 9%, respectively.

Investors clearly see an opportunity in the housing sector if interest rates go down, and if we continue to see the AI trade, bond yields are likely to fall further.

A month ago, investors thought another Fed rate hike in October was more likely than not. After several data points over the last month, including weak jobs growth in September and cooler-than-expected PCE inflation in August, investors now see a 93% chance that the Fed holds rates steady at 375-400 basis points. Over the next year, rates are still expected to go up, but it’s much harder to predict what will happen several months from now, and the Fed’s own projections are often wrong.

Overall, concerns about interest rates continuing to go up have taken a significant step back over the last month.

Should you buy housing stocks now?

I’m not ready to call an AI bubble, though there’s clearly pressure on stocks like CoreWeave. Still, the evidence shows that demand for AI compute remains strong, and there are bottlenecks in the supply chain for memory and beyond, indicating that demand greatly exceeds supply.

However, the reaction in the housing sector shows that if you’re an investor with some AI winnings, shifting some of those gains to a homebuilder or a home furnishing stock might make sense. This isn’t the first time we’ve seen beaten-down stocks soar on a similar rotation, as apparel stocks like Nike, Lululemon, and Deckers Outdoor jumped in a single session earlier this month. That’s another sign that investors are looking for the next set of winners after AI, and it makes sense to look for stocks that have struggled.

Interest rates will tell the tale for the housing sector. If inflation cools, economic gains remain modest, and worries about AI growth continue to mount, rates are likely to come down, and that will favor the housing sector, as we saw on Thursday.