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Good morning partner,
Few things to cover this morning:
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Yesterday’s Session
Most talking heads made you believe rising bond yields wouldn’t be a bad thing for the stock market or the AI trade, since there is so much compute and chip “demand” out there to offset these costs.
Well,
You can’t escape the laws of finance, especially when the 10-year Treasury yield has now hit 5.14% (highest since the internet bubble.)
I will call most of what we see right now in the overnight session as a broader equity de-risking, as both hyperscalers and semis/memory are going down together instead of going in the opposite direction as usual.
Interestingly though, there are two areas still managing to push higher, those being defensives and energy.
Because of renewed fears in the Middle East, crude has crossed above $90 a barrel again, so your best bet is to expect inflation pressures to resurface.
Defensives joining the party is a very important fact to consider this morning, because a broader equity de-risking should include all equities.
I believe this is because the market expects to see two major macro shifts ahead:
Higher bond yields for the foreseeable
A weaker dollar
This is the perfect setup for these multi-national defensive companies to operate in.
And again, it proves two of our most recent ideas (bonds and Japan) are working and point us to add exposure to them in the coming weeks.
Let’s take a look at Yesterday’s leaders and laggards:
Energy Defensives, Utilities.
Again, there is not much to say about these leaders on top of the breakdown above.
What I will say is that the energy trade is beginning to rotate in a very particular way right now.
Despite oil crossing above $90 again to reject a bear trend, the mechanics of the sector showed participants have a different expectation in mind.
Those who buy fuel as an input cost are beginning to rally aggressively on the up days, while those who sell fuel as a product are selling hard on the down days.
That’s not a coincidence, is the market’s way of building a position for the next 3-6 months and what they expect will happen then.
Remember what I said about defensives?
Oil changes, car maintenance, and all the daily uses involving oil and diesel will likely be the best bets running up to November’s midterm elections.
And don’t forget about used cars, over three million leases are expiring next year, and these vehicles are running into a market where higher interest costs keep people from buying new units.
Check the Banks
10y vs 2y Yield Curve, Fred
2-year yields are rising faster than the 10-year yields, which is what we call a “bear flattening” of the yield curve.
We cover this in the money markets module of our analyst program.
In a nutshell, it means two things for you and the market:
Short-term risk is rising quickly, and money is running away from it
Liquidity and profits at the banks are being hit
Which is why you begin to see the broken market we have today, negative correlations overall as stocks go in every direction except where the S&P 500 is going.
Because the market has become 10 companies now, and about 100 others are correlated to the AI trade in some way or another.
So, the bond market tries to break the equity market in order to rebalance it, get correlations back in line, and hit the problem where it hurts (which is financing costs for more AI projects.)
Unfortunately, it also hurts banks as a flatter yield curve offers less profit to be made on loans made to consumers.
This is why Truist (TFC) and Fifth Third Bank (FITB) are down more than 10% from the highs.
However,
The bigger names like Goldman Sachs (GS) and J.P. Morgan Chase (JPM) are not suffering from this one bit.
Why? Because they still are making record profits from being assigned huge AI IPOs, and collecting fees when they structure equity and debt issuance when these broke AI companies need to raise money.
Again, a disconnected market, forcing you to be a skeptic and look at every detail.
News
Trump and Xi Extend Truce to January 10th, 2027. This comes as an obvious result of neither country being able to afford a fight right now, there’s an energy crisis to solve first.
OpenAI Agent Hacked Australian government’s health website, making this the second dozen or so hacks sponsored by OpenAI. In my view, this only creates more demand for cybersecurity and data governance companies.
J.P. Morgan Sees Quarterly Profits Rising from trading and investment banking fees, my point above. When banks begin making more from capital markets than lending interest, it usually signals market excess and euphoria.
SoftBank Takes on $11 Billion through bond issuance in order to fund their OpenAI bets, even with hacks and lower prices being announced. The connection between NVIDIA and SoftBank should be studied, as they’ll do whatever it takes to keep the casino open.
Movers & ES Levels
Palantir 📈 Gained almost 4% after the FAA announced some airports began using its AI software for traffic control. Key word being software, it is not dead, only amplified through AI supplementation.
Cracker Barrel 📈 Climbed 4.5% after an upbeat earnings announcement, citing better customer traffic and demand. This is a welcoming sign of a potential bottom in the consumer sector, one of my favorite coiled springs right now.
Alibaba 📉 Slipped almost 5% after Beijing began investigations around Chinese AI, showing potential headwinds and regulatory bottlenecks to slow down the company’s current growth engine. Good thing we took profits on that call spread.
Astrana Health 📉 Lost 2.2% after disclosing a significant data breach in its operations, once again leading me to think that cybersecurity stocks may become a hot area amidst these hacks and breach reports becoming more common.
Now let’s get into some ES levels for today.
After a quiet run in the index, we finally got some volatility.
I expect a bit of a higher VIX to come along considering how aggressively bonds are starting to move now, and how much attention the market is paying to rising yields as well.
A key support level given yesterday was reached at $7,725 and still holding, which makes sellers and bears stand on the sidelines for now until we can ram through and close below this level, ideally $7,700 or below for the ultimate confirmation.
Buyers know that aggressive sellers came in hard at $7,810 or so, and a second wave of more passive sellers hit the tape at $7,760.
If you’re a buyer, you have a nice range going from $7,725-$7,760 to play with today, and $7,810 as your ultimate take profit before another potential round of aggressive selling.
If you’re a seller, you want to play either the break below $7,725 or wait to retrace higher toward $7,760 to come out and deal.
Portfolio
$11,112 of profit has been realized so far since June, with the latest round coming from the Chinese call spreads returning about ~$800 of profit to the pool.
In the AI long/short portfolios, I will probably trim some profits in a name that’s already run up by 28%, especially as bond yields continue to apply pressure to this sensitive market area.
Japanese, AI cooling, and diesel long/short spreads are all chugging along to provide a net ~$920 of profit, and we are still early to these plays where I expect a lot more to be had out of them.
As the market structure begins to become less clear compared to last quarter, the portfolio will rely more and more on these long/short strategies, which are designed to protect your capital in case these whipsaws continue showing up.
There are times to go for the home runs (like we did in Software last quarter.) And times to stay alive with the “bunts” as we’re doing now in these long/shorts.
Your main job as a portfolio manager is to know when the market is “hot” or “cold” and shift strategies accordingly.
If you have the time, and capital, to watch your portfolio like a hawk…
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Here’s the positioning update for today’s premium members:
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