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Good morning partner,
Few things to cover this morning:
Last Week’s Session
Really mixed session overall, with the market pushing higher to close near an all-time high again.
Most of this move, however, seemed to come from the concentrated push in the AI constituents like communications and semiconductors/memory.
This is one of the two types of days we’ll keep seeing in this market, and the ones I’ve been covering in recent weeks. A tug-of-war between AI concentration and real economy rotations.
I had started to think that the orderly rotation would have been the ultimate outcome, keeping market drawdowns contained at 10-15%.
Now, after some research into the dispersion trade (posting today after the close), it’s become evident that we’ll just continue to grind higher in the S&P and the overall AI trade.
Until one of the many headwinds comes to break the finance plumbing that’s fueling everything underneath, especially capex.
Stay tuned for that post later today.
Let’s take a look at last week’s leaders and laggers:
Materials, Technology, Industrials.
These are all AI-related bids happening to push the market into all-time highs, the concentration that continues to further entrench itself in the tug-of-war.
I think some nuance comes from the fact that communication services ended the week in the red, while this was very clearly an AI-led week.
The reason is that these three leaders are the ones seeing the cash flow right now, reporting capex spending and NVIDIA’s circular equity financing as gains.
Meanwhile, communications are doing most of the spending, and some arguably holding the bag on unsold equipment like semiconductors/memory chips.
Such behavior has been noticed a few times this quarter, so I will dig further into the capital cycle for the broader sector and deliver you with a proper insight to follow along this new divergence.
What matters is cash flow, who is accumulating it and who is burning it.
Funding AI
Everyone knows there’s a computing shortage, and it has been mostly underwritten by now.
Otherwise, why did most AI stocks go on 200-500% runs this past year?
What most have not underwritten for is just how much capital is truly needed to win this race altogether.
China is raising roughly $217 billion this year to build their AI infrastructure (versus $1.4 trillion in the US) while still achieving similar results in terms of inference and compute capacity.
Even more telling is how the debt is being issued in China as compared to the US.
Chinese corporate AI debt carries ~2% yields (investment grade)
US corporate AI debt carries ~5% yields (near junk status)
The reason for this divergence, I believe, is that US debt going into AI is coming from negative FCF, and is rather large compared to how much these AI models can deliver.
Let’s zoom out for a bit…
A $20-$50 subscription in these AI models (which is over 90% of users) can only bring in so much money. So far that’s an estimated $300 billion in annualized revenues.
OpenAI and Anthropic have racked up over $6 trillion in commitments at this point, 20x the revenues they bring in combined.
With token prices falling by 40% since May, these companies must now 2.5x their volume (or prices) in order to catch up to that old 20x curve.
Again, there’s only so many people in the world that will sign up for a $20-$50 subscription rather than use the free version of AI models (which is, again, most of the world’s population.)
All this to say, Chinese debt is trading as safer than the US, because they are actually underfunded on purpose as they let the dust settle.
News
China Holds 97% of the humanoid market, according to shipping volumes. Think about this the next time someone pitches you on a robotics theme, and be careful about promises versus actual results.
Copper Hits $14,000 as commodity traders bid metals, showing the consensus has shifted to a Fed that will shy away from hiking rates and rather ease conditions. Eyes on this bet deepening across asset classes.
TSMC Sales Jump 45% as hardware demand continues to rise, the compute shortage continues to be a theme for the space, shifting the market’s attention to the supply side of the equation.
Brazil Cuts Interest Rates Again to draw down on its real interest rate levels (highest in the world) to also create the necessary backdrop for consumer and banking stocks to make a new wave higher.
Movers & ES Levels
Airbnb 📈 Is up over 17% after reporting a strong quarter, one of my biggest takes on this company is how they’re slowly becoming a credit house, with a rising share of interest income making up their operating results.
Software Stocks 📈 Push well into the double digits after strong earnings from Atlassian, Twilio, and others. The “AI will kill software” narrative is dying in real time, and the Offside Portfolio is benefitting from it all.
Under Armour 📉 Lost 4.5% after a weak quarter, reiterating my thesis on premium names taking over the consumer. This should be helpful for our Lululemon & ON Holdings thesis.
Akami Technologies 📉 Saw a 6.8% decline despite announcing a $600 million cloud contract. I suspect markets aren’t rewarding a good share of these OpenAI centered contracts, knowing that they likely won’t get paid.
Now let’s get into some ES levels for today.
Low volatility on Friday has kept the outlook identical for today **
$7,750 was taken and supported as expected from yesterday’s take.
It now seems that a lot of passive buyers have come in at $7,725 as well to continue to support the move higher, understanding that volatility is overdue to creep in for the market soon.
Which is why these buyers were so passive, understanding that a volatility breakout could quickly bring them to the below distribution starting at $7,620 or so.
This is preemptive risk management on their part, but also gives sellers the opening they would need if they truly want to step in with some aggressive selling.
As we’re prepared to get the NFP print here in a few, I believe this is the volatility that is being anticipated (at least in the short term.)
I believe $7,780 remains the cutoff point on the upside where business is just not getting done, drawing price away from that print.
On the downside, things become a bit nuanced here as the market seems to be in some disagreement.
$7,630 - $7,620 marks the mid-point between a “P” shaped profile running up to $7,750 and a “b” shaped profile running down to $7,450.
Very rarely do we get these symmetrical double distributions, and it typically signals the markets are “okay” with either move as conviction remains low.
Based on everything we’ve covered above, I would also think there’s lack of conviction here.
Portfolio
The portfolio remains near its all-time highs.
Right now, we still carry less than 6% annualized volatility with a net return of 11.2% so far into our first quarter.
That’s nearly a 2.0x Sharpe Ratio.
Believe me, keeping your volatility under control will be paramount in the second half of this year, lest you want to end up like most Twitter investors celebrating a ~30% swing on their accounts last week due to AI rebounds.
That’s not something to celebrate, it’s a symptom of overleverage and concentration.
I obsess over risk so that my portfolios (and yours) never blow up.
It’s what keeps you in the long game.
For $2/day, you can see firsthand how an Ex. Goldman Sachs analyst approaches each trade and idea, and more importantly how they are implemented in a portfolio.
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