AI regulation fears hit the stock market

Fear of tighter AI regulation following the Democrats' major victory in the midterm elections has sent shockwaves through global stock markets. Sharp declines in technology and AI stocks on Thursday spread to the broader US market, and the sell-off subsequently continued on Asian exchanges overnight.

The Democrats' victory in both chambers of Congress triggered a historic market decline on Thursday. The S&P 500 fell 4.4%, the Nasdaq fell 5.5%, while the Dow Jones fell 3.4%, erasing all of Wednesday's post-election gains.

Chip stocks were hit hardest. The Philadelphia Semiconductor Index fell around 12% as concerns grew that the Democrats' advances could make the expansion of new data centers more difficult. Stricter requirements on power consumption, grid connection, water usage, and local approvals could delay new projects, dampening growth in demand for GPUs, memory, networking equipment, and other AI hardware. Nvidia fell 9.3% and was the largest single drag on the S&P 500. What began as a targeted rotation out of chip stocks quickly evolved into a broad risk reduction across all 11 sectors of the S&P 500. The VIX index simultaneously rose 70%.

It is important to put the recent declines in perspective, as they follow strong gains earlier in the year. Before the sell-off, the MSCI All Country World Index had risen 20% measured in DKK. After the pullback, the year-to-date return remains around 10%.

Increased regulation may shift the location, but likely not the need for data centers

The regulatory risk is real, but the market's reaction may be too categorical. The newly elected Democratic governor of Texas, Gina Hinojosa, has explicitly stated that all already-approved data center projects in Texas will be allowed to complete construction, effectively covering the entire build-out through 2027 and likely a large portion of 2028. New projects will be subject to clearer rules on taxation, electricity prices, and water usage. The newly elected Democratic governors want more regulation and clearer frameworks, but not to shut down an industry that creates jobs and tax revenues in many smaller communities.

It is difficult to see a genuine slowdown among the major technology companies as long as demand for cloud and AI capacity exceeds available capacity. Amazon expects to invest around $220 billion in 2026 and has stated that capacity is still insufficient to meet demand in 2026 and 2027. Alphabet has similarly maintained a capital expenditure framework of $195–205 billion and highlights that it continues to be constrained by available capacity. These investments are not merely an offensive bet on AI; they are necessary to fulfill existing customer commitments and sustain growth.

Market reaction and outlook

We have been surprised by both the sharp market rotation ahead of the election and the strength of the reaction to the result. We do not share the market's perception that something fundamental has changed. We assess that the market has overreacted, but acknowledge that the narrative needs to turn before the sector can truly regain momentum.

The growth outlook remains stable, earnings are expected to grow solidly next year, and together with more moderate valuations, we see a solid foundation for equities to recover their losses, even though uncertainty may continue to weigh on prices in the short term.