Are You Ready for a Stock Picker’s Market?
Seventy percent of active managers are trailing their benchmarks, and the pressure to catch up could trigger a focus on stock picking.
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Monday’s relief in the oil market didn’t last. The waiver on some Russia sanctions knocked oil down about 2% Monday, but crude is climbing again Tuesday morning, and the United States Brent Oil Fund (BNO) is up nearly 2% to a new high.
The Houthis have claimed new attacks on Saudi oil facilities, and shipping analysts count at least 18 attacks on vessels over the past two weeks. Any hope that the Russia waiver would ease pressure on fuel prices is fading fast.
There is also pressure on technology stocks overseas. SK Hynix (SKHY), the South Korean memory chipmaker, fell more than 4% in Seoul, and SoftBank (SFTBY) dropped more than 6% in Tokyo. South Korea’s main index lost more than 3% on worries about the money being spent on AI and the debt used to finance it. So the bounce in U.S. chip stocks Monday didn’t hold, and that creates a cautious tone as technology earnings season gets underway.
It is likely that strength Monday was due primarily to short covering and unwinding of defensive trades, rather than a belief that it was time to rebuild exposure to the AI trade.
SpaceX Tests the Buildout
Netflix (NFLX) and SpaceX (SPCX) both report after the close Tuesday, and SpaceX is the one the market will be watching most closely. It is only the company’s second report as a public company, and the focus will be on the debate that hit the AI stocks last week.
SpaceX is not just a space stock. It now runs a large data center business, renting computing power to AI companies such as Anthropic and Alphabet (GOOGL) to keep their models running. That business brings in billions of dollars a month, but it costs a lot to build. Capital spending jumped to $18.4 billion in the second quarter from $2.8 billion a year earlier. Investors expect heavy spending to continue on data centers, on the Terafab chip-manufacturing project and on the Starship rocket, with a reported $40 billion capital raise already in the works.
Monday, Amazon (AMZN) was rewarded with a 5% bounce because it can pay for its AI buildout out of its own cash flow. SpaceX is building at a faster pace and needs outside money to do it. Tonight will tell us whether investors are still willing to fund that kind of growth, or whether they will be concerned about the costs of endless capital spending.
There are some other wrinkles. SpaceX scheduled its call with only two business days’ notice, which is unusual for a public company. Morgan Stanley (MS) said in a note that it does not have a good answer for why. There is also continued chatter about a merger with Tesla (TSLA), which reports Wednesday, and questions about the Starlink service in Ukraine after the Ukrainian military said its access was throttled.
I am long SPCX for clients at Hammerhead Financial and will be watching for an opportunity to add to the position as the market digests the earnings.
Stock Pickers Need to Catch Up
The Wall Street Journal has an interesting piece Tuesday morning about fund managers who have been burned by the AI boom. According to Morningstar, 70% of active stock fund and ETF managers were trailing their benchmarks through Oct. 8. Large-cap managers started the year underweight AI stocks by more than 8 percentage points compared with the S&P 500, and that has been enough to put most of them behind the benchmarks.
Timothy Casaletto’s Vanguard Dividend Growth Fund is up 55% over the past four years, compared with 126% for the S&P 500. His doubts center on the same issues I’ve been writing about: rising borrowing costs for companies like CoreWeave (CRWV), and the pace of the data center buildout. “Will we actually be able to build data centers in as great a scale as the market thinks? If we cannot, that will be enough to take down this AI trade,” he says.
This is one of the biggest problems with the two-tiered market. It has rewarded concentration in a small group of mega-cap AI names and punished everyone who owned anything else. That has been extremely frustrating for anyone who tried to build a diversified portfolio of good companies.
Managers can only live with that for so long before the pressure to catch up becomes a market force of its own. With the end of the year approaching, they have two options. They can chase the AI leaders, which helps explain why the mega-caps have held up so well. Or they can focus on the many good stocks that have been punished simply because they aren’t part of the AI trade.
If the AI names stumble on earnings, the second option becomes far more attractive, and that could be the catalyst for the rotation I have been waiting for. Dispersion among stocks is near record levels, according to the WSJ, and much of that comes from the stealth bear market in everything outside of AI, so there is no shortage of beaten-down names for that money to go to. That is consistent with what I wrote earlier this month: The narrow market is more likely to resolve with the laggards catching up than with the leaders collapsing.
Game Plan
For now, the focus is on earnings and on whether investors use good news as an exit. If AI names sell off on decent reports, that suggests holders are looking to get out, and the rotation will pick up speed.
I’m intently focused on the price action and the charts this week, and I’ll be aggressively trading the reaction to the earnings news. The reports will produce opportunities on both sides, and I’ll let the market tell me where they are.
At the time of publication, Rev Shark was long AMZN and SPCX.
