Market sentiment has undergone a dramatic shift in just two weeks, moving from fears of an "AI bubble burst" to a "tech stock comeback." Microsoft (MSFT.US), which had fallen as much as 19% this year, has now turned positive, while Amazon.com (AMZN.US) has gained 18% year-to-date. The question of whether massive AI investments are just "burning cash" or "planting seeds" for long-term value has received a tentative answer from the market.
Microsoft reported earnings after the market close on July 29, with its stock surging 16% the next day. Amazon reported on July 30, and its shares rose 15% in the following session. Over the six trading days since July 29, Microsoft's stock has climbed 28% and Amazon's has risen 20%, adding a combined $1.3 trillion to their market capitalizations. Before the earnings reports, Microsoft was the biggest drag on the S&P 500 with a 19% year-to-date decline; after the reports, its annual gain turned positive at 3.4%. The S&P 500 recently hit new highs, with Microsoft serving as a key driver. Amazon, which had underperformed the broader market for most of the year, now boasts an 18% year-to-date gain, making it the fifth-largest contributor to the index's rise.
"The current market environment is extremely crazy," said Arup Datta, a portfolio manager at MacKenzie who holds shares in both companies. "The market's emotional swings between gains and losses are very volatile, with rapid shifts in momentum, sometimes leading to overreactions." The Nasdaq 100 has surged for four consecutive days, marking one of the most extreme volatility periods in history.
Cloud Business Supports AI Spending: A Justifiable Reason for Huge Investments
The core catalyst for this emotional reversal was the latest earnings reports from Microsoft and Amazon. Microsoft's fourth-quarter Azure cloud revenue grew 43% year-over-year, the highest growth rate since early 2022. Amazon's AWS cloud business saw second-quarter revenue jump 37% year-over-year, marking its fifth consecutive quarter of accelerating growth. These impressive cloud results have led investors to reassess the hefty AI capital expenditures of these tech giants.
Tom Plumb, president and portfolio manager at Wisconsin Capital Management, noted, "The market is gradually reaching a consensus that the investments by leading tech companies have a clear logic. Microsoft and, for the first time in years, Alphabet are facing negative free cash flow due to heavy AI asset investments, but the current return expectations from the cloud business are sufficient to cover short-term costs." He has long held positions in Microsoft, Amazon, and Alphabet (GOOGL.US).
The market's ambivalent attitude toward capital spending was fully reflected in Alphabet's case. The company's earnings report two weeks ago showed strong cloud performance, but it was overshadowed by high capital expenditures and shrinking free cash flow, causing its stock to drop 7.1% the next day. It later rebounded to a recent high, but this week, concerns over the departure of several key AI senior employees and fears of talent drain impacting R&D have weighed on Alphabet's shares again. Despite this, the stock is still up more than 14% for the year.
Three Factors Driving the Rebound: Valuation Recovery, Leverage Clearing, and Macro Improvement
This tech stock rebound is not driven by a single positive factor but is the result of multiple factors converging. First, valuations had fallen significantly, making them more attractive. Before the earnings reports, Microsoft and Amazon's forward price-to-earnings ratios for the next 12 months were below 20x, roughly in line with the S&P 500's valuation. Over the past five years, Microsoft's average P/E ratio was 28x, while Amazon's was 34x. Even after the rebound, the Nasdaq 100's P/E ratio is only 22x. "For a high-growth industry, that's a relatively cheap valuation," said Ed Yardeni, president and chief investment strategist at Yardeni Research, who believes there is further upside for tech stocks.
Another positive sign is that Goldman Sachs data shows investors' overall positions in the "Big Seven" tech giants (including Microsoft, Amazon, Alphabet, Apple (AAPL.US), Meta Platforms, Inc. (META.US), NVIDIA (NVDA.US), and Tesla Motors (TSLA.US)) remain relatively low. This suggests there is still significant room for buying.
Second, forced liquidations by highly leveraged funds have cleared the air. The mandatory sale of AI-related holdings by Leopold Aschenbrenner's highly leveraged Situational Awareness fund had previously intensified selling pressure. The Nasdaq 100 fell 11% from its June high to July 29, with the deep correction creating space for a subsequent rebound. The strong rally in large-cap tech stocks propelled the Nasdaq 100 to four consecutive days of gains. "The Situational Awareness fund event was clearly just a short-term liquidation event," commented Michael O'Rourke, chief market strategist at Jonestrading. "The other catalyst was the earnings reports from Microsoft and Amazon – the key was that their cloud revenue growth met expectations."
Third, macro risks have eased temporarily. Earlier optimism about the reopening of the Strait of Hormuz had pushed oil prices down. However, on Thursday, Iran announced a preliminary agreement with Oman to reopen the strait, though US and Israeli ships would not be allowed passage, causing oil prices to rebound and again putting pressure on the S&P 500. Nonetheless, overall market risk appetite has clearly improved.
Hidden Concerns Amid the Rally
However, not everyone is comfortable with this rebound. O'Rourke stated bluntly, "This is not healthy market behavior; it feels more like a bear market rally, with all the gains happening within a few days. Based on trading activity, I don't see a massive influx of institutional investors buying these mega-cap stocks. It's more driven by quantitative funds, passive index strategies, and options speculation. Retail investors also show a clear herding behavior." He also emphasized that the core negative factors that had previously suppressed tech stocks – massive capital expenditures and free cash flow pressure – still exist and have not truly disappeared. "The only difference is that cloud revenue has partially validated the rationale for these expenditures."
In the short term, the cloud business growth of tech giants has provided hard data support for AI investments. However, whether the market can transition from "surge in a few days" to "steady upward movement" will require more quarters of earnings verification. The journey for these tech giants to "prove themselves" has only just begun.
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