Morning Digest 09/25

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Good morning partner,

Few things to cover this morning:

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Yesterday’s Session

After the Oracle news of calling for “Force Majeure” on their New Mexico data center, a new risk emerged for the rest of the AI trade which was reflected in the price action for most of the semis/memory trade.

In the opposite end of this tug-of-war, we have the hyperscalers and some of the value-oriented names catching a bid in the session, accompanied of course by some of the energy names after crude caught a move above $90 a barrel again.

The pre-market session shows some relief in the energy space, with crude being down by some 2% this morning, all of which should have an effect in other assets like bonds and move this tug-of-war in the direction of semis/memory.

I say this because lower oil pushes inflation expectations lower, which then in turn raise the prospects of more AI project financing down the line.

So I’ll bet that the Oracle news selloff will be reversed if crude breaks below $90 again.

Though here’s a much better trade you can profit from if crude is in fact going to head lower.

Click here to read my thesis on a normalized diesel cost wedge, and the company that wins.

Let’s take a look at Yesterday’s leaders and laggards:

Communications, Healthcare, Energy.

Hyperscalers saw their green day at the expense of the semis/memory selloff yesterday, which is very clearly the side effects of this current tug-of-war which just keeps on amplifying.

Therefore, I am more interested in understanding why healthcare and energy were the follow up leaders outside of the hyperscalers…

I believe it is a combination of defensive inflation, given energy’s rally on oil spikes and the hyperscaler rally on defensive free cash flow quality.

That’s where healthcare meets both in the middle.

Inflation helps future premiums on healthcare providers, and also raises the prices which hospitals and product manufacturers can command.

Not to mention, you also have the quality and free cash flow moats around healthcare, so to me it seems the market is looking for a scapegoat away from an uncertain economic environment and rising inflation prospects.

Here is why I think bond yields will stay over 5% for a bit longer, affecting the sectors above.

Predictive Power

One of the most powerful market forces out there is found in the capital cycle.

I can stand by this claim given the amount of times I have used the tool to accurately spot (and avoid) investments where the cycle pointed to poor future returns.

It works in the following way, specifically in the capex to depreciation ratio:

As you can probably already tell, demand plays a diminishing role once you continuedly expand on supply capacity, especially when new competitors enter the scene.

I will give you one perfect example in Daqo New Energy (DQ.)

It exports 80% of China’s polysilicon, used in the manufacturing of solar panels (a high-growth industry.)

Yet, even through the upcycle of solar demand, DQ has gone nowhere for over five years.

The reason is that they have invested at over 3.0x capex to depreciation ratios for several years in a row.

Therefore, no amount of demand could ever come to absorb the massive supply that is currently online for polysilicon, making DQ a tough investment no matter how good the story sounds.

Here is how the memory chip industry is going through a similar oversupply setup now.

News

Movers & ES Levels

Now let’s get into some ES levels for today.

We remain in the supportive range of $7,700-$7,725 as given yesterday.

If you’re a buyer, then you probably should take advantage of this range while it builds some volume, you can still target $7,810 or so as your next target before a potential breakout.

As we end the week before important economic data coming up, I would decrease trading size and tighten up risk management.

For now the $7,725-$7,810 remains the most likely area to deal, where next week will probably shed some light into future dealing ranges.

A close above this $7,700-$7,725 area does signal a potential bullish path for the index I must say, so trade the odds accordingly.

Portfolio

After taking some profits out of the AI buildout names yesterday, we remain on a path to reclaim the portfolio’s all-time high performance by the end of the year.

Next week will likely fill up the pipeline with new ideas as the PMI reports are released, where I also expect to see further confirmation on the current long/short spreads through AI and energy.

Lots of good movers so far this week, I would summarize the holdings and risk exposures as being “under control.”

Click here to see what we bought this week in diesel.

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Here’s the positioning update for today’s premium members: