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i-squared Wealth Management Inc. Market Update
Margin calls, positioning, de-grossing, options, rebalancing, and technicals dominated the market action in July. The epicenter of the action was Korea. Before the last day of the month, the KOSPI was on pace for its biggest monthly drop ever, larger than in 2008. Korean investors entered the month highly levered both Korean stocks and US tech stocks. The volatility in tech stocks during the month caused a lot of pain for them. According to Goldman Sachs, 1.2 million Korean brokerage accounts were hit with margin calls. Approximately 320,000-360,000 accounts were fully liquidated in Korea. Approximately 3.4% of the Korean population got margin called. To put this in perspective during the 2008 crisis 1-5% of US retail accounts got margin called.
July was a reminder of how important understanding market structure is for investors. Much of the volatility during the month was exacerbated by market structure. Multi-manager platforms (pod-shops), levered hedge funds, quant funds, options traders, and retail now dominate. Coming into the month this cohort was very long AI infrastructure stocks and short certain large cap tech, software, and equal-weight S&P names. As Korean investors got margin called, this created volatility in AI infrastructure names. Many AI infrastructure names were down 20-40% in just a couple of weeks. This caused a massive de-grossing / de-leveraging event for certain levered hedge funds, pod-shops, quant funds, retail investors, and CTAs. The current market structure allows for quick gains, as we have seen with AI infrastructure names, but it will take those gains away quickly too. Extreme volatility is here to stay. It makes understanding what kind of investor you are incredibly important so that emotional decisions are not made during these periods of extreme volatility. Understanding what these investors are long and short is also critical. It will help create a balanced portfolio so that you can ride out the volatility. Fixed income won’t hedge a 20-40% down move in a couple of weeks. Understanding what they are short and going to cover in a de-grossing event will help mitigate losses on the long side. Position sizing will also be more critical than ever. Finally, having conviction in fundamentals can go a long way to riding out the volatility and let you play offence during these periods.
This de-grossing / de-leveraging event is an opportunity for long-term investors in the AI-infrastructure names. Positioning has been cleaned up; we had the largest selling on record according to Goldman Sachs. We are going through a generational value transfer from hyperscalers and software to AI infrastructure and hardware. We remain in the early stages. Cap-ex estimates for 2027 continue to move up, now expected to be north of $1 trillion. The software companies are now confirming the value transfer to AI infrastructure and hardware. IBM preannounced earnings saying, “In the last few weeks of June, we saw clients shift their quarterly capex spend toward servers, storage, and memory purchases to secure supply-constrained infrastructure ahead of expected price increases. This dynamic impacted client buying patterns. While we anticipated some supply chain related impact in our expectations, we did not anticipate the magnitude of the capex reprioritization.”
The fundamentals for AI infrastructure remain excellent. South Korea’s semiconductor exports climbed by 181% YoY in July. Taiwan’s June export orders from the US rose nearly 84% year-on-year, the fastest pace on record. DRAM prices continue to accelerate upward. There is essentially no GPU availability. Taiwan Semiconductor raised cap-ex and prices. SK Hynix’s Chairman said that the memory shortage will worsen next year and could last past 2030. King Slide, an Nvidia AI server rail supplier, posted accelerating revenue growth of 220.5% year-over-year for June. Foxconn, a large maker of AI servers, reported its biggest year-over-year revenue growth this year (+52.11%), an acceleration for the month of June. GE Vernova’s order growth hit 88%. ASML said on its earnings call, “ASML’s 2Q reinforces our view that the AI-driven semi investment cycle remains in its early stages, with demand strength across both advanced logic and memory, and meaningful 2027 and 2028 orders already in hand.” The release of Chinese open-source model Kimi K3 likely accelerates the AI war between both the US and China and frontier models and open source. That leads to even more demand for compute and AI infrastructure.
This is not a boom-and-bust cycle driven by a PC upgrade cycle or a consumer electronic. This demand for compute is driven by digital agents that are working 24/7 365. We are just at the beginning of recursive self-improvement. We haven’t even gotten to autonomous vehicles in mass or robotics, which will require more than 10x the compute. The demand for compute is structural. With the correction this month, you are able to buy infrastructure names below their historical average and below the market multiple.
Looking forward the market will focus on the latest in geopolitics, earnings, economic data, and the Fed’s Jackson Hole meeting.