Is the AI bubble bursting?

That question was on the minds of millions of investors on Thursday, as the Nasdaq Composite (NASDAQINDEX:^IXIC) had one of its worst days ever, plunging 5.5% as fears spread that a political backlash could choke the AI boom, following the midterm election.

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Investors believe that election winners in Texas and elsewhere will slap significant restrictions or even outright bans on data centers, which became a lightning rod during the campaign. After chip stocks were among the few losers on Wednesday, they collapsed on Thursday, with the VanEck Semiconductor ETF losing 11.2%. Even industry leader Nvidia lost 9.1%, and the crash triggered a broader sell-off across the stock market, with all 11 sectors falling, even defensive ones like utilities and consumer staples.

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What's happening in the data center sector

AI infrastructure stocks began to wobble a few weeks ago, starting with a chart showing that neocloud operator CoreWeave's (NASDAQ:CRWV) bond yields had risen as high as 15%, and worries about a potential default sent the stock tumbling.

Earnings reports from the big hyperscalers were greeted similarly, as investors worried about soaring capital expenditures and negative free cash flow, even as these companies continue to grow rapidly and are hugely profitable.

Then, the election happened, and now fears of a slowdown in the data center build-out have led investors to flee AI stocks.

Stock market reactions to elections are famously rash and often fleeting. Stocks tumbled following the Brexit decision before bouncing back over the following days, and stocks plunged overnight when President Trump was first elected before turning green the following day.

This looks like a similar reaction. Tech stocks initially fell on Tuesday night before the Nasdaq jumped on Wednesday. The response is understandable as data centers have been a major talking point during the campaign, but the sell-off seems like an overreaction.

Gina Hinojosa, the governor-elect of Texas, campaigned on a temporary moratorium on data centers and reasonable guidelines, like a ban on subsidies for data centers. However, she is no radical, telling CNN, "We will have laws to protect Texans, and we need to stop what we are doing with data centers until we have those protections."