Investor sentiment toward companies tied to the AI trade has weakened considerably in recent weeks, prolonging the sector's selloff and dimming its near-term prospects.
Beyond concerns over stretched valuations and AI-related circular financing deals, surging oil prices and the risk of an AI-driven market correction are adding to the challenges faced by the tech sector. The tech-heavy Nasdaq Composite fell about 1.74% on Wednesday, bringing its losses to about 2.65% over the past five trading sessions and 4.15% over the past month, underscoring the increasingly bearish sentiment surrounding the tech sector.
Additionally, investor sentiment toward semiconductor stocks has deteriorated sharply, leaving the sector among the weakest performers in the market. The Philadelphia Semiconductor Index (SOX) fell 5.3% on Wednesday, taking its losses to roughly 13.9% over the past five trading sessions and 21.1% over the past month.
Oil Prices Add to Tech's Woes
As per an article by OilPrice.com, as AI investments accelerate, Big Tech is emerging as a key driver of global energy demand, making the industry increasingly dependent on energy commodities. Against this backdrop, with Big Tech expected to spend more than $725 billion on AI initiatives this year and ongoing tensions in the Middle East pushing oil prices higher, rising energy costs could become a meaningful headwind for the sector.
According to the article, the AI industry's ambitious data center expansion is already straining global energy supplies. Any disruption to energy commodity markets could further constrain supply, raise energy costs and force hyperscalers to further increase their capex on AI infrastructure.
Beyond the challenges of securing sufficient power generation capacity for new data centers, rising oil prices can drive up costs across the supply chain. From semiconductors and industrial equipment to construction, higher energy prices could materially increase the cost of building and operating AI infrastructure.
Investors are already scrutinizing the sharp increase in AI-related capital spending. If AI expansion becomes even more expensive due to higher energy costs, it could further dampen sentiment and intensify pressure on technology stocks.
Higher oil prices could become a significant headwind for hyperscalers and investors banking on continued AI-driven expansion. Oil prices climbed after U.S. strikes against Iran late Wednesday, reigniting fears of a broader conflict in the Middle East, as per a CNBC article. The escalation, coupled with threats of retaliation from Iran’s Islamic Revolutionary Guard Corps, has raised concerns over potential disruptions to global energy supplies.
AI Trade Faces Correction Risks
The Fed's latest policy meeting has pushed the Nasdaq Composite close to correction territory, with technical indicators signaling additional downside risk, as per a Reuters article. Per the article, the index is now hovering near the threshold for a correction.
Adding to concerns over a potential market correction, Fitch highlighted the AI boom and the risk of a sharp pullback as emerging global credit concerns. Per another Reuters article, the warning underscores growing worries that lofty tech valuations and massive AI spending commitments may not be justified by future growth prospects.
As quoted on the abovementioned Reuters article, Fitch's third-quarter Global Risk Outlook identified growing vulnerability to a potential AI-driven market correction as a key short-term risk for the global credit landscape.
ETFs to Play
Inverse and inverse-leveraged ETFs either create an inverse short position or a leveraged inverse short position in the underlying index through the use of swaps, options, futures contracts and other financial instruments. Due to their compounding effect, investors can enjoy higher returns in a very short time, provided the trend prevails.
However, these funds run risks of huge losses compared with traditional funds. Investors should note that these products are best suited for short-term trading, as they are rebalanced daily. Additionally, limited liquidity can increase trading costs beyond what they initially appear.
Inverse Technology ETFs
The recent pullback reflects growing investor caution, raising doubts about whether the AI-driven rally can sustain the momentum in the near term. In this backdrop, investors seeking to capitalize on further weakness may consider increasing exposure to inverse technology ETFs.
Investors can consider ProShares UltraPro Short QQQ SQQQ, ProShares Short QQQ PSQ and ProShares UltraShort QQQ QID.
There is no difference in fees among the funds, each charging an annual fee of 0.95%. SQQQ is the most liquid, with a one-month average trading volume of about 54.56 million shares.
Leveraged-Inverse ETFs to Play
Investors with a higher risk tolerance may consider leveraged inverse ETFs to magnify bearish bets. Direxion Daily Technology Bear 3X ETF TECS and MicroSectors FANG & Innovation -3X Inverse Leveraged ETN BERZ can be considered.
Regarding annual fees, BERZ is the cheapest option, charging 0.95%. TECS is the most liquid, with a one-month average trading volume of about 691,000 shares.
Investors looking for a more concentrated leveraged inverse bet on semiconductor companies can consider Direxion Daily Semiconductor Bear 3X ETF SOXS. SOXS charges an annual fee of 1.0%.
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This article originally published on Zacks Investment Research (zacks.com).