Why Arm Holdings, Broadcom, and Other Artificial Intelligence (AI) Stocks Soared Thursday Morning

There is no doubt that one of the biggest contributors to the market rally that began early last year is the growing adoption of artificial intelligence (AI). Countering this upbeat sentiment, however, are lingering concerns about the ongoing battle with inflation and its impact on the economy.

The Federal Reserve Bank was determined not to start lowering interest rates until there was a significant improvement in the rate of inflation. As a result, interest rates remain at 22-year highs, but the latest reading on inflation was better than expected, fueling hopes for a rate cut and sparking a broad market rally.

With that as a background, chip designer Arm holds (ARM 3.49%) rose 3.2%, the semiconductor giant Broadcom (AVGO 5.34%) rose 4.9% and the maker of memory and storage chips Micron technology (MU 7.37%) was up 6.5% as of 1:06 p.m. ET Thursday.

A check of all the usual sources — regulatory filings, earnings results, and changes in analyst ratings and price targets — turned up very little in the way of company-specific news that helped drive these AI stocks higher (more on that in a moment ). It appears that today’s market rally was driven primarily by the improving state of the economy and what it portends for the future.

Image source: Getty Images.

Persistent and stubborn inflation

Yesterday’s monthly inflation report, courtesy of the US Bureau of Labor Statistics, offered some good news on the inflation front. Prices continued to fall, providing much-needed relief to price-weary consumers. The consumer price index (CPI), the most watched measure of inflation, rose 2.9% in July compared to the same period a year earlier. Prices rose just 0.2% month-on-month. This is the lowest rate since early 2021.

The monthly rate came in as predicted, but the annual offset was better than expected, as economists had predicted inflation would rise 3% year-on-year and 0.2% sequentially. The “core” data, which excludes volatile food and energy prices, rose 3.2 percent from this time last year and rose 0.2 percent sequentially, both in line with expectations.

The Fed continues to push for its 2% inflation target. However, a growing chorus of economists are predicting that the Fed will cut interest rates by 0.25% in September, while some are even suggesting that rates could be cut by 0.5%.

While progress is being made, hot spots remain. Housing prices — made up mainly of rental rates — were the biggest contributor to the increases as consumers continue to bear the brunt of high housing costs.

Interest rates have been rising since March 2022, and investors and businesses alike are eager to see the first of many rate cuts, as this would spur additional spending by businesses and consumers, ultimately boosting the economy. With inflation marking the slowest rise in more than three years, Wall Street is increasingly counting on rate cuts to start sooner rather than later.

The only other catalyst

Yesterday marked the deadline for hedge funds to file their quarterly portfolio disclosures with the Securities and Exchange Commission (SEC). Disclosures that prominent investors have made changes to their holdings are known to alter share prices.

To close out the second quarter, Paul Singer’s Elliott Investment Management disclosed in a regulatory filing that it took a stake in Arm Holdings, albeit a small one. The billionaire investor bought about 150,000 shares of Arm stock in a deal valued at $24.5 million. For context, that’s only 0.24% of Elliott’s total portfolio, so it probably didn’t move the needle much.

Artificial intelligence has generated a lot of headlines since the start of last year, largely due to heavy spending by large-scale cloud providers and big tech companies that have been eager to cash in on the technology. However, other companies have been reluctant to spend on new and so far largely unproven technologies, particularly in the face of higher borrowing costs. That said, many more may take the plunge as interest rates fall and generative AI proves its worth.

To be clear, excitement over the potential of this innovative technology has driven valuations in the space higher. Micron Technology, Arm Holdings, and Broadcom are selling at a whopping 332, 71 times, and 52 times earnings, respectively. That said, the price-to-earnings (P/E) ratio is virtually useless for evaluating high-growth stocks. The more appropriate price-to-earnings-growth (PEG) ratio, which considers a high growth trajectory, reveals multiples of 0.1, 0.2, and 0.8, respectively, where any value less than 1 indicates a undervalued stock.

This suggests that for investors with an appropriate investment timeline and stomach for volatility, these AI stocks may be worth a look.