Hello, my friends. Today is July 25th and this is Markets Weekly. All right, guys. I think we're on the cusp of some major turbulence in the financial markets. So, just by way of background, if you look at the major indexes, you can see that we have been basically been going nowhere for weeks and are very clearly losing momentum, losing some key moving averages. In addition, the background is of course one of great speculation. There's tremendous amount of public involvement, a lot of people pouring into triple levered ETFs, buying call options and so forth. And of course, we move past the VIX expiration, monthly OPEX, and so we're losing that support as well. Now, I think we're moving towards three major risks. First, of course, is that it looks like the AI trade is peaking. Secondly, it looks like there is going to be imminent escalation in the Iraq war. And lastly, it looks like the Fed is going to be hiking, maybe maybe even this week. All right. First, let's start with the AI trade. So, as we all know, the AI trade has been powering the major indexes for the past few months, even despite all the geopolitical uncertainty. Now, we all know that the big tech companies are spending hundreds of billions of dollars in building out their AI stuff. And the market correctly identified certain bottlenecks in the AI supply chain, like GPUs and of course like RAM chips, where you just can't make as much to meet demand. And so, uh the sellers of those products have been able to raise prices and reap record profits. So, if you look at the SOX index, been basically going straight up, but also note that it looks like it has basically V-topped. In addition, we've had some notable news failures the past couple of weeks. We had TSMC, ASML, major players in the AI story, uh give great earnings, very upbeat outlooks. you know, AI buildout is just so wonderful. It's going to continue for a who knows when. And yet their stock popped and then sold off. So, you have to think uh is the news as good as it gets? What else would it take to take the AI uh companies up the next leg?

Now, last week we also had a very concerning report um by Google, actually. So, Google earnings, first hyperscaler to report, well, was very good. Of course, Google is a very successful business. And of course, like all companies, management, you know, discusses with analysts, manages expectations, so that companies always beat, right? It's It's uh not a secret. So, what was interesting, though, is that Google marginally raised their CapEx expenditures. And yet the market punished them pretty harshly for it. So, after earnings, the stock was down 4 or 5%. Now, in the past, large AI expenditures by these hyperscalers would have been greeted positively by the market. The market seemed to perceive that these guys are investing in AI. AI is wonderful. They're going to do even better in the future. Uh but it seems like we're at a point where more spending on AI is no longer viewed positively, and maybe the market wants to see some more tangible results from all this AI expenditure. Now, it's also worth noting that Google, for the first time, reported negative free cash flow. They're making a ton of money. They have very good businesses. But of course, they're spending even more uh on building out AI stuff. And not just issuing stock, as Google has done, but also borrowing more in the debt markets. Now, when you look at the debt markets of the hyperscalers, you also note that the market is becoming a bit more skeptical and asking for a slightly higher risk premium in order to finance these uh these expenditures. So, the market The debt market is also becoming a bit more uh cautious on all this AI spending by the by the hyperscalers. So, we only had one big tech company report last week. In the coming week, we'll have more. But, the overall tone is suggesting that the market is becoming more cautious on AI, both the equity market and the debt market. And so, that tells me that we could be at a point where there's an inflection, well, at least temporarily, where maybe this AI boom is going to recede. Now, there are good fundamental drivers for that, of course. Like we discussed last week, it looks like the open weight models from China are becoming very competitive, and that's going to have significant amounts of impact on the closed-end models, Anthropic, ChatGPT, ChatGPT. And also, there seems to be some technological advancements from these uh Chinese models that's going to reduce demand for things like RAM. Of course, we know that in China, they are compute constrained because uh there is a constraint on them getting Nvidia chips. But, you know, that constraint seems to be feeding innovation, as is often the case. And if there's some kind of innovation that would change um how efficient AI models work, then that means there's going to be a lot less need, all things equal, for RAM and GPU. And that would be bad for the AI um AI bottleneck trades. I I would also note that some interesting developments is that you had Jensen Huang post his first ever um tweet on Twitter. And his tweet was in support of open weight models. So, as we all know, Anthropic and ChatGPT would love be a duopoly reap reap some duopoly profits and are also politically well connected. And so, they're trying to lobby the White House to ban these open weight models. And now, we see a countervailing force in Nvidia, even Microsoft and Meta, supporting open weight models. So, that I think is good news uh for the global economy, of course. Being having competition, having access to open weight models is going to reduce costs for everyone. and at the expense of these two duopolies which I'm sure they'll still be fine. In any case, the AI trade seems to be weakening.

Now, the second thing that is very concerning is that it looks like we have imminent escalation in the Iran war. Now, all the signs are there. So, the Wall Street Journal reports that there's been a surge of the military assets going to the Middle East. If you're on Twitter, you can also see that many open-source intelligence uh handles are also saying the same thing. Now, over the past couple weeks, there've been nightly skirmishes. The US has been bombing Iran nightly and and Iran has been shooting missiles at US bases and causing some casualties. Now, the war this time it looks like it's heating up because we also have the Houthis entering into the war. Now, this is actually fairly dangerous for the global oil market because if you look at this map, although Iran can close the Strait of Hormuz, a lot of oil has been getting out through the Red Sea. Now, the Houthis have basically been putting up obstacles to limit the amount of oil that can come out of the Red Sea. Specifically, Saudi oil tankers. It looks like they're willing to let some Chinese oil tankers leave. Now, this of course represents an escalation and it means that world oil supply trade world supply is going to be even more constrained this time around compared to what happened in March. And again, this is in a context where um the SPR has been drawn out a lot and we don't know how much more we can draw down from it. And so, if you look at oil prices, you can see that they absolutely surged up just shy of $100 on Brent. Now, there's strong indication that escalation is imminent not just from um the surging military assets, but also from commentary from from the president. So, there's a couple things that happened. So, a couple weeks ago, as many of you may remember, the president gave a primetime speech and he didn't talk about the war, he talked about um voting security and basically blamed foreign countries for interfering into the US elections. I didn't say that he actually won the 2020, um but he heavily suggested that. Now, that was a curious speech to give given at that time what people were thinking about was geopolitics. Now, Ian Bremmer had a very interesting take and his take is that what Trump is doing is that he is acknowledging that he's going to lose the midterms. And so what he's doing is he's creating a narrative to blame his upcoming loss on basically illegitimate election, foreign interference, and so forth. And so if he's given up the midterms, that tells you that he is okay with escalation because this escalation thing is going to cost them the midterms in a big way. Now, the second thing that's really interesting that happened was that he posted on Twitter basically telling Russia and telling China to stay out of the Iran war, warning them to stay out. Now, Professor Robert Pape is interpreting this as preparing for big as big escalation as he's warning everyone to stay out. So, it looks like this is going to happen. Now, I'm fairly certain that the outcome of this war is going to be the same thing as happened in March. Eventually, the US is going to have to give up the Um so, the conflict basically boils down to who controls the Strait of Hormuz. Now, there doesn't seem to be a diplomatic solution in this particular case because Iran is adamant that it must control the Strait of Hormuz. It's part of its new national security doctrine and the US just doesn't want to let that happen. Now, Iran has been attacked by two nuclear powers, Israel and the US, last year and this year. So, obviously, it's feeling insecure and it's trying to bolster its national security by having control over the Strait of Hormuz and maybe getting nuclear weapons. So, they're not going to negotiate on either of those things. They view that as an issue of survival. And the US doesn't seem to be willing to give, but honestly between the two it's pretty clear that the US is more willing to give um because it's just not that important to the US. And at the end of the day, Iran is really just asking for a dollar a per barrel of tariffs through the Strait of Hormuz, which many other nations have already said that they're willing to pay. Um for them, of course, if you look at a map, Iran is very far away. 90 million people, you have this foreign power coming in uh threatening to destroy and kill your civilians, killing your leaders. So, they have a tremendous amounts of determination uh to take whatever pain the US can dish out. And at the same time, uh the US is feeling kind of queasy when you have, let's say, 10, 15 people die in a war. But guys, you know, in war people die. Sometimes thousands, sometimes hundreds of thousands, sometimes millions. And if you want to fight a war, but you have you don't want anybody to die, you know, that's not how this works. So, the US has very low pain tolerance. So, it's pretty clear that they will eventually have to back down. Now, what could happen and what's been people have been discussing, the president has been discussing is maybe they might make a pass on this new nuclear facility target called Pickaxe Mountain. Maybe they'll bomb that. Maybe they'll try to take down some more leaders. And so, it could be a very intense bombing campaign. But at the end of the day, I think the market widely expects the president to taco, as they say. And I'm fairly confident that will happen. But again, between here and now and uh it could be S&P down another 10%. Could be more, who knows. Uh I think the market, from my observation, has been very, very eager uh to buy any news of a peace settlement because they've been trained so well over the past few weeks that um you know, the president is going to taco, he's going to tweet something, the market is going to go straight back up. That's what the market has been conditioned to and it's very, very eager to do that. Um, and I think that's right, but I think it could be I think it could be a bit soon because we haven't even seen the escalation yet and that could happen uh this week. Also note that of course Prime Minister of Israel, Benjamin Netanyahu, will be meeting the president on Tuesday and that usually precedes some major, major escalation.

All right, the last significant headwind that the market is facing of course is rate hikes. So, the market is pricing in at the moment two hikes, probably by the end of this year. And as you can see, the rise in oil prices has really been um really bad for the global bond market. Yields globally have risen significantly and if you want to get more technical, people would say that a lot of the increase in yields has been in real yields. Now, higher oil prices is something that affects everyone. The United States a little bit less than other countries, but if you're looking at, let's say Europe land Euro land or if you're looking at East Asia, these countries import their oil and they have central banks that are just focused on inflation. So, it's definitely going to impact the reaction function of those central banks and of course global bond markets are global. So, higher oil prices is pushing up global interest rates and that is very clearly not good for equity markets. Now, but for the Fed in particular though, the Fed is come con- coalesced into a house view that inflation is being driven by three factors. One is the AI buildout, two is tariffs, and three is high energy prices. Now, when we had that memorandum of understanding, oil prices had declined significantly. So, you could actually make a good argument, especially if you are a dove, that the energy shock is over, that was transitory, and we have to look through that. Can't do that anymore. The price is going up a lot. And you know, maybe it'll go up even further. So, you just you can't look through that anymore. Secondly, the AI build out, it's still happening. We have Google raising their CapEx. Maybe we have more hyperscalers are going to raise their CapEx as well. So, that's going to continue to be a source of inflation. Tariffs are still there. I think it's So, we had the tariffs last year. Court challenged it, but the president the past year rebuilt his tariff wall on sturdier legal ground. So, you know, that's probably going to be mostly passed through. So, that is something that I don't think is going to be a problem going forward. It's already in in the CPI levels. So, these two things, oil and AI are going to be headwinds for for the Fed. They're going to be tailwinds for inflation, push inflation up. So, the Fed is is I think it's going to have to hike. Now, here's the hard part though. When are they going to hike? So, and are they going to tell us? So, in the past, the Fed would not surprise the markets. They would always guide the markets to what they're going to do. At the moment, the market's pricing in 30% chance of a hike this coming week. 30% chance, that's that's not trivial. So, that's significant. And you know, Kevin is not going to tell you whether he hikes or not. So, um we can't really count on that count on his guidance anymore. Now, if he doesn't hike now, he can hike later. But then if you hike later, you are going to be hiking right before the midterms. And we know that the president doesn't like that. So, from my perspective, given geopolitical developments, I think it would make sense for them to hike this coming week. It because that would do two things. One is that it will show the world that we are a different Fed. We are willing to surprise the markets, so you better be careful. And it would do that in a way that is far from the midterms, so whatever turbulence that caused, you know, maybe we won't have to hike again in September. Should the equity market decline enough, then I think the market would take out the probability of of hikes. And so you won't have to be, you know, be hiking around such a politically sensitive time. So, I So, I I think we should be very cautious as to what we see coming out of the upcoming Fed meeting, and that will be risk negative. Now, the markets, especially long bond, actually traded very poorly. I continue to like it a lot. I think that um gosh, guys, such high yields um at a time where you have uh I think potential for significant equity downside is attractive, but I I have to say that it it doesn't trade very well. And so that could also be another reason why you could have downturns in the markets, whereas you can have maybe some misbehavior in the bond market. Now, to be totally clear, um there's never never going to be an implosion of the bond market. The bond market is controlled by the government. If we had disorderly behavior, the authorities would step in, they would stabilize it. So, guys, that's not going to happen. Um but um you could still have volatility that is unhealthy for the equity market. All right, so that's all I prepared for today. I will be back after the Fed meeting to uh talk about what I thought. Who knows? Maybe we won't even have a press conference anymore. Kevin said he doesn't like talking to the press. Maybe he has nothing to report. But I do think that this is a time where we have to be very cautious in the equity markets. Doesn't mean we're going to crash. Could just be a correction, maybe down to the 200-day moving average around 7,000, we have all the crazy people come in and buy it again. Um but I I do think we should be very careful. All right, talk to you guys soon.