Market Volatility and the AI Outlook

Adam Phillips, Managing Director, Investments

Last week brought significant market volatility as investors weighed the results of the midterm elections, shifting expectations for artificial intelligence (AI) investment, and the broader economic outlook. While the sharp market swings reflected renewed uncertainty, recent economic data suggest the underlying economy remains resilient.

Election Results and Market Volatility
The midterm elections delivered larger-than-expected Democratic victories, initially prompting a market selloff Tuesday evening. By Wednesday morning, however, stocks rallied sharply as investors appeared reassured by the decisive results and reduced likelihood of contested outcomes.

Encouraging developments in the Middle East also contributed to optimism, raising hopes for progress toward resolving the ongoing conflict.

That optimism was short-lived. On Thursday, the S&P 500 declined more than 4%, while the Nasdaq fell more than 6%, marking their largest single-day declines since the April 2025 tariff announcement.

Beneath those broad market declines, however, a more nuanced story emerged, particularly among technology and AI-related companies.

A Shift in AI Investment Expectations
Despite the broader technology selloff, performance varied considerably across companies. Amazon gained nearly 8% for the week, while Alphabet and Microsoft finished modestly higher. Semiconductor manufacturers and data center operators, meanwhile, experienced substantial losses.

The divergence reflects an important distinction between companies financing AI infrastructure and those benefiting directly from that spending.

Major technology companies have committed enormous amounts of capital to expanding AI capabilities, placing pressure on their free cash flow. A slowdown in spending could improve their financial flexibility, potentially benefiting shareholders.

For semiconductor manufacturers and other infrastructure providers, however, that same slowdown could weaken an important source of revenue growth.

These concerns intensified following the elections as investors considered whether newly elected state and local officials might pursue policies that slow AI infrastructure development.

Rather than questioning AI's long-term potential, investors appear to be reassessing which companies stand to benefit—or face challenges—if investment growth moderates.

Could Slower AI Spending Benefit the Economy?
Although markets have reacted sharply to the possibility of reduced AI investment, several considerations suggest a more measured pace of spending could ultimately be constructive.

First, potential policy changes remain speculative. Newly elected officials will not take office until the new year, and meaningful changes would likely take additional time to implement. Investors should distinguish between concerns about future developments and changes that have already occurred.

Second, a slowdown in AI capital expenditures would not necessarily mean an end to investment. The unprecedented speed and scale of the AI buildout have raised questions about whether companies could develop more infrastructure than the economy ultimately requires.

The rapid expansion has also created pressures beyond the technology sector.

Financing AI infrastructure requires substantial capital, contributing to increased corporate debt issuance. As that debt competes with U.S. Treasuries for investor capital, borrowing costs could face additional upward pressure.

Housing affordability presents another challenge. Data center construction competes with residential development for many of the same workers and building materials, potentially increasing construction costs and making it more difficult to expand the nation's housing supply.

A more sustainable pace of AI investment could help alleviate some of these pressures while supporting longer-term economic growth.

Economic Fundamentals Remain Resilient
As investors evaluate the future of AI spending, other sources of economic growth become increasingly important, particularly consumer spending.

Recent economic reports offer encouraging signs.

Third-quarter GDP data showed personal consumption growing at a 3.8% annualized rate, indicating continued strength among American consumers.

October's employment report also exceeded expectations, with the economy adding 165,000 jobs, the strongest monthly increase since March. Meanwhile, the unemployment rate edged down to 4.1%.

Together, these figures suggest the economy continues to demonstrate resilience despite political uncertainty and shifting investment expectations.

The Importance of Diversification
Last week's volatility underscores the risks associated with having a substantial portion of market performance concentrated in a relatively small group of technology companies.

At EP Wealth, we have maintained an underweight position in technology and AI-related investments, reflecting both recognition of AI's long-term potential and an awareness of the risks associated with elevated market concentration.

While a moderation in AI spending could create near-term challenges for certain companies, it could also help support a more balanced and sustainable economic expansion.

Ultimately, changing market sentiment reinforces the importance of maintaining a diversified portfolio, remaining disciplined through periods of volatility, and staying focused on long-term financial goals.

Often quoted in major national media, Adam is a Chartered Financial Analyst (CFA^®), a CERTIFIED FINANCIAL PLANNER™ (CFP^®), and has been included on the Forbes NextGen Best-in-State Wealth Advisors 2019 list. He is a member of the CFA Society of Los Angeles and the CFA Institute. Adam helps establish asset allocation strategy as a member of the EP Wealth Investment Committee, which supports all EP Wealth Advisors and their clients. The Committee’s top-down approach to portfolio construction begins with an outlook on the economy’s likely direction, followed by the implications for different economic sectors and asset classes. This culminates in strategic selection of the individual stocks, bonds, mutual funds or other investments deemed most appropriate for each individual client’s portfolio. 

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Video Transcript: 

Adam Phillips:

Well, last week certainly gave investors plenty to think about.

Between the midterm elections, some dramatic swings in the stock market, and renewed questions about the outlook for artificial intelligence, there was no shortage of headlines.

So let's start with the elections.

For all the criticism election polling has received over the years, the polls actually got it right this time—at least directionally. What they underestimated was the magnitude of the Democratic Party's victories.

Markets initially sold off Tuesday evening as the results came into focus, but rallied sharply when trading opened Wednesday. Why the change in sentiment?

One explanation was that the outcome was so decisive there was little room for contested results. Regardless of how anyone feels about the outcome, markets don't like uncertainty, and investors were happy to move on.

Adding to that optimism were encouraging developments in the Middle East, raising hopes for some form of resolution to the ongoing conflict.

Unfortunately, Wednesday's optimism proved short-lived. On Thursday, the S&P 500 fell more than 4%, while the Nasdaq declined more than 6%—the largest single-day declines since the Liberation Day tariff announcement in April 2025.

But what's interesting is that not all technology and AI-related stocks were affected equally. I came across an interesting chart from BlackRock over the weekend that illustrates this.

Amazon gained nearly 8% last week, while Alphabet and Microsoft closed modestly higher. Meanwhile, semiconductor stocks and data center operators posted sharp losses.

So why the big difference? Well, think about who's spending the money and who's receiving it.

The largest technology companies have been pouring enormous amounts of cash into AI infrastructure, and in the process, putting considerable pressure on their free cash flow. Investors may actually welcome a slowdown in that spending because it could improve their cash flow and financial flexibility.

But for companies like Micron and Marvel, that spending represents a major source of revenue growth. So any slowdown could have the opposite effect on their businesses.

Those concerns intensified following the election, as investors considered whether newly elected leaders, particularly at the state and local levels, might introduce policies that slow the AI buildout.

So investors weren't necessarily questioning the long-term potential of AI. Rather, they were reassessing who stands to benefit—and who might be hurt—if the pace of AI investment slows.

So where does that leave us? Well, I think there are three things worth keeping in mind.

First, for now, nothing has actually changed. Newly elected officials won't take office until the new year, and even then, meaningful policy changes would likely take time. So while markets could remain choppy, we shouldn't confuse concerns about what might happen with changes that have actually occurred.

Second, we're talking about a potential slowdown in AI-related capital spending—not a complete stop. And frankly, a more measured pace of investment might not be such a bad thing.

It's the unprecedented speed and scale of the AI buildout that has raised concerns about a potential bubble and the risk of creating more capacity than the economy ultimately needs.

That spending has also created challenges elsewhere in the economy. The enormous financing needs of AI infrastructure have resulted in increased corporate debt issuance, which may put upward pressure on borrowing costs as that debt competes with Treasuries for investor capital.

And then there's housing. The massive AI data-center buildout is competing with homebuilders for many of the same construction workers and building materials. That's driving up costs and making it harder to build the additional homes the country needs, making an already difficult affordability problem even worse.

So while slower AI spending could create some near-term headwinds, it might also alleviate some of these pressures and contribute to more sustainable economic growth.

And third, all of this reinforces the importance of diversification. At EP Wealth, we've deliberately maintained an underweight position in technology and AI-related investments for some time now—not because we don't recognize AI's tremendous potential, but because we also recognize the risks of having so much of the market's performance dependent on a relatively narrow group of companies.

And if AI spending does moderate, other drivers of economic growth become that much more important. Perhaps none more so than the American consumer.

Fortunately, the latest data suggest consumers are holding up reasonably well. Third-quarter GDP showed personal consumption growing at a strong 3.8% annualized pace.

And last Friday's employment report provided another encouraging sign, with the economy adding 165,000 jobs in October—the strongest monthly gain since March—while unemployment edged down to a still-healthy 4.1%.

Taken together, these numbers suggest that despite all the uncertainty surrounding politics and AI spending, the underlying economy remains reasonably resilient.

So what's the bottom line? Last week's volatility reminds us how quickly investor sentiment can change, even when the underlying economy remains reasonably healthy. And while AI spending may moderate, that could actually support a more sustainable expansion over time.

As always, we believe the best response to uncertainty is maintaining a diversified portfolio, staying disciplined, and keeping your focus on your long-term financial goals.

Thanks for watching, and we'll see you next week.