Why Advanced Micro Devices, C3.ai, Arm Holdings, and Other Artificial Intelligence (AI) Stocks Tumbled Tuesday

It's clear that several forces have been driving the market higher over the past year or so. Recent developments in the field of artificial intelligence (AI) helped kick-start the bull market last year, as the technology is expected to unleash a wave of productivity growth. Market watchers are also keen to find out when the Federal Reserve will start cutting interest rates and how quickly it will do so.

Against this backdrop, some stocks related to artificial intelligence fell on Tuesday. As of 1:16 p.m. ET, semiconductor specialistAdvanced Micro Devices (NASDAQ: AMD)Down 3.71 TP3T, maker of artificial intelligence softwareC3.ai (New York Stock Exchange: AI)) fell 2.81 TP3T as Chip Design, Inc.Arm Holdings(NASDAQ resonance stock code:ARM) fell 1.81 TP3T as chipmakerMicron Technology Inc. (NASDAQ resonance code: MU)Also down 1.8%.

An examination of all the common factors such as changes in regulatory filings, financial reports, and analysts' target share prices revealed that there was no company-specific news that could explain the drop in share prices, suggesting that investors were focusing on broader economic developments.

A rate cut in June? Not so fast.

Market watchers have been eager for the Federal Reserve to start lowering its benchmark interest rate - an event that would be an important indicator that U.S. inflation is finally under control. However, Fed matron Jerome Powell poured cold water on investors' hopes on Friday, suggesting that while the central bank still plans to cut the federal funds rate this year, it is in no hurry to start doing so. Speaking at the Federal Reserve Bank of San Francisco, Powell said the Fed is looking for "more good inflation data" and doesn't want to make a rash change in monetary policy before inflation is under control.

On Tuesday morning, the Institute for Supply Management (ISM) released its closely watched ISM Manufacturing Index, which rose from 47.8 to 50.3, above economists' expectations of 48.1. Any number above 50 indicates growth in the manufacturing sector, suggesting that inflation is not yet fully under control and that there are increasing indications that the Fed may not be able to cut interest rates as quickly as market observers had hoped. This is a sign that inflation is not yet fully under control and there are increasing signs that the Fed may not cut rates as quickly as market observers would like. This also suggests that the likelihood of a rate cut in June may be waning.

The U.S. Bureau of Labor Statistics released strong employment data on Tuesday, further reinforcing this view. The number of job openings was 8.8 million, virtually unchanged, while the number of hires and departures were also little changed at 5.8 million and 5.6 million, respectively.

Strong economic growth, as indicated by robust manufacturing and employment data, suggests that while inflation is weakening, it is not yet under control.

Why it matters

So what does this have to do with our four AI stocks? In short, where the cost of borrowing increases, companies are less likely to adopt game-changing and costly technologies like generative AI. Where money is tight, managers are content to put off such spending until the cost of borrowing goes down.

• AMD provides graphics processing units (GPUs) that facilitate the training and use of AI models. These systems can cost tens of thousands of dollars or more per chip, so many potential buyers consider the cost of borrowing.

• C3.ai provides companies with off-the-shelf software models that they may be reluctant to adopt in times of capital constraints.

• Arm Holdings creates many of the blueprints upon which widely used semiconductors are based and receives license fees and royalties for the use of its designs. Higher inflation and slower technology adoption could result in lower revenues.

• The flash and storage processors produced by Micron Technology, Inc. are an important component of AI processing, and as such are also affected by interest rate increases.

You get what you pay for.

In terms of valuation, this group of stocks is a mixed bag, but none of them are particularly cheap by the most widely used metrics: Arm Holdings, AMD, C3.ai, and Micron are currently trading at 27x, 9x, 9x, and 4x forward sales, respectively. However, when measured by forward price-to-earnings (PEG) ratios, which take into account how much the companies have grown over time, Arm Holdings, Micron, and AMD all have P/E ratios below 1, which meets the criteria for an undervalued stock. c3.ai is the riskiest of the four, as the company hasn't yet produced a profit.

Artificial Intelligence is still in its early stages, so there is still a lot of room for growth in the future. That said, investing in AI-related companies is not for the faint of heart. Those considering investing should carefully weigh their risk tolerance and their ability to withstand the heartbreaking volatility that is sure to continue.

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Danny Vena does not own any of the stocks mentioned above.The Motley Fool's position in Advanced Micro Devices is recommended.The Motley Fool recommends C3.ai.The Motley Fool has a disclosure policy.

Why AdvancedMicro Devices, C3.ai, Arm Holdings, and Other Artificial Intelligence (AI) Stocks Tumbled Tuesday