AI Disruption Is Taking its Toll in the Credit Market

My biggest concern for equities is the AI “disruption” story and the risk that the credit markets will really start leading the way.

We have seen CLO equity and BDCs hit so far, due to their holdings of leveraged loans. That is starting to slip into more senior credit and even the leveraged loan space itself — like (BKLN) . I’d avoid leveraged loan ETFs at this stage, and would be very careful even on ETFs that focus on highly rated tranches. I have zero fear of defaults at senior tranches of CLOs, but default risk isn’t the only risk. If investors get nervous, and start selling, we can see price declines again.

So far, I think credit in the AI “disruption” space has been following equities. There is a risk that credit now takes the lead. That credit does worse, making it difficult for equities to rebound.

This is a case of selling what you can, rather than what you need. Private credit is locked up. This also has the potential to put some pressure on banks.

So, I am cautious on credit and equities (away from a potential relief rally).

Middle East

My base view on the Middle East (while working with many retired generals, admirals and former CIA directors) is:

U.S. and Israeli intelligence was even better than people thought. Military execution has been superb.
Iranian intelligence and military execution have been subpar, at best.
Iran trying to drag the rest of the Middle East against the U.S. failed. The rest of the Middle East really just wants to move on to trying to become the data center capital of the world. They will not let Iran disrupt that.
At some point, someone fills the power vacuum in Iran, who is desperate for power but also wants to be alive (along with his family) in a few months and tries to broker some sort of a deal. I'm thinking this is more like "Venezuela 2.0" than “regime change.” The U.S. president himself has said that dismantling the infrastructure in Iraq was a mistake. This seems like a plausible off ramp.
I am watching the strait for any more “permanent” disruption of passage. That would be mines, or sunken ships, so that shipping cannot return to “normal” sooner rather than later.

I remain constructive but increased “nervousness” on is warranted.

Oil

The key focus has been on anything that would more permanently impact traversing the Strait of Hormuz. It is clearly not being traversed right now, but that should be largely priced in.

The start of the campaign was very positive, but it is continuing and seems to be escalating. There have also been some tragic events for the U.S., which are concerning, given how incredibly well the initial strikes went.
I continue to think we will see lower crude prices, even as early as Monday, but the risk of extended and higher prices has increased in the last 24 hours. That's something I’m keeping a close eye on, but it has not yet changed my view that you should be taking profits, reducing positions in the oil space (the commodity itself more than the companies, but even there it has been a great run, and this Iran spike, is still more likely to fade, than increase dramatically for longer).
China has a large stockpile and the U.S. inventories are in decent shape, which I think give us time (weeks, not days) before this has real permanent damage.

Rates have little to do with oil and higher inflation expectations.

Markets priced in a “risk off” premium in treasuries, which was accentuated by month-end index buying in the bond world. Look for ongoing weakness. Also, I think the expense (and potential borrowing) to rearm the military will weigh on bonds.

On equities, the reaction is warranted, but if I was going to discuss equities, I’d still spend more time on the AI “disruption” story as, unless this goes really pear shaped, the AI “disruption” story is going to move the American economy and markets more than the events in the Middle East.

We can only hope for the safety of U.S. and allied military and civilian and truly hope that my relatively optimistic outlook on the situation turns out to be the correct analysis.

At the time of publication, Tchir had no positions in any securities mentioned.