âWe cannot direct the wind: but we can adjust the sails.â- Dolly Parton
October has, so far, lived up to its spooky season moniker as markets fret over a barrage of bad news on multiple fronts. Yet equities continue to be resilient in the face of an unending stream of bad news. To summarize the macro environment: itâs ugly.
- First Brands & Tricolor bankruptcies shaking the banking and private credit markets. Are we looking at a looming banking crisis and deluge of bad loans?
- JP Morgan CEO Jamie Dimon warning on risks in private credit, stating glibly âwhen you see one cockroach there are probably more.â
- Government has been shut down for 20+ days with no end in sight. Most government employees have already missed one paycheck 10/15, and 10/31 looking awfully suspect. Itâs estimated between 50-65% of the USA lives paycheck to paycheck, which could have a large impact on consumer spending.
- Trade war with China moved from a simmer back to a boil. Tariff threats abound.
- Argentina needed a $20B+ lifeline from the USA to stay afloat with its currency down -30% this year sparking concerns on possible debt defaults and contagion across Latin America.
You would think with all these headlines that markets would be down sharply. But so far in October, most major indices are flat or positive on the month. Yes, we saw some drawdowns mid-October, but they were brief and did not even make a -3% pullback before rallying. Technology and AI continue to be leaders in the markets, and the expanded cap-ex cycle continues to drive economic activity and earnings growth. The biggest risks remain geopolitical â trade and shutdown related â as we feel the credit risk is contained and should not spread. There seems to be potential malfeasance in the First Brands bankruptcy with $2B unaccounted for and very complex related company transactions, as well as potentially illegally pledging the same collateral to multiple creditors. While itâs a black eye on the due diligence of multiple banks and private credit funds, it seems unlikely itâs a systemic problem and more than likely it is a failure to properly review risk and collateral. Private credit has been inundated with new capital and the rush to deploy may have left some significant gaps in underwriting. Most banks have now reported earnings and across the board we saw strong revenue beats, minimal charge-offs for bad debt, and a generally upbeat outlook on credit and health of the US consumer and business market. While there were some issues with Zionâs bank reporting a $50mm charge off from fraud and bad loans, it seemed extremely isolated and not a lurking time bomb across balance sheets.
But credit isnât the main story of this bull market â AI is. With 5 of the Magnificent 7 stocks set to report next week (META, MSFT, GOOGL, AMZN, AAPL) we will get a deeper read on spending and growth, but for now the AI driven growth story is intact. We continue to refute the concerns that AI is a bubble as many of these companies existed and were highly profitable before AI, and will remain even bigger revenue cash cows as AI adoption accelerates. While we acknowledge some of the circular AI spending (OpenAI pledges billions in a cloud deal with ORCL ï ORCL spends billions with NVDA for chips ï NVDA invests billions in OpenAI), even before pre-AI frenzy NVDA produced $27B in free cash flow in 2024 and ORCL $11.8B1. These are not the dreaded pets.com of the internet bubble, and NVDA trades at a 41x forward PE while ORCL at 42x. Neither are cheap, both are strong companies well positioned to benefit as AI becomes mainstream. If there is a bubble, itâs in power, specifically nuclear power start-ups. For instance, OKLO (Oklo Inc.) is up 644% YTD2 with a market cap of almost $24 billion, yet has produced exactly $0.00 in revenue and has yet to build an operating reactor or even get the necessary licensing. AI is driving market mania, but it comes from the small, unproven, zero revenue club, not necessarily in the MegaCaps. While a few of these companies may make it, history says many will flame out, and that is where we see the bubble popping.
More volatility should be expected, mostly because we are exiting a period of historically LOW volatility, so it really has no place to go but up. All summer the VIX stayed anchored around 15, a historically low reading. Before last weekâs selloff, the worst daily drawdown we have seen in the S&P 500 (post Liberation Day meltdowns of April) had been mild at -1.61% 5/21 and -1.60% 8/01. Even the recent drop was only a -2.71% drop 10/10 and an almost immediate rebound +1.56% 10/13. The S&P 500 has not fallen by more than -3% since April. Not -3% in one day, -3% total. So, while consternation on bad headlines and high valuations isnât irrational, we feel this bull market will continue to successfully climb this wall of worry to end the year on a positive note.