These Two IPOs Could Decide the Fate of the Market Rally

The markets were up modestly last week with the Nasdaq leading the way with a gain of .9%. It was not a broad-based rally and one that left out the small caps. The Russell 2000 was off just over 1% last week.  Given the macroeconomic and geopolitical backdrop, it is more than impressive that this rally has continued as long as it has.

It does seem there has been some progress in restoring a large chunk of the pre-war flows of oil, LNG and other commodities and refined products through the Strait of Hormuz. That said, hostilities flared up again over the weekend and there is still a significant deficit compared to where global supply chains were prior to this conflict. This deficit is being compounded by an escalating situation in the Ukrainian war. Russia has suspended diesel exports as a result of numerous refineries in the country being hit by increasingly sophisticated drone swarms and cruise missiles by Ukraine. Diesel spread cracks reached all-time highs last week. The Strategic Petroleum Reserve is now down below the 300-million-barrel threshold. There is a significant debate on how low these reserves can go before they start to damage the sixty salt caverns thousands of feet below the surface in Texas and Louisiana that make up the strategic petroleum reserves.

And the equity and credit markets are sending completely different signals to investors. Nvidia Corporation (NVDA) crushed expectations last week with its quarterly results and boosted guidance.  However, the stock only rose a bit over 2% last week, despite these robust numbers. Worries are growing about the increasing use of circular financing and off-balance sheet liabilities the tech juggernaut is taking on. The credit default swap prices against the company’s debt have doubled since May.

The situation is worse at Oracle (ORCL) where credit default swap prices have recently hit record highs and S&P Global downgraded its debt to one level above junk earlier this summer. The company has hugely increased its debt load as it builds 4.5 gigawatts of compute capacity as part of a five-year $300 billion deal it signed with OpenAI last summer. That has sent Oracle’s free cash flow deep in negative territory. A key reason the stock is down by more than half from its highs late last summer.  Even as the company continues to crank out solid revenue and adjusted earnings growth.

And here is the thing. OpenAI is bleeding cash and losing market share in token usage to much cheaper and rapidly improving open-source models from Chinese alternatives. Not coincidentally, a lot of these market share gains have occurred after OpenAI and its U.S. competitors moved to usage-based pricing in Q2.  The company has also had a rash of high-level executive departures, quite unusual for a company pushing toward a massive initial public offering. 

And this massive capital raise must be executed for OpenAI to be able to start paying Oracle $60 billion annually starting next year. I personally believe Anthropic will be able to go public in September or October, which may help sustain the market rally.

I expect, however, increasing questions around whether OpenAI will ever be able to do the same in the coming months. Given this would have huge ramifications, this would have on the U.S. economy and equities, I also expect chatter around a potential bailout for OpenAI to potentially pick up markedly after the November mid-terms. All in the interest of “national security” in the race for AI supremacy against China, of course.

With the market trading at extreme valuation levels viewed from a historical lens, I am increasingly uncomfortable that so much depends on the success of two massive IPOs.

At the time of publication, Jensen had no position in any security mentioned.