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Good morning partner,
A few things to cover this morning:
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Yesterday’s Session
Judging by how the auction ended yesterday, I believe some short-term lows may be in already, helping boost the AI trade for today at least.
This is a classic setup as the entire week has been nothing but a massive rotation out of AI-related stocks and back into the real economy with a defensive preference.
Now that the psychology around participants is set toward buying the dip, the comeback rally could trap a lot of buyers here at these key S&P 500 levels only to create another “ram through” range.
And, it makes all the sense in the world, as Goldman Sachs’ prime brokerage data showed hedge funds and other clients are dumping technology stocks at the fastest pace since 2022.
Markets, on the other hand, have also voted through lower forward P/E ratios, signaling lost confidence in the growth and/or quality of future AI earnings.
Why wouldn’t they?
After Anthropic’s recent S-1 prospectus leak, it’s become clear as day that trillions of dollars in AI-related debt will go unpaid.
It’s why credit spreads are spiking, and why these AI labs have issued debt paying over 12% yield!
Talk about junk…
And that same junk has run out of funding, so Wall Street turned to pensions, savings, and insurance money to dump this risk (sound familiar?)
Let’s take a look at Yesterday’s leaders and laggards:
Industrials, Real Estate, Technology.
These are the rebound names to keep in mind for today, with the defensives lagging in the pre-market right now.
What started as a chipmaker vs hyperscaler tug-of-war earlier this year has now turned into a much broader battle.
Significantly more capital is trying to be passed back and forth between these sectors rather than just two industries.
Meaning,
We need adequate liquidity and ease of funding in the system to allow for this to happen without anything breaking.
Which is turning into a bit of a problem now that the 10-year yield is much higher than it was last quarter and looks to remain above 5% for the foreseeable.
I wouldn’t want to be caught between this tug-of-war, as it will probably be a highly frustrating process as the market rotates and assesses the AI debt risk contagion.
Naturally, I want to start building a book of companies that institutions are likely going to ignore due to:
Size (a trillionaire asset manager won’t buy $500 million sized companies)
And because institutions won’t buy them, analysts won’t cover them, leaving most of the undiscovered edge for us to find.
I’ve already found one of these gems just as it was being accumulated for over three months by some “smart money” and insiders themselves.
That company managed to rally by over 15% yesterday alone, all while the indexes and AI trade were losing their minds.
And don’t worry, part two and three are coming out soon for Premium Members.
This Time is Different
Einstein coined the saying that:
Doing the same thing over and over expecting a different result is the definition of insanity
You probably have seen this happen beyond markets as well.
Countries adopting a certain economic or political system that didn’t work elsewhere, explaining that this time it will work because they’ll do it right or “different.”
Lots of people have mentioned that the AI debt bubble is not at all the same compared to the subprime mortgage bubble.
And they’d be right to a certain extent…
Different assets, products, customers for sure.
But,
The risk and structure remains just about the same:
$3.7 trillion of AI debt, representing 11.3% of GDP today
$1.5 trillion of mortgage debt, representing 10.3% of GDP in 2007
Just like that burst, a lot of the banks and private equity/credit funds that got tied up in the mortgage bond packages needed to offload massive amounts onto someone else.
Also known as risk transfer.
Wall Street is now leaving your pension, savings, and insurance money to hold the AI loans with over 65% of default probability baked into the current price.
As you know, when America sneezes, Asia catches a cold.
That’s why I want to be positioned when hundreds of billions are pushed out of South Korea’s and Taiwan’s AI-driven stock market to look for a new home.
That home is likely to be Chinese equities.
Look at every S&P 500 bear market, with 2022 being the most recent one, and notice how China’s stock market outperforms the U.S. during those times.
If you believe this current rotation out of AI will continue and accelerate…
Then you want to be positioned where money is headed next.
I’ve given you a domestic name already.
News
Citigroup Moves an Equity Business to China to allow domestic and international clients more direct access to their equity market, and as only a fraction of the population buys equities, we could see a trillion-dollar inflow to China’s stock market soon.
AI Agents Run Rogue Inside banking customer accounts, doing more than they were initially asked for, extending to fraudulent activities and excessive risk-taking.
Norway’s Sovereign Wealth Fund lost over $30 billion this week in their concentrated AI portfolio, creating another exit risk coming from the world’s largest fund of its kind.
Anthropic Spreads AI Doubts as its recent prospectus showed an $80 billion loss and halving revenue growth, showing that they will be well below 50% of their initial guidance yet still looking for a $2 trillion IPO value.
Movers & ES Levels
Southwest Airlines 📈 Rallied by 5.4% after demonstrating a customer willingness to keep spending on travel despite higher fares, as well as cost management discipline on rising fuel costs.
SAP 📈 Gained 3.5% after beating quarterly expectations in this real economy software company, challenging pretty much every narrative that AI bulls have pushed out to the crowd.
SpaceX 📉 Lost over 9% after Elon Musk announced a potential merger with Tesla, a combination that may make sense for most fans of the technology and vision, but not so much for the banking and finance crowd.
Micron 📉 Slipped nearly 5% after the AI-related credit risks begin to spread into other areas of the sector, where the memory complex is increasingly at risk of running into a margin collapse.
Now let’s get into some ES levels for today.
Yesterday I warned you that the auction was in the seller’s favor, and to tread lightly around $7,700 as we could see a ram through.
And ram through we did.
Now we’re sitting at a previous aggressive buyer range surrounding $7,685 where another small round of aggressive buyers have been supporting.
Sellers know this, and the rotation momentum is on their side.
However, I don’t think these buyers will let that level go that easily today.
Especially it being Friday, usually this is when dip buyers are tricked into stepping in to fill the damage done by aggressive participants.
If this is going to be you buying the fixing…
Then keep $7,685 as your entry range, and consider that you may only get a move to $7,700-$7,715 with $7,750 as your best short-term scenario.
If you did not sell $7,750 down to $7,685 like I told you this week, then today should be your day off, as chasing this after the fact could end up in trouble for you.
Portfolio
This week has been busy in the market and our portfolio.
Recent PMI picks, and a boring micro-cap company have driven most of our returns recently, outperforming the S&P and the AI complex while at it.
I continue to expect a few more points of upside in the PMI watchlist picks going into the end of the month, while that micro-cap company pick will likely carry the bulk of our year-end returns as a “home run.”
Not only is that stock up over 15% in a day, we are also engaging in monthly cash-secured put selling for additional cash flows and returns on our deployed cash.
While everyone else is focused on surviving the AI dips, and concentrating more of their capital into hopes that these dips turn into new highs…
We are going to focus on areas where all of this noise is likely to move past, and where capital will be headed next for more attractive risk-adjusted returns.
I look forward to the rest of the year with you.
Here’s the positioning update for today’s premium members:
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