I have been writing about the buildup of systemic risks in the system for months now, ever since I turned less bullish on equities and took more of a neutral stance. The risks that existed under the surface for months were there BEFORE the Democratic sweep was even a catalyst on the horizon. This is very typical of market cycles: There is building fragility that is just waiting for a small prick to unwind it.
Here is the problem: The market still fundamentally misunderstands HOW MUCH risk exists in the AI space as well as HOW BAD the geopolitical situation is about to get due to the Democratic sweep.
“headwinds for equities are increasing due to the macro risks”
-Midterms risks report by Capital Flows: link
I continue to emphasize that there are significant risks and headwinds in markets. Massive directional bets on the index continue to have minimal risk-reward.
-Midterms risks report by Capital Flows: link
Where did all of this risk start? It actually started with China. It comes down to the foreign net position: everyone needs to push money into US assets in order to maintain their current account relationship with the United States so that they can compete with all the cheap goods China is dumping onto the market. Simply put, foreigners are pushing up the valuations in US equity markets. This is THE defining issue of our time that is fundamentally misunderstood.
I explained the entire logic for this and the regime we have entered here:
What does this have to do with AI, though? When capital flows into a system, it has to go somewhere, and one of the largest capex build-outs in history happened to take place in the context of the AI arms race between the US and China. Where do you think all the money would go? Right into this theme!
The AI complex has real promise in the fundamentals and technology, but this doesn’t mean it translates into profits on a time horizon that sustains equity markets. This is exactly why CoreWeave is down 77% from the highs. It is the highest-risk stock with the greatest sensitivity to the credit risk in AI.
But why are AI stocks going down? I thought more people were using AI? Just because people are using AI doesn’t mean it’s translating into bottom-line profits. We can see a massive divergence occurring between H100 prices and token prices:
People fundamentally misunderstand where the high valuations are coming from because they misunderstand how global liquidity is driven by China manipulating its currency to carve out the world’s production base. ON TOP OF THIS, people fundamentally misunderstand the balance sheet dynamics of the AI complex because they think capex and demand always translate into bottom-line profits.
This is why the entire AI supply chain is falling off a cliff right now.
WHERE capital is coming from and HOW MUCH risk the AI complex holds are misunderstood by the market as people are panic-selling their biggest winners from the last 2 years. But this is all setting the stage for an even larger risk that people aren’t even aware of right now.
