Looking at the week overall, markets continued to march in place as midterms approach. However, that doesn't mean traders sat on their hands all week; far from it.
"Third-quarter earnings better be good," was the focus of one of my last columns. For Alphabet and some other AI tech stocks like Intel and Amazon, it was a disaster. Alphabet missed earnings. As a result, the stock dropped almost 13 percent on Thursday. That means it lost about $500 billion, the second-biggest one-day wipeout ever for a U.S.-listed stock.
And given that AI has become a global trade, Google's results drove down Asian equities as well — anxiety over the AI supply-chain trade spread across the region. As readers realize by now, the bloom is off the rose and has been for the entire AI equity universe recently.
As with most declines of this magnitude, I expected a dead cat bounce trade. We got one over the first three days of this week, in anticipation of home-run results from Microsoft and Google after Wednesday's close. The entire AI space rallied from an oversold position.
While Microsoft beat, it just wasn't enough to make up for Google's poor showing. The only index that wasn't down on Thursday was the small-cap Russell 2000. Friday, Amazon and Intel reported. They joined the rest of the AI gang in its downward spiral, dragging the indexes down.
Over the past few weeks, I warned investors of the precarious nature of the AI trade. For those asking, I publish two columns each week — one on weekdays and another on weekends. If you have not read my last two weekday columns on AI, you should, because where AI stocks go, so does the market.
The FOMC meeting on Wednesday was almost an afterthought. As expected, the Fed held rates steady and offered few clues about what to expect at the December meeting. On Thursday, the government released two important data points. The Personal Consumption Expenditures Index (PCE) rose to 3.6 percent annual inflation, and GDP grew in the third quarter at an annualized rate of 3.4 percent. Credit the AI buildout for much of that growth.
As a government data cynic, I am not surprised that the GDP number was higher than expected less than a week before the elections. As for the PCE, the Fed's supposed primary inflation gauge, I was looking for a 3.8 percent increase, so I was a bit too high. However, readers may recall that the PCE tends to understate real inflation growth after recent changes were enacted last month.
Despite AI stocks imploding, the indexes remain somewhat stable, except for the Nasdaq. The reason for this is rotation. As technology stockholders sell, the money isn't going to cash. Instead, it's flowing into health care, utilities, financials, Treasury bonds and consumer staples.
This coming week will be eventful. Politics will be front and center for the first half of the week. We know that uncertainty is the bane of most markets. So far in October, markets have held in place, however, with many investors counting on the removal of this big question mark to spur the indexes higher.
I reserve judgment until I see how both parties respond to the election results and how investors react. If it is a close race, we may not know who won what for another month if individual races are disputed. If the Democrats manage a clean sweep of both houses, markets could sell off. If it is a mixed result, history says that could be somewhat positive since little would change. If the polls and betting markets have it wrong (remember that Trump always under polls) and the GOP prevails, well, prepare for even more changes ahead, good and bad.
In closing, I want to advise readers that this will be my last column until the third week in November. Yes, I am taking some time off, three weeks to be exact. It is my first real vacation since 2020. They say absence makes the heart grow fonder. It must be true because I already miss you.
Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.
Anyone seeking individualized investment advice should contact a qualified investment adviser. None of the information presented in this article is intended to be and should not be construed as an endorsement of OPI, Inc. or a solicitation to become a client of OPI. The reader should not assume that any strategies or specific investments discussed are employed, bought, sold, or held by OPI. Investments in securities are not insured, protected, or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct. Investments in securities are not insured, protected, or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct.
PITTSFIELD, Mass. — Has the artificial intelligence boom gone too far, too fast? Traders recently have decided to sell first and find out later. Is this simple profit-taking or something more insidious?
In my last column, I examined how equity investors have bid up stocks in the AI area for more than a year. A feedback loop of higher earnings expectations in the group triggered higher prices, which reinforced even higher earnings. Looking under the hood, I questioned some of the accounting moves that have driven these earnings in the past.
The market is now looking for a 30 percent jump in earnings results versus last year as third-quarter earnings are underway. In many respects, the fate of the economy and both the stock and bond markets now depends upon what happens in the AI sphere. That may sound like an exaggeration, but consider this. Goldman Sachs’s head equity analyst expects more than half of third-quarter earnings to come from 10 stocks, with more than one-third of that coming from just two companies.
And what is happening in the stock market is also happening in the bond market. In the corporate bond world, AI-related bond transactions accounted for over 50 percent of all investment-grade issues as of the end of August. Appetite for these AI offerings has been so strong that, for example, a Microsoft bond issue was preferred over government bonds of the same duration.
Apollo Management estimates that the bond market will raise $1.8 trillion by the end of this year. This is part of why bond yields have risen as much as they have. Between the U.S. government’s need to finance our debt and AI companies in the private sector, the supply of newly issued debt has overwhelmed demand.
That doesn't include the "off-book" borrowings that Microsoft, Alphabet, Amazon, Meta, and Oracle have taken this year. Those obligations amount, at last count, to $1.65 trillion in hidden, off-balance-sheet debt. These include future obligations like long-term operating leases for data centers yet to be built, bulk GPU supply contracts, and joint ventures. Accounting rules say companies don't have to record these liabilities on their balance sheets until after the assets are delivered or go live.
And speaking of pros, guess who has become big players in both AI stocks and bonds as well as U.S. Treasury bonds—hedge funds. This is according to a recent International Monetary Fund (IMF) report. The IMF is sounding an alarm about the growing risk hedge funds represent to the global financial markets.
These risky, private investment firms are leveraged entities that have doubled their assets in the last 6 years to about $13 trillion. A little more than half that amount is borrowed money. They invest alike. They are all up to their ears in the same AI stocks, as well as the same Treasuries and AI bonds. Their share of the U.S. Treasury market is more than 12 percent right now.
These are not buy-and-hold money managers or pension funds. They borrow money and buy stocks and bonds. If the trade goes against them, they are quick to sell out. Usually, they do so en masse. In the first quarter, their combined assets under management, plus the face value of their derivatives, were estimated at $42.2 trillion. That leaves us with a highly concentrated market, dominated by a mercurial group of players. A large portion of the retail crowd backs them, and are far more focused on the narrative than the numbers.
That narrative, however, is real enough. The global macro picture on AI is clearly on track. Like the internet before it, AI is real and promises to transform society yet again in the years to come. That doesn’t mean the AI space, like the internet before it, can’t get over its skies on occasion.
I don’t think we will see a protracted decline like the dot.com bubble where 50 percent or more of those companies disintegrated in the early 2000s. Remember, it took years for the boom-and-bust cycle of the Dot-Com era to unfold. What worries me most is the degree of AI concentration risk on both sides of the bond-and-stock market equation. Between the hedge funds and the 50 percent weight of the big tech players in the S&P 500, let’s hope third-quarter earnings are better than expected.
Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.
Anyone seeking individualized investment advice should contact a qualified investment adviser. None of the information presented in this article is intended to be and should not be construed as an endorsement of OPI, Inc. or a solicitation to become a client of OPI. The reader should not assume that any strategies or specific investments discussed are employed, bought, sold, or held by OPI. Investments in securities are not insured, protected, or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct. Investments in securities are not insured, protected, or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct.
The stock market is trading lower, but still close to its all-time highs. That's somewhat unexpected given that it is October in an election year.
Historically, October and November are great times to buy equities. Since 1950, October has generated an average gain of 3 percent, while November has averaged 2.7 percent. Not this year. So far this month, looking back 30 days, I see only the Dow performing well. That index is up a little over 1.6 percent while the Nasdaq is down more than 3.3 percent, the S&P 500 is off a little less than one percent, and the small cap Russel 2000 has suffered more than a 2.7 percent loss.
This is all the more surprising given that third-quarter earnings are expected to be up 30 percent. So far, 80 percent of companies reporting are beating earnings estimates. If it isn't earnings, then what could be keeping a lid on markets this late in October?
It could be the ongoing AI saga. Investors worry that all the spending by this group of companies may not return an investment for several years. There are now questions about whether there is even enough capital to finance all these ambitious AI spending plans.
Gone are the days when investors were willing to wait for the answers. The Warren Buffett approach is not in vogue. For an in-depth look at my take on AI, read my weekly columns "Corporate earnings better be good" and next week's, "AI and the financial markets." Warning: you won't get your typical kumbaya conclusions that you read from Wall Street and money managers all the time.
Climbing higher on this wall of worry, we find the possibility of a lower house sweep by Democrats and a close race in the Senate. I don't listen to pollsters given their track record and flaws in data gathering. However, I do follow the gambling sites like Kashi and Polymarket where people put real money on election results. Their results currently echo the polls.
The betting market is giving the Democratic Party a 67-68 percent chance of taking control of the Senate and a 91-94 percent chance of flipping the House. If so, it may heighten consternation among market participants. It would change the direction of government policy and would likely disrupt the economic landscape.
Historically, a party taking both the House and Senate was the worst-case scenario for markets. Many political experts with their ear to the ground in the capital dispute the betting market's odds on the U.S. Senate outcome. They think the Senate is still a toss-up.
The best outcome for the markets would be either a mixed result in Congress or a return of the ruling party to power. That outcome would increase the chance of continuing existing policies. There is a chance that whoever wins will contest the election, requiring recounts, court cases, etc. If so, that could extend election results into December. The markets are giving that a low probability, which could be a mistake.
Further up on the worry wall is the climbing energy prices and inflation levels, the prospect of a resumption of a shooting war with Iran after the elections, the guessing game of whether the Fed will raise rates next week at their FOMC meeting or wait until December, and finally Trump's apparent embrace of Russia and his seemingly abandonment of Ukraine.
That's a pretty steep wall to contend with, and yet, we remain within spitting distance of highs. It is uncanny how just before stocks roll over on a new negative data headline, something else hits the tape that pushes the averages back higher.
In any case, it appears astute players are making a concerted effort to keep markets aloft at least until the elections. And why not? The government has a long history of manipulating markets before elections by announcing or leaking better-than-expected economic data. In addition, there are carefully timed "breakthroughs" or "initiatives" that move markets in the direction most beneficial to the ruling party or president.
I think next week's earnings announcements by Alphabet, Amazon, and Microsoft, along with the outcome of the FOMC meeting, will give direction to the markets. After that, it will be all about the elections. Do nothing but strap in because there is turbulence ahead.
Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.
Anyone seeking individualized investment advice should contact a qualified investment adviser. None of the information presented in this article is intended to be and should not be construed as an endorsement of OPI, Inc. or a solicitation to become a client of OPI. The reader should not assume that any strategies or specific investments discussed are employed, bought, sold, or held by OPI. Investments in securities are not insured, protected, or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct. Investments in securities are not insured, protected, or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct.
This week saw three major changes in the financial markets. Bond yields fell, AI stocks plummeted, and inflation reared its ugly head. Markets didn't take that well.
Let's start with inflation, since for some reason, the higher Consumer Price Index (CPI) and Producer Price Index (PPI) for September surprised the markets. Our readers were prepared for that, but I guess most of the public doesn't read my columns. In any case, yes, the data was much "hotter" than the market expected.
The PPI gained the most in four years. The last time it soared 1.3 percent from the previous month was back when Russia invaded Ukraine. The CPI was also higher, indicating that the annual inflation rate has now accelerated to 3.7 percent. As you may guess, both indexes rose on higher gas and diesel prices due to Trump's war on Iran.
Next in line was the rapid decline in the technology index, represented by the Nasdaq, which dragged the whole market down with it. The culprit, however, was not inflation, but rather worries over AI financing. Some of the second- and third-tier AI players in that space are highly leveraged. Several have spent or borrowed 3 or 4 times their annual cash flow.
Higher inflation, fears of rate hikes, and the spike in bond yields have led investors to worry that many AI companies may be over their heads in managing their debt load. As if this were something new, but suddenly it matters. The rout that has followed belies the almost 4 percent decline in the overall tech index. Many AI equities suffered double- and even triple-digit losses.
Given that the largest 10 companies in the S&P 500 are tech or AI centric and they represent almost 50 percent of the index, when technology falls, so does the S&P. However, the benchmark index finished the week down less than 1.5 percent thanks to some unforeseen support.
It should have been worse, but that's where the decline in bond yields came in. You might think that with such strong inflation numbers, bond yields would have soared, while prices declined. They didn't.
Yields dropped like a stone. I suspect the reason has something to do with a shift in who is buying and selling U.S. Treasury bonds. The historically staid crowd of insurance companies, pension fund managers, sovereign funds, and the like is still there, but now invest shoulder to shoulder with those masked villains: the bond vigilantes.
Who are behind those masks? Hedge fund managers. Hedge funds now represent at least 12 percent of the trading in the recently "hot" government debt market. Oh, and by the way, they also hold big positions in AI stocks.
By CPI Wednesday, bond yields were at the top of their risk range and technically overbought. Unlike traditional bond players, hedge funds pay attention to this, as does U.S. Treasury Secretary Scott Bessent. The CPI data was announced. Yields shot up and then bang! That was the signal traders needed to sell (cover) their profitable bond shorts and buy back bonds with both hands (possibly with a little help from ex-hedge fund manager Bessent and his Treasury).
In minutes, the narrative changed. Gone was the inflation risk; in its place was a dash to the safety of government bonds amid AI credit-risk worries. The subsequent sharp sell-off in AI equities, likely aided and abetted by these very same hedge funds, just added to the trade — traders seeking better credit investments piled into good old USA "Govies."
That move supported the S&P 500 and Dow indexes somewhat. As for the markets over the next two weeks, as I wrote yesterday, third-quarter earnings better be good. Despite everything the administration is doing to support the markets, I suspect less-than-stellar results from AI companies will lead to more downside for stocks.
With oil almost back to $100 a barrel, the downward pressure on equities is building. That is not what the administration wants with just three weeks to go before the midterms. Of course, if things get truly dicey, the president could always throw in the towel and make nice with the Iranians. It has worked before to bolster the markets; it might again.
Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.
Anyone seeking individualized investment advice should contact a qualified investment adviser. None of the information presented in this article is intended to be and should not be construed as an endorsement of OPI, Inc. or a solicitation to become a client of OPI. The reader should not assume that any strategies or specific investments discussed are employed, bought, sold, or held by OPI. Investments in securities are not insured, protected, or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct. Investments in securities are not insured, protected, or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct.
Third-quarter corporate profit results kick off this week. A lot is riding on what company management tells Wall Street. Both the stock market's present and future fortunes depend on what they say.
It has been an extraordinary year for revenues, profits, and profit margins for many companies listed in the benchmark S& P 500 index. In the second quarter alone, earnings results were 50 percent higher than they were last year. This time around, investors expect a further 29 percent to 30 percent increase over 2025. That’s good news and makes great headlines, but the truth is that a relatively small handful of stocks are responsible for such stellar results.
None of us should be surprised that artificial intelligence is the engine of growth behind this remarkable performance. And while these technology stocks will generate the lion’s share of earnings, they won't generate all of it. You see, while companies like Micron Technology and Nvidia benefit greatly from the AI infrastructure buildout, AI is boosting business for just about everything from construction companies to copper miners.
One caveat the reader should note, however, is that most companies on the receiving end are booking the $166 billion in tariff refunds occurring now (due to the illegality of Trump’s first round of tariffs) as profit. In a past column, I predicted that little, if any, of this money would be returned to the consumer (who paid 90+ percent of these tariffs). As a result, these refunds are partially responsible for record profit margins throughout the economy.
As readers know, I use the S&P 500 Index as my benchmark when analyzing the market’s fortunes, since most other markets key off its performance. Thanks to AI, the technology sector now represents about 40 percent of the index market capitalization. However, neither Meta nor Amazon, two of the largest hyperscalers, are included in that index. If you include them, the AI-related weighting of the S&P 500 is almost 50 percent.
But let’s get back to earnings. In the second quarter, the top contributors to the massive earnings gain were Amazon (+242 percent) and Alphabet (300 percent). To bank those gains, a lot of people would have had to spend most of each day online buying everything Amazon offered. As for Google, I’m not sure it would have even been possible- without an accounting twist. For both companies, much of their profit came from huge, non-operating, unrealized gains on their private equity stakes in other tech companies (read: AI darlings Anthropic and SpaceX).
How would corporate results have fared without that accounting treatment? Second-quarter earnings would have dropped from 47.7 percent to 28.8 percent if you excluded just these two companies’ profits from these investments. Rest assured, they weren't the only two companies that used this accounting convention. I’m sorry to get all wanky on this, but that’s not the only accounting smoke and mirrors involved in the AI investment boom.
General accounting practices dictate that a company's wages and other expenses are deducted from its sales. What is left over is profit. However, large capital expenditures are treated differently. An AI company can plunk down $300 billion for data center or three, but it doesn't subtract that cost from revenue. Instead, it's listed as property on the company’s balance sheet. As such, they recognize the costs only over time as the value of this property declines due to wear and tear, etc.
And now the plot thickens. At the same time, all these billions of dollars are being spent on infrastructure; the Nvidias of the world that sell semiconductor chips, GPUs, CPUs, and the like to big hyperscalers like Microsoft and Alphabet get to book their sales and profits immediately.
Bottom line: the huge AI infrastructure price tag is dramatically understated and pushed into the future. That accounting standard softens the impact on earnings, while the profits of the various AI spenders are booked immediately and are overstated.
Together, these accounting principles create a virtuous circle: more AI spending guarantees higher sales and profits for companies. That translates into higher prices for the individual stocks, both private and public. In the case of private company shares held as investments by some hyperscalers, more unrealized gains can be booked as income.
How does this merry-go-round end? This bubble will burst, but only after investors and Wall Street analysts alike start looking under the hood and not just the headlines, do the work, and start coming up with their own conclusions. It took years during the early boom-and-bust cycle of the Dot-com era for this to happen. In this case, some early calls for caution are beginning to be heard.
But it is not only the stock market where the AI mania has caught hold. Next week, I will discuss how AI companies have been forced to either raise new rounds of equity or tap the bond market for funds now that their cash flows have been depleted. I also look at another player that has entered the fray and what that may mean for AI in the near term.
Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.
Anyone seeking individualized investment advice should contact a qualified investment adviser. None of the information presented in this article is intended to be and should not be construed as an endorsement of OPI, Inc. or a solicitation to become a client of OPI. The reader should not assume that any strategies or specific investments discussed are employed, bought, sold, or held by OPI. Investments in securities are not insured, protected, or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct. Investments in securities are not insured, protected, or guaranteed and may result in loss of income and/or principal. This communication may include opinions and forward-looking statements, and we can give no assurance that such beliefs and expectations will prove to be correct.
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