A New Week 09/06

Here’s an interesting figure to think about as we consider the state of the AI trade, its financing, and all the whipsaws we’ve experienced this past quarter…

In other words,

The vehicle through which the United States itself finances its operations and debt schedules is now being matched (in size) by one single industry of the stock market.

I don’t know about you but I find that to be very illogical.

Especially when you see how other models and countries have approached their growth and adoption of AI, as they spend 10% as much as the U.S. and have already generated a net return on that spend.

Hyperscalers have yet to see an ROI on that spend, and they are very obscure about the language around that expectation…

Because, there isn’t one.

I would be the first one to tell you all this spending will eventually turn profitable and look “obvious” in the next five years.

However,

You can’t have over $5 trillion in cloud commitments rely on token prices that have dropped over 50% from their highs, and expect the economics of these investments to remain the same.

This is exactly why NVIDIA, at the center of all this financing, has struggled to make a new high since May.

Click here to read how NVIDIA’s earnings explain the price uncertainty and AI risks.

Now let’s get an update on what the market likes and dislikes:

Momentum made a comeback last week, rising by 1.1% compared to other factors.

That’s the driver behind some of the positive AI price action you may have noticed in the tape, whereas value and quality names fell at the expense of these speculative assets.

Zooming out though,

Momentum is still in a bear market, while factors like breadth (RSP) and value (IVE) have bounced off their lows to correct previous bearish expectations.

This dynamic and gap relationships would lead me to think we are entering a major inflection point in markets, especially as rising bond yields and spillover volatility creates further uncertainty on future earnings and business/consumer demand.

Buffett says you only know who’s swimming naked when the tide goes out, and in this case momentum is the proverbial tide.

That’s exactly why the tug-of-war between “quality cash flow” and “growth at any cost” is becoming more accentuated, especially as AI rallies stopped benefiting most of the capex beneficiaries of the second quarter.

Right now, the only ones benefiting from the AI narrative are semis/memory names, even though energy and materials were the ultimate “bottleneck.”

The market has clearly shown us so far this isn’t the case.

When fundamentals come back on the table, valuations and yields will matter again, and right now I have reason to believe a trillion-dollar capital rotation is going to find better deals outside of the U.S. market.

Such as Japan, where a select few industries are set up to benefit from a swinging USD/JPY.

Click here to read my Japan thesis and portfolio ideas.

My usual read on the commitment of traders (COT) report has been extremely quiet as of late…

So I decided to create a new gauge and begin covering it until the futures market provides a reliable signal once again.

This measure represents the spread between daily VIX implied moves versus S&P 500 daily realized moves through time.

As you can see, each time we reach a 1-2 standard deviation, it creates a fantastic dip buying event, especially if you start playing options portfolios.

Right now, things are quiet and supportive of a continued breakout in the S&P especially now that we’ve reclaimed $7,700.

However,

This also means volatility spikes could show up unannounced.

Note: Whenever this spread widens, it means current market conditions and assumptions have changed enough to correct the options market, and consequently the VIX (which is priced upon these option expectations.)

No such expectation corrections coming about.

Now let’s cover some items for this coming week:

New Earnings:

Somewhat quiet week ahead, especially with the Labor Day holiday.

Still,

A few names are worth following (and covering) as they release earnings:

Last week, we got the ultimate AI vs software war in Snowflake and Broadcom.

This week, these two names will likely continue to prove why the “AI will kill software” narrative is dead and over with.

You can see why we became bullish on Adobe in the low $200s here.

More importantly,

Oracle’s earnings will show us just how bad things are getting for the neoclouds, especially those who rely on OpenAI and Anthropic to collect their cloud commitments and keep the lights on.

I’m very much looking forward to covering both earnings for you this week.

Inflation - Thursday & Friday:

Thursday is CPI, Friday is PPI.

Judging by how intensely prices have gone up in both PMI reports, I would say that Friday’s PPI will have a big surprise in store for us (on the hotter side.)

Still, most of that PPI print is driven by AI-related commodities and shortages, so it’s anyone’s guess what happens inside that report.

CPI is also a tricky one as of late.

We know the consumer is struggling, so demand isn’t really going to push CPI.

Oil prices will, that’s a given, but there’s also the spillover effect that AI is having in the broader economy through:

If there’s any connection between CPI and PPI, it will show up through AI.

Warsh, and the rest of the Fed, know this.

Meanwhile, here’s the latest from Goldman Sachs walking you through how AI debt-raising is beginning to affect global markets in credit and fixed income.

It’s one very important theme to keep in mind as yields continue to max out:

Until next time,

OFFSIDE RESEARCH

Against the Tape, Ahead of the Curve.