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THE REAL BOTTLENECK
Last week I warned you about the pending rotation signaled by relative performances between commercial vs investment banks.
This week, that signal proved useful as the market did indeed begin what could become a long-run rotation to balance the excesses of AI.
Most will still swear by the usual soundbite they’ve been fed, that demand is going to outpace supply until at least 2030.
And they’re right, AI demand is not going to slow down any time soon, especially as more people and businesses begin to adopt the technology.
The problem is in implementation…
Computing power is a real constraint, one which only gets fixed if enough investors are willing to lend money out to data center builders and finance the compute commitments upon which the entire AI trade depends on.
As covered in this newsletter, AI-linked debt issuance has more than halved in the past month, and is down over 80% for the quarter.
Markets are fed up with the fact that the sector borrowed too much, and overpromised on results that are now questionable.
Especially as token prices hit all-time lows and customers begin to migrate toward cheaper open-source models in China.
What you saw last week in CoreWeave and Oracle is the end result of this mess.
That’s old news, and I told you that would happen right after Oracle’s debt collapse and data center delays…
Now I’m focused on the next opportunity set, which is likely going to be AI-proof businesses in the real economy as part of this rotation into value and quality factors.
That’s why our PMI picks have worked so well even through this selloff, and also why I decided to buy another multi-bagger on Friday.
Now let’s get an update on what the market likes and dislikes:
Value, Quality.
You can see an almost mirror image happening between momentum (yellow) and value (red) during the week’s rotation in the market.
All of the money that left the AI trade and these speculative growth names went directly in to the value and quality factors in the market.
Exactly the areas I’ve been telling you to focus on and dig for ideas in.
That is also the reason why I don’t believe this will be a broader equity selloff or “crash” but rather an orderly rotation back into fundamental deals that make more sense.
Otherwise, we would see a waterfall of sell orders and no bids anywhere in the market, and that’s not the case (at least yet.)
When things do end up accelerating into potential margin calls or an outright “panicky” rotation, I want us to be prepared and protected.
To most people, that would mean buying something like healthcare or staples blue-chip companies.
That’s great if you want to just stay flat and collect some dividends…
To me, it means buying where institutions can’t go.
During a broader de-risking, institutions can’t sell what they don’t own!
Which leads me to look for deep value deals inside the AI-proof areas of the real economy, backed by these factor rotations and protected by the fact that institutions can’t influence these companies below a certain size.
Yes, I’m talking about small and micro caps.
I’ve done the research, and it turns out this is the best area to be in during broad market rotations.
In fact, I just started buying into this idea during Friday’s selloff, into a stock that is up ~2% from where I bought.
CHART OF THE DAY
I think that the best companies we know of today all started in a similar way to the AI giants.
Shaky foundations, unstable financials, and an unproven product that was hard to make sense of.
Think of Tesla, bankrupt in 2008 and unproven for nearly a decade, yet it made an entire breed of millionaires.
I think Anthropic, or someone like it, will be the next generational run once they become public (if they even IPO.)
However, I don’t think it will be that easy.
ARE YOU COVERED? —>
The reason I say that is because Anthropic is currently valued at $2 trillion but still asking for financing at double-digit yields.
Survivability and double-digit corporate bond yields do not and will not ever go together…
I would therefore dismiss Anthropic as the likely candidate and wait for new competitors or beneficiaries to show up once the rotation is done and excesses are wiped out.
IMPORTANT GAUGES
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.
For the first time since I started issuing this indicator, we have now seen the daily S&P 500 moves move beyond the implied range from the daily VIX.
Which typically means we’re going into a back-to-back volatility cluster before any reversion kicks in.
Keep in mind, these clusters tend to last between 27-33 days on average, just in time for a shaky earnings season with lots of AI questions to be answered.
All the more reason to protect your capital in areas where institutions can’t influence the tape as they cannot own certain assets.
Now let’s cover some items for this coming week:
New Earnings:
Busy week for the AI trade.
On Tuesday, we’ll get some insights into the energy and infrastructure corner of the booming race through:
GE Aerospace, Vicor
Then on Wednesday, more of the same in infrastructure through NextEra Energy and even some data out of chipmaking as Lam Research is also set to report.
Thursday is the big day though, for both the AI trade and the Offside Portfolio:
Bloom Energy as one of the most speculative AI energy names in the market, and Valero as part of our diesel/spreads normalization trade
From that thesis, which you can check out here, I am expecting the company to issue guidance that will seem disappointing to the market given how the future looks for diesel spreads.
Building Permits - Tuesday:
We will get another update from the housing sector in the United States this week, either as another confirmation or a renewed headwind to the signals received from last month’s PMI.
From that report, I selected a few companies (which are now in profit) centered in the wood products industry.
Economically, this breakout in wood products could be a leading indicator to an improving environment in the housing sector, which we will check this week through the permits data.
I also think that yields may have topped, at least in the short term, helping ease off pressures in the mortgage market as lower rates could help consumers jump back into the market.
From this report, we will reiterate the holdings in the PMI watchlist selection and potentially add more risk to these trades.
A Final Note
COMING UP NEXT (Reminder for This Week)
As the market rotation begins to accelerate, a few studies have been prepared for members to go over the new opportunity set that will show up for compounding opportunities.
Deep dives on some companies are coming your way as well now that due diligence is finishing up for those candidates, especially now that the watchlist keeps expanding.
Anthropic’s latest financials are out, and M&A activity in the AI sector is beginning to shift its preferences on top of a broader U.S. bond rally, all of which deserves a macro update for you.
Meanwhile, I will give you a foreshadow of where my mind is at when it comes to portfolio strategy in 2027.
From Warren Buffett himself, to be supplemented with my historical study pointing to high-quality small and micro cap stocks that tend to outperform and protect your capital the most during rotations and market declines.
Sounds counterintuitive, and that’s the way Wall Street likes it:
Until next time,
OFFSIDE RESEARCH
Against the Tape, Ahead of the Curve.