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Good morning partner,
A few things to cover this morning:
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Yesterday’s Session
The tug-of-war is beginning to shift into the AI complex and away from the defensive real economy.
That’s due to last night’s AMD earnings lifting most of the chip trade, and by default everything else that has to do with the broader AI buildout and constituents.
However,
I believe that this will be shorter lived now that the midterm elections are out of the way, and a Democrat win poses a direct threat to the current optimism around data centers and other extended themes in tech.
Why?
Texas represents ~20% of all data center projects, and the Democrat mandate points to helping the population keep:
Utility prices lower
Rent prices and property prices under control
Grid and infrastructure integrity
All of which can and would be solved by slowing down or outright canceling some of the biggest data center pipelines in the state.
Then comes the financial implications…
Democrats have made it clear there will be no bailout money or any sort of aid to help the AI buildout continue through government intervention.
Which comes at probably the worst time in this buildout, especially as Anthropic’s S-1 filing showed all these loans are going to go unfunded.
$3.7 trillion of them.
Zooming out, economic data already points to a case for rotations into defensives and away from AI as:
GDP shifted into defensive business and consumer spending
PMIs have begun their rotation as well
Credit is tightening and yields keep rising
Combine all of that with the fact that the S&P 500 looks eerily similar to previous “lost decade” episodes.
If it talks like a duck, walks like a duck, and flies like a duck…
It’s probably not a chicken.
After studying 36 countries for over 50 years, I have landed on the two areas that tend to outperform during these lost decades.
Let’s take a look at yesterday’s leaders and laggards:
Basic Materials, Technology, Communications.
Clearly this is the culprit of the AI trade rebounding from the AMD earnings lift.
As that has been explained, I am more interested in knowing what the market decided to bid outside of anything AI-related.
Seems like the choice mix of financials, cyclicals, and defensives all point back to the rotation thesis I have been pointing you to for the past month.
More importantly, it does begin to confirm the economic growth shock view that’s been building momentum in the background so far.
Where the AI growth shock then feeds back into the areas where the economy is clearly beginning to break out in activity.
Just yesterday, we saw the benefits of that selection through our investment in Vital Farms (VITL.)
Even through a depressed consumer, tight budgets, and the Iran war continuing to disrupt input costs…
This company demonstrated why picking areas with disconnected expectations tends to pay off.
If this defensive AI-proof rotation continues, I expect our other watchlist names will begin to earn their place in the portfolio and deliver similar returns.
What Comes Next?
What happens when input costs keep rising along with expanding production and new orders?
You get an economic contraction in the cyclical areas of the economy.
That has been the case for as long as the Manufacturing PMI index has been recorded, and carries a highly predictive relationship both economically and statistically.
Given we are back to such a scenario, I would expect the next six to nine months to throw the cyclical economy into contraction.
Which pretty much matches my view on the rotation away from AI and back into the real economy defensive areas of the market.
I’m risking sounding repetitive, but that’s okay, I’m here to deliver alpha not sound trendy.
Today we’ll get the second part to this update through the Services PMI index, where the most important gauge comes from employment.
After that is said and done, we’ll be able to deliver a watchlist on the industries we see as expanding/contracting from here.
Last time we did this, three out of three picks ended up turning a profit for the month.
Time to do it again.
News
Trump Eases on Iran Strike Threats after the election results, materializing my catalyst behind the diesel crisis and my long/short equity spread trade. Here are the mechanics behind that deal.
Meta Looks to EU Bonds to keep financing its aggressive AI capex, a decision that comes as U.S. financing becomes too costly for its own good. In the end, this is simply spreading the contagion risk globally.
Apple Points to a Margin Squeeze amid rising memory chip costs and a mixed sales makeup this quarter, this is a proxy for the oversupply thesis I spotted in memory, which may need another quarter or two.
Disney Enforces More Layoffs as another plan to cut roughly 20% of costs amid continued slowdowns and weakening profits in most segments. This stock has been cursed for over four years now, and I don’t see much of a way out of it.
Movers & ES Levels
Vital Farms 📈 Gained over 10% after posting an earnings print that directly demonstrated our original thesis is well underway to delivering our underwritten 200% upside from the execution price.
Coinbase 📈 Rallied more than 5% despite an analyst downgrade, which I believe is due to the recent Binance hacking, sending customers and assets to the next closest competitor, which is Coinbase.
Pfizer 📉 Lost 2.3% despite beating earnings expectations and raising the full-year outlook, which still disappointed the previous hype on healthcare AI and robotics.
Zebra Technologies 📉 Fell more than 8% even with an earnings beat, which I believe has more to do with the AI trade getting bid and hurting the software short hedges.
Now let’s get into some ES levels for today.
This is why I wanted to sit it out yesterday, despite having the $7,500 level clearly in my sights.
I still would let this market simmer and absorb the news of the election results and how it may affect the rotational trade that’s brewing here.
For now,
The key level is still $7,700 as the cutoff point for the monthly distribution, with an initial 50-point range up and down as tradeable opportunities.
Keeping this vague for now as I personally would not trade until the print becomes structured again.
Which, as counterintuitive as it sounds, is the better thing to do during aggressive balance expansion days like these.
Portfolio
We will likely see some performance shifts today as the AI trade gets bid.
While we still have some long/short exposure into AI infrastructure names, most of the driving forces in the portfolio are now centered around the diesel price normalization and the defensive rotation.
That’s going to be working back and forth as the market decides what to do post-election.
From here, there are only two things I will do in the short-term future:
Roll out the short put positions for a paycheck this month
Restructure my put spread trades around the memory complex into next year
Apart from that,
The Services PMI print today will lead me to a finalized watchlist to trade through the month.
Premium members will receive that watchlist over the weekend.
Here’s the positioning update for today’s premium members:
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