How I'm Shifting Position Amid AI Transition, Geopolitical Tension

Volatility has returned. While precious metals and bitcoin have been the most volatile, we have seen some large swings in stocks, with the software sector getting rattled the most.

There are so many risks to this market, it is difficult to name them all. Normally, that would bring out calls about “climbing the wall of worry,” but I think it is too early for that.

Low Levels of 'True' Liquidity

Markets have long since moved to an algorithm-based, electronic trading architecture. That works well for small moves, but tends to create “air pockets” where liquidity disappears for moments in time, creating price dislocations (precious metals and bitcoin have had that occur frequently of late).

Leveraged ETFs (especially single-stock leveraged ETFs) and zero-day-to-expiration options amplify those moves, once they get beyond a certain percentage move (they always amplify the move, but it is only meaningful, when moves are well over 1%).

Multiple AI Transition Stories

Last week, we were hit mostly with the “is software dead?” transition. That may well be overdone.

Will the AI spend really continue? 

That remains a concern. Despite what look like robust pipelines, there is increasing concern (at least in my circle) that the benefits versus the cost of deploying AI in its current state is being questioned.

Will the electricity generation be there if the AI spend does occur? 

This is big, and I think more people are finally seeing not only this, and it is leading them to the nuclear bandwagon.

Smelt, process and refine. 

Those are the areas where China is eating our lunch (and Europe’s too). We have realized it and are starting to do things about it. There are plenty of investment opportunities still. Next is the rest of the world joining in. Probably a tad early, but look for the world to realize what China and now the U.S. have figured out.

Japan in particular, but easy money and fiscal policy in general? 

Globally this is putting pressure on bond yields, and potentially keeping a lid on the upside to many stock markets (Japan was up almost 5% at one time overnight, but that is because the election results had not been priced in).

What will Warsh do? 

I fully expect 75 BPS of cuts by September and some attempt to keep the 10-year yield (which is important for the mortgage market) low. Some stories came out over the weekend that Kevin Warsh may be comfortable with yield curve control. To me, that would be a last resort (and more balance expansion than he might be comfortable with), but I don’t doubt for a moment that the Federal Reserve and U.S. Treasury will work closely to try and control the entire curve as much as possible. 

Generally, that is a good thing, but yield curve control would be very bad for the dollar. I, for one, still think Jerome Powell might cut once more before his term is done and surprise almost everyone.

Geopolitical Tensions?

Increasingly, it seems that the U.S. and Russia are working toward an arrangement that would be skewed toward economic development between the two countries, possibly at the expense of Ukraine and possibly at the expense of relations with Europe. I do think U.S. companies will be given significant advantages in the rebuilding of Russia and Ukraine.

Iran seems to be simmering. 

So far, no escalation, but that could reverse course quickly. Key for markets will be what happens to oil production. Attacks that disrupt production and shipping would cause oil to spike. But some sort of “regime change” allowing the U.S. to back off on existing sanctions (which are only loosely enforced) would let oil prices drop more (which would not be good for U.S. energy stocks).

The American brand. 

Brand values are often intangible. They take years (even decades) to build. They, like reputation, can be lost quickly. When thinking about sales of U.S. brands in Europe, will we see a slowdown? Can that be picked up in other countries, like Japan, which seems to be drifting closer (in some ways) to the U.S.? This is a question I’ve been wondering, that suddenly seems to be getting a lot more traction.

Positioning and Trading

I am getting fully committed to owning duration in my fixed income portion of my portfolio. My preferred mechanism is closed-end muni funds. I have added some EM local currency bonds (EMLC) and even a smattering of REITs (more of an equity play than pure income play). I am eyeing BDCs, as they have been hit so hard, but looking for a sign they have bottomed. Again, this would be a small portion of my “income” side, which is heavily skewed to closed-end muni funds.

On equities, I like the smelting, refining and processing side of commodities. I like uranium and critical minerals. I am going to add to some solar holdings (some upside, with less downside than the nuclear section — guess it is my “electricity barbell” play).

Intel  (INTC)  remains my largest single stock position.

If adding here, I will focus on South America (have some ILFC) and maybe even Europe.

At the time of publication, Tchir was long INTC.