‘Right Tail Risk’ Trade Put to Test by Megacap Earnings Deluge

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(Bloomberg) — With the US-Iran standoff keeping energy prices at levels that threaten the economy, investors have plenty of risks to worry about when analyzing possible outcomes that could damage portfolios.

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Yet focusing too much on what can go wrong exposes investors to another big risk: Missing out on further gains if the stock market keeps ripping higher and higher. That type of outcome is often referred to as a right-tail risk, due to where it lands on a bell curve.

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For Ohsung Kwon, chief equity strategist at Wells Fargo & Co., there’s a simple way to manage that risk: Buy the Nasdaq 100 Index.

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It’s a trade that’s worked wonders this year as renewed exuberance for artificial intelligence has pushed the index dominated by mega-cap tech stocks up more than 8% since early January. But it’s being put to the test again, following a hectic deluge of earnings reports that landed with a thud in less than two minutes after the close of regular trading on Wednesday.

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As the dust settles, questions are once again arising about the market’s near-term sentiment for the mega-cap names. As Kwon put it in a note on Monday, the AI cycle has reached an “inflection point” as it matures from a focus on capital expenditures to questions on how well all that spending will be monetized.

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“Over the past two years, the AI cycle was really being driven by a capex-led bull market,” said Kwon. “I think now we are starting to move into a monetization-led bull market, which I think is actually healthier for the AI cycle overall.”

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By most measures, the results from Alphabet Inc., Amazon.com Inc., Meta Platforms Inc. and Microsoft Corp. were strong, but the share moves were mixed, owing to how much progress has been made on AI efforts. Bloomberg’s gauge for the Magnificent Seven fell 1.4% at 12:32 p.m. in New York in its third day of losses. 

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Yet skepticism around the level of spending on AI has become a bugbear for traders, who have become fatigued over the technology and worried that it will not deliver the promised seismic changes to the economy. Post-earnings share moves highlight how AI has become kingmaker: those gaining have shown tangible progress on AI, while those falling have struggled.

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“There is no question that demand for AI is strong, but we know that and the stocks have reflected that for the last month,” said Matt Maley, chief strategist at Miller Tabak & Co. “So the question is, demand is really strong, but is all this spending actually going to turn into profit?”

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Google parent Alphabet surged 7.9% on Thursday, having reported high demand for its cloud and AI offerings. Amazon, meanwhile, dipped 1.4% despite reporting growth in its cloud unit.

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Losses in Meta and Microsoft were more pronounced. Microsoft stumbled 5.5% on Thursday after failing to convince investors that huge bets in AI are poised to pay off. And Meta plunged 9.1% as traders worried the historic levels of investment being made to catch up in the AI race will not pay off.