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LAWS OF CAPITAL
Every investment boom through history follows a similar cycle:
Demand outpaces supply
Capex intensifies to fix rising costs and bottlenecks
Supply lands, and overextended players see their margins erode
As depicted above, three such cycles have happened since 2000.
The telecom, shale, and memory investment booms all ended up in a similar way…
Returns and margins down anywhere from 55%-70%.
Think about this next time you wonder why Micron (MU) trades at such a low forward P/E despite it being an essential player in building more AI capacity.
Over the weekend, I dug deeper into the supply and capex dynamics for most of the AI-related industries and their top companies.
What I’ve found could be the most accurate compass to selectively invest in the next capex wave beneficiaries.
More importantly,
To avoid the losers.
Stay tuned,
Take advantage of a 7-day free trial of Offside Premium to receive our next acquisition targets.
Now let’s get an update on what the market likes and dislikes:
Something unexpected happened over the past week in market factor performance.
It’s even more telling when you consider the fact that this past week’s volatility was significantly compressed.
Value and momentum stocks moved higher together, outperforming all other factors.
Understanding the nature of these two factors, you would be the first one to remind me this isn’t supposed to happen…
Unless,
Value stocks are now becoming momentum stocks, as the continued unwind in AI-related plays and their single-stock volatility premiums shift capital elsewhere.
From what we’ve seen this week in software (like Workday’s 17% rally) it makes sense to see a rare lockstep move in these two factors.
It also could mean that our mid-caps thesis is landing on more desks at fund manager offices.
In other words,
The underperforming value plays could soon become the top-of-mind names CTAs and other managers choose to buy as the momentum mix makes them more attractive.
Construction Partners (ROAD) could be one of them.
Lucky for you, I’ve already dropped my deep dive and valuation on it.
CHART OF THE DAY
Corporate employee adoption of AI is still at a fraction of what it could be.
Still,
The latest surveys show a massive gap in spending tiers for the employees that have adopted it so far.
Here’s the most important metric for you to think about this week.
Especially as OpenAI and Anthropic get fluffed up as IPO talks continue to spread around financial media…
A 55x gap between the top 10% and median spenders
ARE YOU COVERED? —>
There isn’t a scenario where adoption alone fixes the revenue-to-commitment gap at these AI labs.
No product or service survives when the median spend is this far behind the curve.
Remember, these labs still carry over $6 trillion in commitments.
IMPORTANT GAUGES
Commitment of Traders Tracker, Offside Capital
Both managers and leveraged money have been selling down S&P 500 exposure since July 14th, an entire month.
As I covered in last week’s read, this is a very rare event as these participants tend to shift their books in the opposite direction most of the time.
When managers (pensions, mutual funds, indexes) sell, usually leveraged money (hedge funds and prime brokers) tend to buy and vice versa.
Buying or selling on both parts tends to signal a strong conviction in terms of direction, and right now that direction seems to be headed lower.
10-year TIPS, Fred
One prevailing reason, amongst a handful, is that the 10-year TIPS yield continues to break out of its previous range.
The mechanics behind this move are a result of falling inflation through cooler PPI and CPI prints last week, and a continued rise of the 10-year bond yields.
In other words,
Restrictive monetary policy is the consensus outlook out of money markets, and perhaps the reason why both gold and Bitcoin have struggled to perform on a year-to-date basis.
Now let’s cover some items for this coming week:
New Earnings:
Everyone’s worried about Chinese open-source models and the competitive effects of their new capex waves on the US markets.
On Tuesday, Baidu (BIDU) will report before the open to give us a fresh look into those concerns.
The Home Depot (HD) offers another look into the state of the US consumer, which we know has been struggling in this K-shaped economy, a fact that has been translated into weaker GDP growth levers and PMI demand shifts.
Thursday offers a bit more of a handful for us at Offside:
Alibaba (BABA) before the open, an important release as this is one of our portfolio holdings, now up ~20% since buying
Walmart (WMT) as another gauge to the consumer, real inflation, and tariff refunds
Daqo New Energy (DQ) as the world’s largest polysilicon maker/exporter in China, which is now suffering the side effects of the 2021-2023 solar market boom
After that solar boom, the market was flooded with supply that wasn’t underwritten for in valuation outlooks, keeping the most important company in that chain in a deep bear market for years now.
I suspect something similar may happen to the AI trade, as I’ve prepared a research piece on the state of capex and supply for the sector.
Tuesday - Housing Data:
Building permits and housing starts on Tuesday will give us an additional measure of how the consumer is feeling right now.
With the 30-year mortgage rate reaching a two-decade high, and home prices still leaving most participants out of the market…
I don’t expect permits to be headed higher any time soon, which is also the reflection of low confidence on the part of banks and household economics.
Reiterating my take on a needed reset in part of the bond market to normalize the economy away from all the AI-related areas.
Wednesday - FOMC Notes:
Kevin Warsh has been secretive about guidance from the Fed.
So I don’t really expect much from these FOMC notes, but at least we should get some language around the labor market and price instability.
I am particularly concerned about the price side of the equation, as the continued capex investment wave keeps price pressure higher than normal for select items in the inflation indexes.
Whether Warsh will tackle the effects of the AI bonanza in the notes will be seen.
A Final Note
COMING UP NEXT (Reminder for This Week)
Every investment boom has led to a capex intensity wave and unexpected supply landing, leading to margin and pricing power erosion for most players
From the internet boom, to shale and solar, the laws of the capital cycle apply. Today’s AI capex boom could potentially lead to a similar outcome
We’ll cover the industries and companies that could be most/least affected by the landing of supply next
Here’s the latest from Goldman Sachs and their outlook on the Fed, interest rates, and inflation altogether.
This can be a great lead-up to the FOMC notes on Wednesday, at least as an expectations groundwork:
Until next time,
OFFSIDE RESEARCH
Against the Tape, Ahead of the Curve.