Compute Rush
We are entering a new era in terms of artificial intelligence where compute power is becoming a valuable commodity. History has shown us in the past; a first mover advantage is visible to the entity who owns the commodity in demand. This is what is currently happening as mega-scalers are spending a vast amount of capital expenditure to secure what is needed in terms of data centers.
It will be quite interesting to see who wins this fight and time will show obviously, but the question that arises like every time something revolutionary comes through; is all this spending excessive or will it result in adequate earnings? I believe no one knows the answer but the market is taking a more bullish view into this matter as every time a capex announcement is made by one of the mega-scaler technology companies, it’s stock price rallies. The market is not penalizing, at least for now, increased capital expenditure that might or might not result to a necessary profit target.
But let’s see what happened in the market this week. In terms of data, it was quiet as the US government shutdown implies limitations to what the statistical department can offer. There was a headline pointing out that the BLS department, responsible for providing the data, has asked some of its employees to return to the office so they can provide the September CPI number. For the time being, the market does not associate any risk premium that portraits data uncertainty and it is still pricing almost 2 FED rate cuts by year end. (see below table)
In the US, yields have taken a breather this week with 10yr government bonds wrapped around 4.1%. The US equity market continues its upward trajectory with technology companies leading the rally. NASDAQ is trading circa 1.5% higher in the week with everyone expecting to see how MAG 7 will perform in this earning cycle. In Europe, political instability has risen in France post the resignation of PM Lecornu. There have been renewed efforts to avoid the dissolution of the parliament and by default new elections. The OAT-Bund spread (the yield differential of French -and German 10yr government bonds) has traded as wide as 89bps but post the news that would avert a new election is wrapped around 82-80bps. May I remind you that a few years back this pair traded at a spread of 30-35bps, so the market is
attaching a significant risk premium due to the French political instability. On the European equity side, the market is stable this week with no significant moves. The market is expecting to see any further strength on the earning cycle as European companies trade in a meaningful different way vs the US, mostly because the AI boost is not there. EURUSD has taken another leg lower to 1.1575, breaking the 1.16-1.18 range we have seen for the last few weeks. I guess it is a combination of negative news from France and some consolidation of positions given how crowded trade this is. Gold has broken the $4000 mark this week and it is currently trading just below that, continuing its fantastic positive trajectory this year. It has been a great diversifier in portfolios this year and has added meaningfully to returns, something which we are happy to say that we have experienced in our Athlos Balanced Strategy AMC.
On the geopolitical side, Israel and Hamas have agreed to terms for the release of all hostages as part of a US/Qatari brokered deal to end the war. This agreement is a major step towards ending the conflict and redesigning the political landscape in the Middle East.
Looking ahead…
On a forward basis, it is unclear when we will be getting a concrete set of data which may define the FED rates cut trajectory. We expect fewer surprises as the market is heading for its final run for the year. It has been a long and very exciting year to trade, full of opportunities and we are going through an AI revolution that will change not just the market but all our lives. On the fundamental side, next week will kickstart an avalanche of earnings results which will define the last mile in terms of price action for year end. I remain an optimist and I believe the risk is to the upside for next year as the market is not “long” enough on the equity side.
Written by: Michael Konstantinou, Senior Portfolio Manager
Source: Bloomberg
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