The End of 'Free' Money

Last week we talked about rotation and our concerns the worst was not yet behind us in the AI space. The "pAIn" did in fact continue, with the Nasdaq 100 leading the way down more than 3%. There was some further “rotation” as the S&P 500 dropped 2% and our favorite way of expressing rotation, the S&P 500 Equal Weight, dropped “only” 0.9%.

While many of these topics were discussed over the last two weeks, I want to focus on 'free' money today.

'Free' Money

What do I even mean by 'free' money?

When you announce that you are going to spend X and your stock price goes up by more than X, you have generated 'free' money.

If you say you are going to spend $10 billion and your stock goes up $15 billion, it seems logical that your next move would be to announce even more spending.

There are two main areas where we saw this playing out:

AI, Data Centers, Hyperscalers, etc. 

Commitment to building it out (the "build it, they will come" adage) is no longer being rewarded. Simply announcing more spending is not translating into increases in share price. 

Is the next step companies scaling back their spending? Will their stocks be rewarded if they do? Something we will think out loud about in a bit. 

This spending has been such a big driver in the economy, it could slow the economy. While on the surface, shareholders might be expected to reward companies for smaller spending (reverse the recent trend), I suspect there could be another leg down.

Crypto and Specifically DATs

The crypto community has been hit, in no small part because of weakness in the digital asset treasury companies (DATs), though there is a circular nature here. The bitcoin-mining companies have been hit as a mix of the AI concerns and crytpo concerns.

During the pAIn trade, the end of 'free' money has been a major factor in the downturn, and could weigh on the economy and markets going forward.

Correlations and Volatility

Crypto has the potential to influence other markets in a variety of ways:

• Bitcoin had a market cap of almost $2.5 trillion as recently as early October, and it is now down to $1.85 trillion. Still hefty, but a loss of $650 billion may leave a mark on the global economy.

• While possibly simplistic, I do think the fact that crypto ETFs and DATs reside in people’s equity portfolios, it is more difficult to separate the asset classes (stocks vs crypto) than it was when crypto was in wallets, or specialized accounts. I think that is contributing to an increased link between stocks and crypto. As many of you know, I often look at the ARK Innovation ETF ARKK as a “proxy” for disruption. It too is down around 20% in the past month or so. That correlation, at least to me, seems “rational.” We have clearly seen a connection to “momentum” trades, including those “lottery tickets” that can play a role in your ProSec portfolio.

• What also caught our eye, and supports our view, was a tweet by an acclaimed investor who was surprised by how correlated a couple of his investments had become with bitcoin, despite no logical linkage. Presumably just a “similar” investor group that was selling other holdings to create liquidity?

Until crypto stabilizes, we could see an impact in all markets.

A Quick Rant

This is not the correct audience to trade credit default swaps (CDS), but I think buying protection on Oracle  (ORCL)  CDS as some “hedge” against the AI valuation shifting, is silly, but that is a more complex story and you would need the ability to trade CDS, I will leave it at that in this note.

Bottom Line

I think the economy is at a greater risk than we’ve seen in some time.

The AI/Data Center buildout could possibly slow, and that seems plausible given how the stocks have been reacting to spending (given how important that spending has been to the economy). The end of 'free' money is probably worth more than the small pullback we’ve seen, but again, not an alarming turn of events.

The wealth effect of some of the high-flying names and asset classes is potentially an issue for the economy. The crypto/disruption wealth effect is clearly top of mind for me.

I’d cut rates in December, but I’m not sure the Fed will, but in any case, I think the risk-reward at the long end of the curve remains biased to higher yields, unless stocks decline by more than I expect. I still think this is more about rotation than a real, across-the-board, need to sell ( (QQQ)  vs.  (RSP) ).

Safe travels and have a great Thanksgiving.