Ugly October, Better November?

Friday capped off an ugly month for the AI trade, and realistically, we topped in June, which at this point, was a while ago. For the month, the AI ETF (BAI), was -18%, while the Consumer Staples ETF (XLP), was up 11%. Quite the dispersion. Is the AI trade dead?

I still don’t think so, as the vast majority of signs point to a lack of supply meeting incessant demand. Big tech problems were more about soft search numbers, while AI business looked great. AI worries are more about financing it and getting an ROI much more than demand just disappearing. Thus, when something like SK Hynix (SKHY) is down -8% on Friday after talking about incredible long-term demand and having already been about 17% off highs, there’s probably something else going on.

I think the real problem is positioning. There are a number of entities levered long on tech. When one of their picks goes too wrong, their other names also get sold. Effectively, it works like a carry-trade crash. I’m hearing rumors of multiple hedge funds being liquidated and chat forums seem replete with panicked sellers. It may not help that the end of October is the last day for mutual funds to book losses, and recent AI buyers have plenty of losses they can take.

When does it end? Some may remember I thought last Thursday had been a possibility for AI selling to end. On Friday, we opened around that level and went below, so that idea is out the window. Next week is a new month, where institutions reallocate, so next week seems like a reasonable time to think we may turn around. October is a big month for a lot of funds, and something as simple as closing the books on the month can remove some motivated sellers.

Again, I think macro problems have peaked, though they haven’t been going away quickly. For instance, rates look like they peaked, this month, but it wouldn’t take much to restart the fear. The story is the same with credit spreads, oil, and inflation. The fear peaked but hasn’t gone away. Obviously, some sort of deal in Iran or Ukraine would be helpful.

Given that, it shouldn’t take much to get a bid. I’d bet we mostly just need to run out of sellers, like in a traditional carry-trade blowup. There’s reason to believe that could happen soon, but we’ll have to see. The chart above, from Steno Research, shows Friday’s selling was the biggest de-grossing since the data began in 2016. At this point, if we don’t see a bounce next week, we’ll likely have to raise cash in response. At some point, you have to defer to market action.

For people who haven’t been with us for very long, I’d point out that almost all of our AI trades were created last year, though, to be fair, we did buy Oracle (ORCL) this year. Some of our current stress is because we were reluctant to be overly aggressive taking short-term gains, as the tax hit was large. That issue is now gone, at least for clients who’ve been with us for a while, and given AI demand still seems present, we’re hoping to wait for better prices before trimming or selling.

Ultimately, we try to look out a year ahead, in the hopes we can largely get long-term gains, for the great majority of our buys. Instead of buying AI stocks, our latest buys have tended to be more of a mix of quality growth and value. This is because we’re concerned the growth of AI investment may slow next year, making AI investment unattractive at high valuations.

Note the two key words in the above paragraph are “may” and “high.” We don’t know for sure that AI spending will slow. Thus far, there’s no sign of an AI slowdown. The current numbers indicate a real possibility of a slowdown, but that can definitely change. For now, predicting the death of the AI trade would be based on very little data. We also no longer have the high valuations of June, near where we were trimming. The BAI ETF is down 29% from highs, those high valuations aren’t in the room with us, right now.

One thing that has made me think about waiting for better times is the idea that “tops are processes,” an idea even favored by relatively staid market observers like John Hussman. While the idea of optimism may seem long-dead to tired AI investors, the basic business still looks solid. Sentiment can change rapidly with price. As usual, we’ll see what happens but from here, it seems reasonable to push against AI pessimism. There could be more gas in the AI tank.

Employment Costs were nothing exciting, at 0.8% m/m, as expected, which is a modest slowdown from last month’s 0.9%. That does get Y/Y to 3.37%, the least since 2021, which should be encouraging, as the Fed supposedly looks at this metric closely. Labor costs don’t seem to be an issue for companies.

Chicago PMI was 55.3 vs. exp. 56.1.

Oil is -4% after no escalation took place over the weekend, and talks continue.

Steno Research says Friday’s long/short de-grossing was the biggest since data began in 2016. That implies quality names are being tossed out, most likely.

The Nasdaq 100 (QQQ) finished October -6.66% on the month. Seems fitting.

Korea’s Kospi index was up 2%overnight, from a -1.5% open, as markets bounce back from the tech wreck.

Manufacturing PMI today. We also have AAPL reporting tonight.

Bottom Line: As the calendar turns, we’re seeing stocks bounce back.

Click here to schedule a meeting — I’m here to help you take the next step toward financial freedom.

Disclosures/Regulation:

This content is intended to provide general information about Lloyd Financial. It is not intended to offer or deliver investment advice in any way. Information regarding investment services are provided solely to gain an understanding of our investment philosophy, our strategies and to be able to contact us for further information.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Past performance is no guarantee of future returns.

Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy will be profitable

Want a clearer view of where you stand? Schedule a free portfolio analysis.