Shares of artificial intelligence related chip stocks including Arista Networks (ANET 0.01%), Advanced Micro Devices (AMD 5.22%), and Arm Holdings (ARM 3.75%) fell in April, declining 11.5%, 12.2%, and 19%, respectively, according to data from S&P Global Market Intelligence.
After essentially six straight months of impressive gains, stocks in general and especially AI-related tech stocks were perhaps due for a breather. April provided that excuse, as inflation perked up a bit, some AI-related bellwethers reported imperfect earnings reports, and Arista Networks specifically caught a notable analyst downgrade.
NYSE: ANET
Key Data Points
Tech giants "disappoint" their high expectations, and inflation bites
The notable sell-off across the market and especially technology growth stocks snowballed when the March consumer inflation index (CPI) came out on April 11. The March figures showed inflation increasing year-over-year to 3.5%, up from 3.2% in the prior month. Although much of that was attributable to rising gas prices amid the tensions in the Middle East, "core" CPI, stripping out food and energy, came in at 3.8%. That was flat with the prior month, but above the 3.7% that analysts had expected.
Higher inflation is a concern for growth stocks that have the bulk of their earnings out in the future, as those earnings get discounted at a higher rate. Moreover, the higher figures might have spurred fears the Federal Reserve could raise interest again and arrest growth.
The rise in AI stocks leading up to April also provided a high bar to clear for first quarter earnings. But early reports from ASML Holdings and Taiwan Semiconductor Manufacturing had some flies in them. ASML, the only company that makes the lithography machines crucial to building AI chips, saw bookings disappoint. TSMC followed by actually lowering its forecast for semiconductor growth for the year, from a low-teens growth rate to around 10%. That certainly threw some cold water on the chip rally coming into the month.
Arista also had some company-specific headwinds, when an analyst double-downgraded its shares from Buy to a Sell. Rosenblatt Securities analyst Mike Genovese lowered his price target from $330 to $210, citing unexpected competitive concerns from Nvidia (NVDA +0.04%). Arista makes switches that caught on in cloud data centers, but its switches are based on ethernet fabric. Nvidia has its own networking fabric called Infiniband, which has been the go-to for AI-specific applications. However, companies are banding together to improve the ethernet standard for AI, as it is so widely used. That was thought to benefit Arista in the future.
However, Genovese cited recent efforts by Nvidia to launch its own ethernet-based networking equipment as a significant competitive threat, given it will potentially package its in-demand chips with that equipment and undercut Arista.
Meanwhile, AMD and Arm were likely taken down by their high valuations to start the month, with AMD's trailing P/E ratio at 269 and Arm's at over 1,600 to start April. Even on a forward-looking basis, their earnings multiples were still high, at 52 and 83 entering April, respectively.
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AI stock fears may be overblown, but competitive fears are not
May saw chip stocks bounce back thus far, as last week's weaker-than-expected job report may have taken some of the inflation fears away. Moreover, Magnificent Seven earnings were solid, especially on the AI front, and virtually all cloud giants are gearing up to greatly increase their capital spending on AI this year.
That may have caused investors to brush off ASML and TSMC's earnings. After all, TSMC noted its lower forecast for chip growth was mostly related to auto chip weakness, while AI remained strong. And ASML's bookings bounce around a lot, perhaps not being that great of an indicator. ASML's management has also noted the industry is catching up to the very strong capital spending of the last few years, and that growth should reignite by year's end into 2025.
So, the AI-related growth story appears to remain intact. However, competition from Nvidia may be a concern for not only Arista but also AMD. AMD recently took a leg down when it only raised its forecast for MI300 revenue from $3.5 billion to $4.0 billion this year, perhaps disappointing some who had hoped for a bigger increase.
While it was still a guide higher and MI300 is growing from basically zero to that impressive level in just one year, again, AMD's AI-boosted valuation coming into the month didn't leave much room for error.
Looking forward, each of these technology growth stocks will likely have strong AI tailwinds on their side, but competitive concerns, interest rate and inflation uncertainties, and relatively high valuations are all working against them. In April, the negatives came to the forefront and the positives were brushed aside.
