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i-squared Wealth Management Inc. Market Update
We are not bursting the AI trade; we are bursting leveraged investors. Bursting leveraged private equity, credit, and real estate investors has been ongoing and will continue. Since the summer, we have been bursting levered public equity investors. It started with Korean retail investors. It then spread to hedge fund Situational Awareness. In October, it hit other leveraged funds and hedge funds including some major hedge funds giving up their entire yearly gain. This will continue. While index volatility has not been that high, volatility among AI names has been historic. The absolute moves of both 3% and 5% have never been greater. Greater than the dot.com bust. The tech momentum factor has collapsed 65%! This is greater than the dot.com bust. This type of volatility will make it really hard for leveraged investors to participate. It will also make it very hard for investors focused on Sharpe ratio to participate. There is a lot of money to be made in the AI trade. The semiconductor ETF is up nearly 50% this year. Many single names are up north of 200% YTD. No reason to be greedy. This is a generational opportunity; leverage is not necessary to make great returns.
While hedge funds sold tech stocks at a historic pace in October, the fundamentals continue to strengthen. Both DRAM and GPU prices continue to move upward. Elon Musk said on SpaceX’s earnings call, “I think it should be obvious to people really is that as you improve the AI software, as the models get better and better, they're able to you get more useful intelligence per watt. And the value of that compute is proportionate to the useful intelligence per watt. And that's why you see things like even old computers like H100s renting for more than they rented when they were new. And I think that's likely to continue. I think we're going to face a shortage of superintelligence compute.” The point that the value of compute staying strong is an important one. It incentivizes the cap-ex spending to continue. Anthropic said that they get 2.08x revenue per dollar of compute. Cap-ex spend will run well north of $1.5 trillion next year, up from about $1 trillion this year. Goldman expects total AI spending will total $7.6 trillion through 2031!
On financing, we saw a number of deals during the month. Meta announced a $95bn equity offering. SpaceX announced a $40bn debt deal led by Apollo. OpenAI is close to raising $30bn in financing led by the UAE. Anthropic will IPO in November. Anthropic has over $100bn in cash on its balance sheet. Even neocloud Nebius secured a $3.5bn facility from Citi at just SOFR + 275bps. IREN raised $2.4bn. There are many sources of capital, ranging from sovereign wealth funds, private equity and credit which are sitting on over a trillion in dry powder, there is over $8 trillion in money market funds, investors shifting priorities from financing things like commercial real estate to AI financing, and there will be a new securitization market that will allow many pension funds, insurance companies, and endowments to participate.
Western Digital, a middle to lower end memory provider, reported earnings that easily beat, while raising guidance. They said that they have good visibility with their top seven customers out to 2030 and 2031. SK Hynix said that they expect a 40% CAGR through 2030 on AI datacenter revenue. We heard similar commentary from Seagate, SanDisk, GE Vernova, and Celestica. The point is that this is not a normal semiconductor cycle, at the very least it is very long cycle with the potential to be a secular shift. Micron said at a presentation during the month that agentic AI will require 30x the memory, and greater than 10x for physical AI. Elon Musk said that “robot RAM will exceed everything else on Earth.” You are getting these stocks after the correction at good prices. South Korean exports rose 105% year-over-year in October, but the valuation of the semiconductor stocks is at record lows. Across the large semiconductor names, you will find stocks trading well below 1.0x PEG, many below 0.5x. Something will have to give, either AI is a bust and the valuation is correct or these are significantly undervalued.
While the Fed paused rate hikes at this meeting, it is not done tightening. The market expects the Fed to raise rates in December and likely one more time in January. The good news for investors is that the market has already priced in the tightening. The two-year Treasury, a proxy for Fed policy, is trading 80bps above the current Fed Funds Rate. Financial conditions are the tightest since 2022. Anything cyclical, rate sensitive, or consumer facing has been crushed in the stock market. If the Fed tightens anything less than 80bps, financial conditions will loosen, which will fuel the next rally in rate-sensitive areas.
Looking forward the market will focus on AI, earnings, midterm elections, geopolitics, and the latest economic data.