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Good morning partner,
Few things to cover this morning:
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Yesterday’s Session
Quite the opposite of my last read on the auction, as we got a bit of a relief rebound in the AI complex while the opposite extreme in this tug-of-war fell as a result of this relief.
Hyperscalers and those with a high-quality cash flow profile gave their spot in the race up for semis/memory stocks to rally instead.
That is the tug-of-war nature we’re having in this market at the moment, and I expect it to continue to amplify as liquidity conditions tighten with rising bond yields globally.
As I’ve explained before, this back-and-forth in the market’s largest companies require the ability for hundreds of billions to be transferred without any fundamental reason other than:
AI and hyperscalers cannot succeed together
Because the market is less confident about the AI trade than they would make it seem, each time semis/memory stocks decline, money rushes straight back into hyperscalers and so goes the game.
At one point though, macro conditions will make this spread trade come to an abrupt stop.
The hopes of an orderly rotation back into the real economy names has been gone since the July revamp of leverage into AI.
Let’s take a look at Friday’s leaders and laggards:
Industrials, Technology, Utilities.
Clearly an AI relief rally in the making here, as all of the leading industries (save for consumer cyclicals) have direct exposure to the theme.
I don’t think a lot of explaining needs to be done on the green side of the auction.
Getting to the laggards, I think this is where the bulk of information can be extracted…
Communications and consumer defensives lagged on the day, which is the hyperscaler and real economy theme in one move.
For what it’s worth, we can assume (for now) that the market concentration and correlation into AI themes is not limited to technology and semis anymore.
Sentiment on the AI trade has spilled over onto materials, industrials, and even real estate as well.
I’m not here to tell you that’s bad or that you should stay away from a market of this nature…
Far from it, if you can’t beat the hottest thing on the tape right now then join it!
But,
Do it in a calculated way, otherwise you may end up on the wrong side of this entire bet.
No More Breathing Room
Government Expenditures (Interest, Defense) & Corporate Profits, FRED
Whatever the Fed ends up doing today, I want you to remember one thing:
Most of the 10-year bond move was driven by term premiums
Not inflation, not the policy path, most of that is already priced in at this point.
Term premiums are the additional compensation investors seek in exchange for keeping their capital in the hands of the U.S. government and the economy.
And,
Measuring cycles in the old methods like GDP or P/E will get you nowhere near the risks we are facing today on a systemic level.
Because they all have been artificially inflated through record accruals and other accounting shenanigans across the market’s biggest companies, a fact that many banks (like Goldman) are starting to float.
On a more direct basis, I want you to compare the level of interest expenditures to corporate profits in the United States.
The cycle of credit and leverage tends to peak and turn around the 28-29% mark, which is exactly where we find ourselves today.
In fact, I think it’s worse…
Roughly a third of all reported corporate profits are characterized by accruals (non-cash items) like unrealized equity gains in AI companies, gains on the rising price of GPUs, or accelerated recognition of compute and construction backlogs.
In other words, a third of all corporate profits are fictional, not real cash.
Meaning we are closer to paying 45-50% of all corporate profits in the nation back into interest payments!
Now you know why bond investors want to get a better return, and why traders are taking it upon themselves to stop the leverage and AI credit mania.
News
OpenAI Seeks New Funding Round at a $1.2 trillion valuation, suspiciously after they claimed to be profitable already and called for the need to slow down AI development, what to believe?
The Clarity Act fails to pass after voting, bringing cryptocurrencies like Bitcoin and Ethereum down on the day and amplifying the potential risk-off sentiment spreading in the market.
Wells Fargo Becomes the First Bank to cut their S&P 500 price target, usually the bigger banks lead the way first, unless they are playing a game of hot potato around IPO mandates and GPU-backed loan exposures.
Costco Begins Rationing Motor Oil as the Hormuz disruptions see no end in sight, this could eventually create a coiled spring trade in vehicle parts and maintenance services which I’m excited about.
Movers & ES Levels
Radiant Logistics 📈 Popped 19.5% after reporting a strong quarter, and becoming one of the first names to give traction to my trucking and transportation bull case found in August’s PMI breakdown.
Skyworks Solutions 📈 Gained over 13% after the CEO mentioned his confidence behind the Qorvo acquisition, proving that the software trade may still have some further room to run.
Circle & Coinbase 📉 Both fell double-digits as a result of the Clarity Act failure bringing the crypto market lower, as these are crypto exchanges they have become the most affected so far.
Sysco 📉 Fell just under 5% after announcing a new round of stock issuance on “strong investor demand”, I think this shows you the market is more bullish on asset-light transport & logistics companies than asset-heavy ones as a result of fuel and other costs.
Now let’s get into some ES levels for today.
A repeat of the structure we have seen all month, scrape of the $7,700 cutoff level only for buyers to be met with overwhelming selling pressure.
As we go into another close below this level, I am leaning more bearish than bullish at this point.
However,
As I mentioned yesterday, I cannot become bearish unless we continue to ram through and close below $7,645 or so. Especially with an inverse head and shoulders keeping $7,585 as the gatekeeper.
At the same time, I also can’t become a bull unless we see $7,700-7,725 taken and close above this range.
For a buyer looking into better R/R, I would consider $7,650 to be a reasonable entry, and knowing that losing the level means canceling the inverse head and shoulders pattern.
For a seller I would also like to enter short at $7,700 or within 10-15 points of it for a better R/R.
Still keeping in mind that the bias cannot be cleared until the levels above are taken and closed beyond on.
Today will be interesting as the Fed gives us some volatility, so keep this cheat sheet handy.
Portfolio
I expect today to be a good relief rebound day on some of the AI long/short plays.
Those have been treating the portfolio volatility and upside tails very well lately, especially as we shift strategies in this factor rotating market.
From looking for home runs, to riding the bunts.
That’s the mantra for the quarter, or until the factors and market structure become a bit clearer.
It is obvious that the current drag is coming from some of the real economy names in the portfolio, affected the most by diesel price spikes increasing input costs significantly.
However,
The long/short options portfolio in both memory and Chinese tech will likely carry us all the way through this volatility.
Here’s the positioning update for today’s premium members:
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