What triggered the stock market to sell off $2.5 trillion worth of stocks?
Investors on Thursday sold off tech stocks, stripping the Nasdaq of a gorgeous $2.5 trillion in worth as the center of the tech sector declined rapidly due to the midterm losses of the Democrats. And another was the pressure that was placed on them to sell because they had been borrowing money to invest in the boom.
Hedge funds and other investors that are borrowing to make larger plays might be forced to sell more stocks to settle other obligations for cash and to offset losses, further fueling a stock sell-off.
The market’s sharp turnaround was remarkable: Futures dropped as election results were released late Tuesday night, but Wednesday morning they were up as investors welcomed the Democrats’ victory. As of Thursday, however, that optimism had been replaced by the concern that Democrats might be able to use the newfound political power to reign down tighter regulation and slow down the AI construction.
Let’s take Texas as an example. Democratic Gov.-elect Gina Hinojosa had pledged to halt new data center construction and to revoke some tax breaks for data center builders in the state. Those pledges are now adding to investor concerns about the future of the AI boom.
People will have to come to realize that this isn’t the end in a day or two, Harris Financial Group’s managing partner Jamie Cox said. Businesses will invest more on expanding the capacity of their existing data centres, he foresees.
Then came in the hedge funds, some of which borrowed to make larger bets on stocks, causing further losses, Cox said.
The use of borrowing means that the money can be used for larger investments than the actual amount of funds that is available, and that any gains or losses that occur will be amplified by the borrowing. When an investor’s stock value declines, funds that borrowed to purchase stocks may be required by their lender or broker to provide additional cash or collateral. In that case they may need to sell stock to make up the necessary cash.
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That selling can drive prices even lower, creating a vicious circle: Lower prices generate more cash requests, which drive prices lower, which in turn generate more cash requests, and so on.
The moves, Cox said “are not indicative of a crash or any type of impending disaster” Thursday. Instead, “companies that have run way too hot and have borrowed money to buy more assets. (Leverage is defined as borrowing money to purchase more assets.)
The hedge fund-driven selling may yet be playing out over a few days yet, further adding to the stock pressure, despite the initial shock from the politics subsiding.
It highlights a greater exposure in the AI business: The more investors are borrowing to invest in the rise, the harder it will be for them to deal with the collapse when it happens.