The Nasdaq Plunges 5%. What the Data Center Crash Means for Investors

Is the AI bubble bursting?

That question was on the minds of millions of investors on Thursday, as the Nasdaq Composite (NASDAQINDEX:^IXIC) had one of its worst days ever, plunging 5.5% as fears spread that a political backlash could choke the AI boom, following the midterm election.

Investors believe that election winners in Texas and elsewhere will slap significant restrictions or even outright bans on data centers, which became a lightning rod during the campaign. After chip stocks were among the few losers on Wednesday, they collapsed on Thursday, with the VanEck Semiconductor ETF losing 11.2%. Even industry leader Nvidia lost 9.1%, and the crash triggered a broader sell-off across the stock market, with all 11 sectors falling, even defensive ones like utilities and consumer staples.

Image source: Getty Images.

What's happening in the data center sector

AI infrastructure stocks began to wobble a few weeks ago, starting with a chart showing that neocloud operator CoreWeave's (NASDAQ:CRWV) bond yields had risen as high as 15%, and worries about a potential default sent the stock tumbling.

Earnings reports from the big hyperscalers were greeted similarly, as investors worried about soaring capital expenditures and negative free cash flow, even as these companies continue to grow rapidly and are hugely profitable.

Then, the election happened, and now fears of a slowdown in the data center build-out have led investors to flee AI stocks.

Stock market reactions to elections are famously rash and often fleeting. Stocks tumbled following the Brexit decision before bouncing back over the following days, and stocks plunged overnight when President Trump was first elected before turning green the following day.

This looks like a similar reaction. Tech stocks initially fell on Tuesday night before the Nasdaq jumped on Wednesday. The response is understandable as data centers have been a major talking point during the campaign, but the sell-off seems like an overreaction.

Gina Hinojosa, the governor-elect of Texas, campaigned on a temporary moratorium on data centers and reasonable guidelines, like a ban on subsidies for data centers. However, she is no radical, telling CNN, "We will have laws to protect Texans, and we need to stop what we are doing with data centers until we have those protections."

In a worst-case scenario with a significant slowdown in data center construction in the U.S., most industry observers believe that activity would just move abroad, meaning that industry growth wouldn't be significantly impacted.

In an interview with the Motley Fool, Arm Holdings (NASDAQ:ARM) CFO Jason Child explained his thinking on the matter, saying, "Let's just say it (the data centers) all slows down. Do we believe AI demand will slow down? I think, generally, most people say no. The genie is out of the bottle." Child also said he was generally skeptical of any political reaction and said the bipartisan interest in economic growth was too strong for there to be a significant slowdown in the build-out. He also noted that Arm could still benefit from a slowdown in data center construction, as Arm's chips excel at performance per watt, which would be in greater demand if data center construction were artificially limited.

What it means for investors

Predicting where the data center debate goes from here isn't easy, but Child is right that demand for AI is strong and is unlikely to be shaken by any slowdown in capacity growth.

Meanwhile, many of the top AI stocks are looking cheaper than ever. Nvidia (NASDAQ:NVDA) now trades at a forward P/E of less than 20, and it's nearly doubling its revenue each quarter. Micron (NASDAQ:MU), the memory chip leader, is trading at a forward P/E of less than 4.

Many of these AI stocks have already soared this year, so the pullback needs to be seen in that context, but like "Liberation Day" and other political issues that have rocked markets, this response seems likely to be an overreaction and a non-issue within the next year. Buying the dip on quality stocks like Nvidia looks like a smart move.

Jeremy Bowman has positions in Arm Holdings, CoreWeave, Micron Technology, and Nvidia. The Motley Fool has positions in and recommends Arm Holdings, Micron Technology, and Nvidia. The Motley Fool has a disclosure policy.