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Good morning partner,
Few things to cover this morning:
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Yesterday’s Session
Only a couple of times has September given us the price action that we saw yesterday, which is characteristic of a broader equity de-risking.
With semis/memory stocks selling off, we should have seen a rotation back into hyperscalers and other cash flow native companies, natural for the tug-of-war that has been present for the past quarter.
We obviously didn’t get that, in fact, all sectors except energy and select healthcare lost ground yesterday.
That tells you a lot about where the true line of defense sits in this market, it is an inflation shock rotation.
Energy benefits from the direct effect of record-high diesel prices, whereas healthcare and its future premiums on services will also benefit from rising inflation (no matter where the increase comes from.)
Why haven’t other defensive names gone up as well? Say consumer defensives or utilities?
Because the problem isn’t inflation, it’s a rising 10-year bond yield (now above 5.0%.)
Typically, fixing inflation would help the economy ease the yield pressures, only that this time around the rally in bonds is barely caused by inflation expectations.
Over 51% of the 10-year’s move since July was driven by term premiums.
They have nothing to do with inflation, something much harder to fix.
Let’s take a look at Friday’s leaders and laggards:
Energy, Healthcare.
For the reasons I explained above, these were the only two sectors moving into the green on an overall weak day.
Let’s instead look at the worst-performing sectors to complete the picture:
Communications, Materials, Financials
Believe it or not, these are all connected to the one narrative that took over the market yesterday.
That of “We must slow down AI development” coming from Dario Amodei, Sam Altman, and even Elon Musk.
Of course, communications and materials will sell off as future perceived demand for data centers and AI supply chains won’t materialize as optimistically as previously forecasted.
But why financials?
Bank of America and Citigroup were among the banks having their worst days since 2022, and I believe the reason is that they are now holding too much exposure to GPU backed loans.
A repeat of every asset-backed security (ABS) crisis before it, leveraged this time to a point where a 10% decline in GPU prices makes the whole bond worthless.
Judging by how most AI-related companies are shuffling their financials…
Set the Record Straight
Meme Referring to Anthropic’s Margin Claims, Twitter
Yesterday, Anthropic touted to the entire world that they now operate at 80% gross margins.
When you look through the selective information they chose to leak from the prospectus, you’ll quickly find one odd fact:
These gross margins don’t include any cost of sales… How are they gross margins?
In other words, Anthropic claims 80% gross margins before adding items like:
Cost of GPUs, R&D for training their models, Commissions/Collaborations owed to partners like Amazon and Google
In other words, Anthropic’s gross margins may be much thinner than they are claiming, and I’d be willing to bet they actually operate at a net loss before other operating costs come into the mix.
The more open source models from China continue to take market share from these AI labs in the U.S. the more I think the token volume share for ChatGPT and OpenAI will decline.
That share is down over 50% this quarter by the way…
Now more than ever, you’ll need to keep up with the actual data, not manipulated earnings or unfulfilled promises of massive backlogs and contracts.
Over a 13-year career in markets, I’ve found that the PMI reports tend to offer a gold mine when it comes to spotting trends and ideas, and I believe they can help you differentiate the noise from signal as well.
News
Bank of America manager surveys show that less investors are overweight on equities compared to last month, citing worries about rising bond yields as the main concern about their stock holdings.
Data Centers are Set to consumer more natural gas than most countries within a decade, which to me sounds like a very low R/R at this point compared to a fix to the root problem, leading me to nuclear as the best alternative.
Saudi Pipelines go Offline to worsen the halt of oil supply flows around the world, adding pressure to the disruptions only creates higher expectations for oil prices.
Chinese Retail Sales Disappoint while investment declines steepen, which is actually good for their stock market as capital deepening has now swung to an extreme over the decade, time to rotate into the finance and tech economy.
Movers & ES Levels
Rumble 📈 Pops 11.6% as the least likely candidate to gain a compute deal from Anthropic, the more obscure companies that enter the circular financing scheme, the closer we are to it all collapsing.
Cybersecurity (Palo Alto & CrowdStrike) 📈 Gain 13% as one of the toll booths to the AI trade, software ensures monetization at scale while cybersecurity ensures enterprise adoption. Conveniently, these were the two areas expected to be replaced by AI.
Corning 📉 Lost over 13% as part of the broader AI selloff on potentially lower compute and data center demand, goes to show how fragile the narrative has become around promises rather than actual results.
Oracle 📉 Slipped nearly 4% even after Co-founder Larry Ellison decided not to sell his shares yesterday, the market doesn’t care about a few billion of cash leaving or not when you have a $700 billion debt pile at risk.
Now let’s get into some ES levels for today.
Another reject above the $7,700 cutoff level for the current quarterly distribution.
We can also argue there’s a reverse head and shoulders forming right now, with the head set at $7,588 or so.
If we manage to take out the $7,650 shoulder, that’s where I think the market will be headed unless aggressive buying activity comes back into the equation.
What I’m noticing from the sell-side is that no aggressive offers have come in at all since the trapped sellers were taken out at $7,625 and yet the price has struggled to hold above certain key levels.
This essentially means the aggressive buyers at $7,588 are now taking profits slowly on each rally, while sellers have gone passive to save their dry powder until a better setup comes about to flip the flows.
Why would anyone go aggressive now with the Fed meeting tomorrow?
While the odds are nearly 100% that the Fed will hike by 25bps, the tails still exist for an unchanged decision or even a 50bps hike.
Neither are being built into the price it seems, but the behavior shows there is still a possibility of a two-way surprise for the meeting.
I would advise extreme caution around this, and resume your trading once we see more decisive order flow.
For now, I cannot be a bull unless we continuously close above $7,700 but I also cannot be a bear unless the $7,650-$7,625 range is taken out lower.
Portfolio
Even with the broader equity de-risking, the portfolio still managed to move higher and remain in a 2x outperformance to the S&P over the quarter.
I will credit this performance to the shift from looking for home runs into taking the bunts, all through a long/short strategy for now.
The power of this strategy is that we significantly lower our risk through short financing, and massively amplify the returns on a single idea.
Today after the bell, you will see how I applied this method to AAON vs JCI, bringing the gross return from ~20% to a net ~47% with the long/short strategy.
Stay tuned for that.
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