Artificial intelligence (AI) stocks were soaring today in response to the Federal Reserve's decision yesterday to cut the benchmark interest rates by 50 basis points.
The federal funds rate is now 4.75%-5%, and the central bank signaled that it would cut rates twice more, by 25 basis points each time, before the end of the year.
While stocks were volatile after the announcement yesterday, investors gave the news a full-throated cheer this morning, with major stock market indexes up sharply. The S&P 500 was up 1.5% and the Nasdaq up 2.3% as of 10:09 a.m. ET. Growth stocks and those dependent on capital investment like AI stocks did especially well.
Among the winners were Broadcom (NASDAQ: AVGO), which was up 4%; Taiwan Semiconductor (NYSE: TSM), which had gained 4.3%; and Arm Holdings (NASDAQ: ARM); which was also up 4.3% at the same time.
The VanEck Semiconductor ETF (NASDAQ: SMH) was up 4.2% as well, showing that the gains were broad-based in the chip sector.
Image source: Getty Images.
Why AI stocks were soaring today
Semiconductors and AI stocks are a sensitive, cyclical sector in any kind of market environment, but that's especially true in the current one, as there's a lot of uncertainty around the strength of the economy, the durability of AI investment, and valuations in the sector.
However, falling interest rates help assuage concerns on all of those fronts, especially since the central bank surprised some investors by cutting rates by 50 basis points instead of 25 bps, showing they want to stay ahead of the curve this time.
Broadcom is a diversified tech company with exposure to cybersecurity, virtualization software, custom semiconductors, Ethernet switches and networking chips, and AI. The company expects to generate $12 billion in AI revenue this year.
Broadcom is known as a prolific acquirer of businesses, buying VMware late last year, and lower rates will make it easier for the company to finance future acquisitions. Lower rates could also reduce Broadcom's interest rate or help it refinance its debt, as the company now has $66.8 billion.
Additionally, Broadcom's customers will benefit from lower borrowing costs, making them more willing to invest in chips and other tech infrastructure.
Taiwan Semiconductor may be the biggest linchpin in the tech industry. It's the world's biggest contract manufacturer of semiconductors, handling production for companies like Apple, Nvidia, Broadcom, and AMD. It's a cyclical business, and lowered interest rates are likely to support spending and demand for its major companies, especially Apple, which makes up about 25% of its revenue, as the iPhone maker is sensitive to consumer spending and demand.
TSMC is also in the process of building massive foundries around the world, and it will need billions of dollars to do so. Lower borrowing costs, at least in the U.S., will make it easier for it to do that.
Finally, Arm Holdings is in a similar position to TSMC as a key supplier for partners like Apple and Nvidia. Arm isn't a manufacturer, however. It licenses its chip designs like CPU architecture to companies like Apple. In fact, the iPhone is estimated to account for roughly half of its royalty revenue currently, so a boost for spending on iPhones is a win for Arm. Notably, Apple stock was up around 4% this morning.
Similarly, the company also has increasing exposure to AI technologies in data centers and elsewhere, and lower rates should help increase investments in those areas, including in Arm technology, benefiting the company.
What's next for AI stocks?
With interest rates expected to come down further this year and into next, that should provide a tailwind for these three stocks and help tamp down concerns about a recession, which should further boost the AI sector.
While there are valid concerns about valuations and the strength of end-user demand for new AI technologies like ChatGPT, the cloud infrastructure giants have signaled their eagerness to keep spending on AI infrastructure, which should support the growth of Broadcom, TSMC, and Arm.
With monetary policy now loosening, AI stocks look poised for another step higher.
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Jeremy Bowman has positions in Broadcom. The Motley Fool has positions in and recommends Advanced Micro Devices, Apple, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
