The tech trade took a breather today after yesterday's rally, which was triggered by the Democratic midterm sweep. Hyperscalers moved higher while Neocloud and chip stocks came under pressure. To help us make sense of the diverging moves, we are joined now by Dan Niles, founder and portfolio manager at Niles Investment Management. Good morning. Great to have you join us.
So, as I just mentioned, we saw markets rally sharply yesterday after the Democratic sweep on Tuesday night. But was that just a knee-jerk reaction, do you think, or are we setting up for a broader year-end rally after last week's sell-off?
Well, I think there are a couple of things to keep in mind. The first is that if you look at the month of November, it's got the best combination in terms of probability of being up, which is about 71%, and the average return you get in the month of November, which is about 1.8%. In midterm years, it's actually even better than that, partly because going into the midterms, the stock market generally underperforms. And so once you get that uncertainty out of the way, the market seems to rally regardless of what happens during the midterms.
But the other big thing that happened was because you had a Democratic sweep for the most part, or blue wave, whatever you want to call it, and you had states like Texas, Georgia, Ohio, and Pennsylvania go blue, they won those governors based on the fact that they were against AI. And so you're dealing with this situation that causes problems for the hyperscalers, the semiconductor companies — I mean, I shouldn't say hyperscalers, I should say neoclouds — the semiconductor companies, the construction infrastructure companies, etc., that service that. And that's why you saw semiconductors get crushed yesterday. You saw neoclouds get crushed, you know, construction companies, engineering, project and construction companies like Sterling, all of them went down. You're seeing them go down again today because of that.
And so I think you have to be really selective. For us, we like a broad diversified basket of, you know, S&P type names to play the November seasonality, but we're trying to be very careful about avoiding the AI names that are going to get hurt as all this data center construction gets, you know, scrutinized a lot more because of the political changes that happened yesterday.
Yeah, that was part of the reason for the wins, but it was also the high cost of living for a lot of Americans that pushed some Democrats to a win. But on the AI front, like, do you think the AI trade would benefit at this point from companies generating stronger cash flows and pulling back on some of their massive capex commitments?
Well, that's a great point, Lindsay. So you saw the semiconductors get hit, but you saw the companies that already have big footprints in the cloud do quite well. So that'd be the names like the Microsofts, the Googles, the Amazons. They already have big footprints. They already have projects that are ongoing. They'll benefit if the neoclouds all go bust, right? Because they've already got the capacity and they'll have less competition. Also, if you have, you know, less AI spending in total and semiconductor prices fall, that'll cut what they need to spend. They can potentially cut back on their capex because there's not as much competition.
People have really hated a lot of these big hyperscalers because of the cash flow burns that they've had, right? These were the most cash generative companies in the world, and all of a sudden they've gone cash negative. This will help, you know, relieve some of that burden, and that's why you saw a lot of those names go up while the neoclouds, the CoreWeaves of the world, got clobbered yesterday. And so I think you're going to see that kind of continue, and you're going to have to watch closely this Anthropic IPO and what happens there.
You know, I think you're going to see a deal that's downsized come in way below the valuation people thought, because you've got all of these companies all raising money in front of that IPO, and these are all the same investors that, you know, Anthropic wants to get to. And so I think it's going to be — you're going to have to watch that very closely, because you've got slowing growth going on at Anthropic, number one. And number two, you've got more competition from the open-weight models. And so you combine all that with the pool of money getting smaller, it's going to make it a very difficult time, I think, going through the end of this year.
I did want to ask you about Anthropic. What do you think the company needs to do to get back to the kind of revenue growth it was seeing before open-weight models started, like, eating into its market share?
