Great Rotation Happening Now: This Sector ‘Is Over’ — Thomas Hayes

[00:00:00] Speaker 1: - The commodity trade within the AI trade is done, okay? Utilities, staples, healthcare, predominantly defensive groups, are starting to get bid in the last five sessions and bid in a material way. Why the hell is anyone surprised? High prices cure high prices. Did you think the Chinese, the Koreans, and the Japanese were gonna sit back and say, "Oh, Micron, look at those margins. Congratulations, you beat us to the game." - As if this was gonna happen in perpetuity and they wouldn't flood the market with memory and flood the market with commodity semiconductor chips. History would suggest is that those who are investing in the CapEx are not going to be the biggest winners. And often, more often than not, historically speaking, they were the biggest losers. [00:00:47] Speaker 2: - This year's biggest market rotation that investors have been waiting for is now happening. The laggards and losing sectors are finally catching a bid. At 5.2% on the US 10-year money is shifting into bonds and chip stocks, once the market leader, are now selling off. What's next to sell off? And where does that capital rotate to next? And what happens once AI CapEx financing slows down? Thomas Hayes is a hedge fund manager and he's back to answer all these questions and reveal to us the stocks and sectors he's buying now. He's a managing member of Great Hill Capital and the author of Hedge Fund Tips, which has an online newsletter as well as a number one podcast in the hedge fund space. Thomas is going to explain why stock market indices may not see stellar returns, but underneath lie huge opportunities for growth. Right now on Cauchy, there's a 22% chance that the S&P closes between 8,000 to 8,200 points by the end of the year. If you agree with those odds, a $50 trade could yield a payout of $206 if you're right. This video is sponsored by Cauchy, the largest prediction market in the United States. Unlike a sports book, you're trading peer-to-peer on real-world events from economic data to political outcomes, and the price moves based on public opinion, not a house. Go to the link in the description down below, or scan the QR code here, and use my code LIN, L-I-N. New users who use my code can get $25 in app credits when they trade $25. Cauchy is CFTC approved and available in all 50 states, including California and Texas. Welcome back, Thomas. Good to see you again. [00:02:20] Speaker 1: - Great to be with you, David. Thanks for having me. [00:02:22] Speaker 2: - Well, we're speaking on Tuesday, October 13th. And right now, in American markets, the S&P 500 is down slightly. The NASDAQ is flat down. And yeah, it looks like things are holding steady on the stocks front. However, if you look overseas, we have a situation where the cost, the cost piece been selling off rapidly. So as you're aware, the cost be fell 5.5% pretty much overnight. It's been falling in the last couple of days. Chip makers are facing a deep slump after reports of rapid tech progress by Chinese rivals, what's going on? - Well, I mean, David, what I can understand is why the hell is anyone surprised? I mean, it's a commodity. High prices cure high prices. Did you think the Chinese, the Koreans, and the Japanese were going to sit back and say, Oh, I mean, it's a commodity. You beat us to the game. They're all yours. You take all the margins. I mean, you can't make this stuff up as if this was going to happen in purpose. [00:03:23] Speaker 1: As if it, as if this was going to happen in perpetuity and they wouldn't flood the market with memory and flood the market with commodity semiconductor chips. I mean, look, when this game started at the Deep Seek moment at the Deep Seek moment, you know what I mean, it's going to be a commodity, high prices cure high prices. High prices cure high prices. Did you think the Chinese, the Koreans and the Japanese were going to sit back and say, Oh, Micron, look at those margins. Congratulations. You beat us to the game. They're all yours. You take all the margins. I mean, you can't make this stuff up as if it, as if this was going to happen in perpetuity and they wouldn't flood the market with memory and flood the market with commodity semiconductor chips. So this game started at the Deep Seek moment. What was the whole narrative for the first year? You can't run. You cannot run AI on CPUs. It has to be on GPUs. Therefore, Nvidia is a monopoly. Well, shortly thereafter, they figured out inference where you could do close to the same amount of work at a much lower cost using CPUs and it changed the game. And we happen to be in a stock called Intel when everyone said they were going out of business at 19 bucks and it went up 5x. Okay. So now you got the same thing going on with memory and Micron and SanDisk. Look, the story of semiconductors and memory is the same. Every four years you have a shortage. They increase capacity. Competition comes on board just in time for demand to go down and the stocks collapse. And like you can't make it up. Your Uber driver, you know, four weeks ago couldn't get enough of Micron. You know, they were telling you to buy the AI trade and no one got the message that you might be a little bit long in the tooth. [00:05:00] Speaker 2: I've been asking this on my show whether or not Chinese stocks, specifically chip makers or software or AI companies are the breaking point for the AI boom in the US. Whether or not we see it from the chips first or on the software side, yet to be determined. But I wonder if Chinese rivals are going to pop the pin in some way or other. What do you think? [00:05:24] Speaker 1: It's already happening. Every major company in the US, you talk to the CEOs, they're like, yeah, we're implementing AI into our business. It's increasing productivity, but the costs are out of control. So guess what? We're running open weight models internally. The problem is, David, is that you've got a half a trillion dollars of bonds that are predicated on two frontier large language models meeting their income projections. The issue with their income projections, if you estimate the amount of cash that OpenAI and Anthropic have to generate to make the math foot, the free cash flow is two times the free cash flow of the rest of the economy, the other nine sectors. So in other words, their customers currently generate one half the amount of free cash flow that is needed to make the model work that all the bond issuance is predicated on. So is there a little froth? Yes. Is the AI trade over? No. AI is just getting started. But the key is who are going to be the winners and who are going to be the losers. History would suggest for anyone who's read a history book is that those who are investing in the CapEx are not going to be the biggest winners. And often, more often than not, historically speaking, they were the biggest losers. The people implementing the technologies and utilizing it to increase productivity and increase margins are going to be the biggest winners, which is why Jeff Bezos is not out there raising money for AI startups. He was out there raising money to buy industrial and manufacturing companies that are going to implement AI and double their margins. But everyone's chasing a commodity like semiconductors where high prices always cures high prices. And you're seeing the early innings of what that looks like in the last week or so. You got your preview in July. Apparently, people didn't get the message because Citadel cleared out the kid who lost $40 billion. But now you're getting a reprise and people still don't believe it. They're saying, buy the dip, buy the dip, buy the dip. And it's not going to end well. [00:07:32] Speaker 2: Yeah, speaking of earnings, this is from AP. The first big batch of summertime profit reports from U.S. companies is making waves on Wall Street. It's a pretty mixed bag here. Goldman Sachs jumped more than 4% at the start of trading after delivering pretty much a good report. And then you have companies need to hit those. United Health Group stocks swung sharply, even though they reported strong profits, revenue from the latest quarter. Now, are you rotating away from certain subsectors within the tech space, given the analysis you've just given us? We're out of tech. [00:08:15] Speaker 1: We told you in June that the semiconductor trade had gotten too frothy and we had just gotten out of Intel at $96 and $97. OK, so in July, the semiconductor trade was down, depending on the name, 35 to 60 percent. Then Citadel clears out the kid that, you know, people can de-risk, the shorts have to cover. You get a dead cat bounce. And now they're rolling back over. Very few stocks, they're a couple in a basket of 30 semiconductor stocks that made marginal new highs that are now rolling over again. So that trade in the short term is over. It doesn't mean that AI will not increase productivity. It doesn't mean the market won't keep going up because of what AI does for the economy and productivity. It just means that the commodity trade within the AI trade is done. OK, how are we expressed for AI were expressed two different ways? OK, picks and shovels. Number one, we own a company called Comstock Resources. They are the lowest cost natural gas producer in the country by 50 percent. It's trading at three point seven or three three point eight billion dollars proved and unproved reserves we estimate is worth about twenty twenty billion dollars. So we think this can be, you know, it's a thirteen, fourteen dollar stock today. We think it can be a forty to sixty dollar stock over the next three to five years. Opinion, not advice. But that's how we're underwriting it internally. Jerry Jones owns seventy one percent. We own a big slug of the stock. And by the way, they're located in the Hainesville Shale in western Louisiana, which happens to be very close to all the export terminals in the Gulf and very close to where they're building all of the data centers in East Texas and where, you know, Trump was out talking about the Koreans investing two hundred billion dollars a couple of weeks ago. One for the Alaskan pipeline from the North Fields down to where they can export out to Asia, but also in East Texas. And Comstock is part of the project that they're doing in East Texas. So that's number one. Number two, we have a company called Alibaba, which is the cheapest A.I. play in the world. They own equity in pretty much every A.I. startup in Asia. And one of them is called Moonshot, which they own about a third. And they're reportedly going public for 50 billion dollars. So that's 15 billion dollars of equity value. That's not priced into Alibaba stock. And that's just one of dozens of companies that they own huge pieces of that will be going public, not to mention free call option. Number one toll taker on the Chinese recovery of the middle class, which is happening if you see property prices for the first time in years have bottomed and are starting to turn up in China. The government is back at stimulating. I think they did about 80 billion dollars last last week or announced 80 billion dollars. So they're back at it with that. Number one compute provider in Asia and the lowest relative multiple with the healthiest balance sheet and and then international growth with A.I. DC. So they've been growing their A.I. revenue triple digits per quarter for now over 10, 12 quarters consecutively in a row. And you can't give the stock away. That's going to change. And I think that's going to be part of a broader theme prospectively where international equities start to outperform the U.S., where small start to outperform large, where value starts to outperform growth and where bonds start to get a bid, all non-consensus trades, all very similar to what happened in 2000 when chips also began to roll over and all of the you know, what would be the equivalent of unmagnificent 493 dramatically outperformed from 2000 to 2006. [00:12:17] Speaker 2: If I were to just to synthesize the picks you've had, it doesn't look like you're preparing for a more risk off environment, you're just kind of picking what you think has better value at this point. Is that is that fair to assume? [00:12:28] Speaker 1: Yes and no. I will say we're not predicting. OK, so here's what I would say in the last since July 31st, I want to give you some statistics. Okay, 89 percent of stocks up until about four days ago, 89 percent of stocks were down more than 10 percent in the S&P 500. That's a correction. Yeah, 54 percent were down more than 20 percent. That's a bear market. Fifty four percent of S&P stocks were in a bear market. Twenty nine percent were down more than 30 percent and seven percent were down more than 50 percent. And yet the indices held up by five or ten A.I. stocks were at or near, you know, within the stone's throw of all time highs. So I think you're going to see the absolute opposite of that over the next nine months, meaning we basically had a bear market under the surface and the indices held up. I think over the next six months, you're going to have a monstrous bull market under the surface and it's not going to be reflected in the indices, meaning the indices will be more subdued than people expect and people will be making doubles and triples under the surface from the unmagnificent four ninety three that have a lower weighting that are like coiled spring beach balls held underwater. And one of the catalysts will be not necessarily that rates have to go down, but now that they're stopping to go up and God forbid you get any positive resolution in the Middle East and rates do drop and you've got a 10 year at 480 or 470 or 430. These things would just absolutely gallop because effectively every single company that has any debt on their balance sheet, irrespective of when that debt matures. We've got companies in our in our portfolio that have debt, but the one thing that we're very careful about is when does that debt mature and most of the most of the debt doesn't roll until 2030, three and a half years off, but they sell off with everything on the basis of the rate of change of the increase of yields, which creates an opportunity for us to buy more stock at incredible values. And now all those have started to turn up and are starting to aggressively gallop into your end. That's number one. Number two, our framework leads us to what's out of favor. So we're not predicting any volatility in the market, but I will say the stocks that are showing up to enter into our portfolio and to add are of the defensive ilk, namely like a crown castle, which we brought to you before anyone wanted it. And it just so happened, the market figured out what we've been saying for months, which is that Starlink can't work. Starlink mobile can't work inside buildings without self towers. And when Musk went out and bought 8 billion of spectrum last week, everyone figured it out and crown castle was up 20% in a day. Now, why was it trading down so much before that? Number one, the market incorrectly thought that they were going to be disintermediated by Elon Musk and their top three customers, Verizon, AT&T Sprint would cease to exist. And Musk wouldn't need any towers because the signal would miraculously go through cement walls with perfection and the world would be changed. It's turned out that's not the case. Starlink, Starlink mobile is great in rural areas. It's great outside. It's great on your boat. It's great on your private plane, David Lynn, but for everyone else that works in buildings, they want to have a decent signal and the cell towers are the way to play it. So that stock, despite rates being high and REITs trading down when rates go up, that stock galloped 20% in two or three days and it's just beginning 5.3% dividend yield while you wait. But that said, what's showing up for us is defensives. Very similar to what happened in 2000 when Buffett was buying Coca, when everyone wanted the internet stocks and the search stocks, Ask Jeeves, Netscape, AOL, he was buying Procter and Gamble and Disney and all the defensive stocks. And the articles on Barron's were saying, has Warren Buffett lost his touch? He's underperformed by 40% over the last two years. And over the next five years when the Nasdaq fell 85% and all these Uber drivers equivalents who were buying the internet at the top, just like they were buying Micron and all these chips in recent weeks and months, they lost all their money. And Buffett had four or five of his best years buying boring stuff. So all the stuff that's showing up for us to buy like Diageo, like Baxter Healthcare, Staples, etc., are what's going to work in the environment that we foresee over the next six to 12 months. AI beneficiaries that are going to utilize it, GXO Logistics, which is the largest pure play warehousing and logistics company. They're already using robots and AI and humanoids in their warehouses to dramatically increase margins. Those are going to continue to fly and be beneficiaries of AI in the middle innings [00:17:49] Speaker 2: of the AI trade. And another thing is utilities. Let me just pull this up. Yeah. So I wonder if this is an indicator of a turning point in the markets. This is a sector that's been down all year and all of a sudden it's shooting up. Is that an indication of rotation into things that haven't beaten down this year? Or is this specific to just utilities? I'm using this as an example. [00:18:11] Speaker 1: No, it's 100% the former. Utilities, Staples, healthcare, which are the three predominantly defensive groups and interest rate sensitive groups are starting to get bid in the last five sessions and bid in a material way. Bonds are starting to get bid. People are figuring out, wait a second, I can get a 5.3% guaranteed yield by buying 10 years versus a 5% earnings yield, not guaranteed buying equities. And people are locking that in. And especially the big money, it's not just mom and pop, it's pensions who have 6% discount rates that say, holy cow, we can lock in our commitments for the next 10 years. Let's do that. And let's reallocate away from equities, which has caught us up to our commitments and into bonds, which is going to guarantee our commitments prospectively. And you're seeing more and more do that. So I think that theme will continue. I think there will be massive rallies under the surface, but I think the indices gains, just as the indices didn't feel the impact of the bear market of the last two months, they're not going to feel the impact of the bull market over the next six months when the 490 is dramatically outperforming. But the indices are only going up modestly because those five or 10 stocks are consolidating and taking a breather and some going down a lot. [00:19:39] Speaker 2: And so potentially, what you're saying is we could see a scenario in which, let's say on on cash, we've got most people thinking the S&P is going to be flat until the end of the year, but you're saying underneath the surface, you know, we could have opportunities there, even though the broader index is going to look flat. [00:19:57] Speaker 1: I think that's, I would extend it out to the next six to 12 months versus between now and the end of the year, because anything can happen in a one to three month period. But if you have any volatility, AKA this crowded, dramatically crowded semiconductor and AI infrastructure trade continues to unwind, that weakness will be offset by everything else rallying because yields will stop yields are stopping to go up. Maybe they start to come down. And that's when you get dividend payers, staples, utilities, REITs will start to get bid, which have been left left for dead, real estate will come come back from the dead like a phoenix rising from the ashes. And all this opportunity is just sitting there. Look, it's no accident. When everyone's saying housing is over, Warren Buffett buys a whole company called Taylor Morrison, and he's buying Lennar stock till his fingers bleed on the keyboard. I mean, this guy didn't become the greatest of all time by accident. He's buying what no one else wants. And, and that's setting them up, you know, with a three, five, 10 year view. Maybe it doesn't work in the next one to three quarters, but it's certainly going to outperform over the longterm because nothing has changed. You still have a 4 million house deficit. You still have the largest portion of our population, the millennials at age 35 that need houses, need family formation, need housing formation. You get any relief in rates and or home builders will just have to build the houses smaller. Instead of getting a 4,000 square foot starter home with an indoor pool, you might have a 1500 to 2,000 square foot starter home like they did in the 50s coming back from World War II and a boom time. So two houses on a lot instead of one house on a lot. [00:21:49] Speaker 2: Yeah, I really appreciate you bringing up housing. Okay, so I've been seeing these posts online. This is Freddie Mac. This is the stock that's down 67% year to date, 78% year to date. It's down 35% just in the last month, 58% since May. The point is I've been seeing posts on social media comparing this chart to 2008 and say, here we go again. Same old song, same old dance. Is it the same thing though? [00:22:18] Speaker 1: Look, everyone followed Ackman into this trade because they thought Ackman could get policy changed. He didn't get it done. So they're all left holding the bag. I mean, what else do you want to talk about? This is not the way I would play housing. The number one way that we're playing housing is we're betting on a jockey called Brad Jacobs. Brad Jacobs has created more wealth for shareholders than any other operator in the history of mankind in roll ups. Okay, so he did it in United Rentals. If you had invested with him when he put his money in in the late 90s, you made 200 times your money. So if you put, you know, 10 million in, you made 2 billion, which is why you fly around on a private plane, David, because I know you did that. Second, XPO Logistics. You put a million in, you made 50 million bucks, only a 50 bagger. He's doing the exact same thing. Excuse me. Yeah, XPO. He's doing the exact same thing now. So that was a logistics roll up. The other one was equipment leasing. Now he's doing home building and commercial building supplies. Okay. Leader in roofing, leader in installation, insulation, etc. He's got, he's already done three big deals. Two and a half million. He's going to seven and a half million of EBITDA stock has been trading down because it's got, you know, $4 billion of debt on the balance sheet. It does. It's, here's the deal. When housing stays down, Brad Jacobs does cheap deals because he raises money at 10 to 20 times EBITDA. He buys businesses at five to 10 times EBITDA. Every deal is accretive. When the housing inflex and rates go down, he makes a lot of money selling the products that he already has. But either way with Brad Jacobs, you win. If you take a three to five year view, you can buy this thing depressed at $10. People are trading it like it's going out of business. This is Brad Jacobs. I mean, this is like, you can't make this stuff up. We're just every share that comes available that we can get our hands on, we're getting our hands on. So we're helping people out just like Buffett helped people out with Lenar and Taylor Morrison. They couldn't get rid of it fast enough. In three to five years, Berkshire is going to look like a genius and we're not going to look like a genius. Brad Jacobs is going to look like a genius. And we're just along for the ride and grateful to do it because he's done it every single time. And then by the way, he rolled up the garbage disposal business before United Rentals. And that was a multi bagger called waste connections, which was sold to what is now, I guess, waste management. So he does it over and over industry by industry. And now he's going to do [00:24:46] Speaker 2: it again in building supplies. Earlier, you made the statement that should the war on Iran wind down and yields follow, assuming that they're closely related. Let's talk about that, whether the 10 years related more to the oil situation and inflation expectations or the AI situation. The other explanation is that as AI companies have been heavily financing themselves through debt, debt issuances, investment grade debt and private debt have been drawing capital out of the treasury markets, sending yields higher. Which is it? I think it's [00:25:21] Speaker 1: it's complicated, but I'm going to try to simplify it for you. So number one, yields are blowing out globally. Okay. The difference between the US and Europe is that European yields are blowing out with no economic growth. And the US yields are blowing out side by side with economic growth. So you got phenomenal 8% growth, which is not going to continue or maybe it'll continue, but I don't think it's going to continue at that pace. I think it's a combination. But when you consider that European and Japanese bond yields are blowing out for three different reasons in Japan, inflation is picking up to a level that they haven't seen in decades, albeit relatively subdued to the rest of the world. In Europe, it's picking up relative to oil because they don't have any natural resources. So they're the most impacted and the fiscal irresponsibility and France's bond yields now blowing out and the chicken's coming home to roost. And the US, look, you could trace it back to the beginning of the Iran war when yields started blowing out. So part of it's a function of growth and demand for capital to your point. But part of it is a function of inflation expectations relative to the input costs and people looking down the road as oil stays elevated for an extended period of time and what will happen to input costs, et cetera. And then everyone's watching diesel. So what I can tell you is, it's a combination of both. But if the war ended tomorrow, I think the 10 year yield would be immediately down to 475. And then we would start to figure out what level of growth is sustainable and what level of growth is not sustainable. If 8% nominal is not sustainable, then you wind up with a 425 to 450 10 year. If it is sustainable, then you know, probably 475.5, but not 556 that everyone's [00:27:18] Speaker 2: talking about. - If, if, if, if the 10 year goes to six, let's say, do we get a massive rotation into bonds? [00:27:26] Speaker 1: - I think you're already starting to get the rotation of bonds. I know everyone's saying the magic numbers, 5.9 and blah, blah, blah. Uh, but I think, you know, okay. Perry pursue. Yeah. Look, it's already competing. You've seen multiple compression in the indices, uh, down from 23, down to 19, you're already getting competition for capital. And, um, I think there's an equilibrium somewhere between here and 575 where that, that, uh, balance becomes more and more aggressive. The other thing that you haven't had is you haven't started to see massive defaults. If you start to see massive defaults in, in the private market and triple C's with spreads blowing out, then you're going to see a flight to safety in, in, in treasuries, which is going to, uh, be helpful on that front. So we haven't seen that yet. Hopefully we don't see it, but, um, certainly in recent weeks, it's something that everyone's [00:28:18] Speaker 2: keeping an eye on. I'm just, just on that. I'm wondering why five and a half on the 10 year, what I actually, I actually below that today, five and two, uh, 5.2 is, is, is somehow competition for stocks. This is an environment. Remember we're in a, we're in a time when people are used to NVIDIA growing a hundred percent over the last, you know, over the next two years is the expectation. Okay. We're, we're used to that. We're used to Bitcoin going up a hundred percent in two years. And yet in 87, um, when, uh, right before the black Monday crash, I've been talking about this, people were comparing this to the 87 crash when yields at the time, the 10 year was above eight and a half, almost 9%. I guess that makes sense from a competition standpoint, but how is 5% [00:28:59] Speaker 1: competition? Because you you've got, look, earnings yield is the inverse of the PE multiple. Okay. So right now you got call it 20 times one divided by 20 is 5% earnings yield. Okay. That's not guaranteed. And, and by the way, earnings expectations, growth expectations are the highest they've been since the fourth quarter of 2021. We all know what happened in 2022. Okay. What happened to tech? So you haven't seen a situation with, so if you believe earnings estimates are correct and will come to pass AKA 30% this quarter, you know, something a little bit less next quarter and 15% next year, then you probably want to, you're probably comfortable with taking a 5% earning, you know, unguaranteed, uh, earnings yield in equity market with downside, not protected, but upside, maybe higher than bonds, which, you know, will trade up to par. But alternatively, you can take a guaranteed 5.2% yield locked in for 10 years with zero, uh, permanent downside temporary. Yes. If yields go to 6%, you could have a short term mark to market against you, but you know, you're getting your money back. Plus you're getting what, what many people will believe will be a yield greater than inflation over the next 10 years. If you look at it in, you know, five and 10 year inflation break evens. Uh, so you're, you're nominally protecting and, and, you know, uh, six months ago that, that trade-off and that calculus was not even on the table. They were incomparable. Like they were, you know, day and night, you couldn't, they were not a trade-off. Now it's a reasonable trade-off, particularly for the people managing the real money that are responsible for firefighters and teachers and pensions who have, you know, 6% hurdle rate that they, that they need to fund everything. And if they can lock in 5.2 in a greater and greater part of their portfolio, then they don't have to rely so much and deal with the volatility of equities. And which means what, which means the most important thing they get to keep their jobs. That's it. Their job is not to lose money and to meet the hurdle. And if they do that, they've got guaranteed job security. If they take risk and they make 30% in equities, they don't get a bonus for doing that. The asymmetry is to the downside. If they lose, they're out. If they win big, they, they don't get more for the most part because it comes, it comes home to roost. So if you think in the context of a pension manager, um, right now, the, the trade-off is very, very compelling in terms of self-preservation, in terms of delivering for the pensioners, um, you, you, you're, you're moving up your allocation in recent weeks for sure. [00:31:43] Speaker 2: Okay. We've talked about sector, um, rotation. What about size rotation? This is a, this is a technical analysis article published on Reuters today, uh, yesterday, actually small caps ripe for a rebound. Is it here? We have a chart of the Russell 2000. It's been going the other way of the S and P 500 and the others making the argument that it's hitting a support zone. What do you think about small caps? [00:32:05] Speaker 1: I couldn't agree more. Uh, they, so small caps just had their second worst quarter versus the S and P this century at the same time, ISM manufacturing at 44, 54.5 in expansion has expanded for nine straight months. Okay. 8 trillion is sitting in money market funds. That is certainly fuel for a broader rally. And I think small caps are going to be the beneficiaries. So why are small caps out? Small caps are down because people, uh, perceive that they're the most levered and, uh, they have to borrow the most money. What they're not accounting for is small caps are the most nimble and don't have to go through five management committees who are afraid of losing their jobs before they implement AI to increase productivity and increase margins. So once as this rate of change slows down in yields going up, or even God forbid yields come in a little bit, small caps are like a beach ball held underwater and are go, or a coiled spring, whatever analogy, uh, sinks better, uh, that are going to absolutely explode higher, we believe over the next nine to 16 months. And that's another group that, uh, that has been showing up in our framework besides defensives and staples, which have been out of favor, healthcare staples, et cetera, uh, small caps have been dramatically out of favor. And there's a huge amount of operating leverage in those businesses where you can make many, many multiples. If you pick the right ones, where the downside is protected, the upside is unlimited and what's in there. Look, I mean, you don't have to look much further than, uh, the consumer sentiment is at its worst levels and retail spending is booming. So, you know, people are hate spending. And, uh, I think you're going to see a big recovery in those things that relate to forks or sneakers in the next 12 months. Okay. You can't give away any company in consumer discretionary, whether that's restaurants or whether that is clothing slash sneakers, consumer discretionary is in the gutter. And I think that's overshot to the downside. And I think people are going to be surprised that when U S consumer, you can never bet against the U S consumer when they have a job, uh, they spend money. And right now they still have jobs with 4.2% unemployment and, um, and an economy that's growing at, you know, 8% nominal for the time being, uh, people are outspending, go try to get a reservation at any decent restaurant on a Friday or Saturday night. It's like, you got to plan one or two weeks ahead still. And, uh, good explanation. Yeah. I was wondering why there's a, [00:34:38] Speaker 2: you know, how you would explain the discrepancy between ISM rising and consumer sentiment in your words than the gutter. And to be more exact, the worst it's ever been according to the university [00:34:48] Speaker 1: of Michigan survey. So yeah, I, you know, it's, it's a unique situation of hate spending, but I mean, you could basically overlay, um, inflation expectations to consumer sentiment and it's a pretty strong correlation. So with what had been occurring in Iran, uh, the obvious man on the street is saying one, look, it's still no fun, no matter how quote unquote, good things are going. You still go to the gas pump, you know, here in Newport beach, $7 a gallon. I mean that no one likes that. Okay. And, and that's the first thing people feel you go to the grocery store and you pick up, uh, all your, all your groceries are, you know, 1.52 X what they were a handful of years ago. So people still feel that, and that, that makes people angry. And that's, that's what's related to consumer sentiment. Uh, what they don't realize for the, for the most part is wages have gone up a bit. Uh, uh, jobs are abundant. So still, uh, that could change if the fed keeps hiking, but it hasn't changed yet. I mean, we got pretty damn close on that yield curve inversion a couple months ago when they hiked or, or last month, it got within 28 basis points of inverting and causing a recession. So, uh, but for now that's not the case. And therefore, uh, there's a lot of, a lot of things to be positive about in the real economy and in the unmagnificent four 93 small caps value international. I think that's where you find your alpha in the next 12 months. If you want beta, then by the most crowded trades, but it might be negative. Beta might be negative. Okay. Small business optimism from [00:36:28] Speaker 2: NF, NFIB, uh, still uncertain. Uh, but if you look at this chart, it's, you know, still elevated since, uh, other his, other crises from, uh, years past. Well, I'm a small business and I like other small businesses are probably wondering to ourselves what we should be preparing for next year growth or deceleration and growth. And, uh, this is especially important in an industry like me where, um, discretionary spending on advertising, for example, will affect my business. So that, that, you know, when, when, when, when the economy starts to slow down, discretionary sectors are the first to start taking the hit, uh, what should we be prepared for? [00:37:05] Speaker 1: I think discretionary already priced in the worst case scenario. Uh, I, I, you know, I, I would view this small business optimism chart the way I would view a producer price index chart. This tends, the business optimism tends to lead consumer optimism and the wholesale prices tend to lead retail prices. PPI leads CPI business optimism leads consumer sentiment. So I would say this is more of a positive than a negative. [00:37:36] Speaker 2: Okay, great. Uh, before we close off, I'd like to play for you a clip of, uh, Paul Duder Jones talking about, um, the current market situation. I think a lot of it echoes what you've already been [00:37:46] Speaker 3: saying. Just take a listen here. Boy, it still feels like 1999, a two-speed market. You got it completely, perfectly bifurcated in the sense that you have obviously everything that's adopting AI and everything that's not, and they're going in opposite directions. And that was pretty much the case in 1999. I'll tell you, it was so crazy. I did this conference about a week ago, uh, and we were going through, you know, what period does this remind you of? And we're talking about 1999. So I asked everyone at the conference, I said, how many of you here were trading in 1999? There's probably 200 people there. What percent do you think we're trading in 1999? Oh goodness. I'm thinking just the way you're asking, I'm going to go with 10%. It was about 20%. And I thought, oh my gosh, because for me, it's just so clear that again, we're on this path that, that could be great short-term, but may not be so great long-term. [00:38:52] Speaker 2: Could be great short-term, may not be so great long-term. What do you think? [00:38:55] Speaker 1: I think from 1995 to 2000, you had this parabolic move in tech. During that period, semiconductors as a basket corrected 50% or more, three separate discrete times. So I think there are froths. There is froth in certain pockets like semiconductors, uh, and memory that could be hit very, very hard. While the theme continues forward. However, the way you insulate yourself, if it is what, uh, uh, John Paul, Jeter, Paul Tudor Jones is talking about is you insulate yourself by buying ones, buying AI beneficiaries where your downside is protected. And your upside is a sim asymmetric, uh, irrespective of whether the AI trade, so to speak unwinds because the AI benefits and technology is in very, very early innings. The question is, is the divergence between how, where in the cycle are the capex spenders versus the beneficiaries, the beneficiaries that are deploying this technology to increase margins and productivity. I think it's the first inning, uh, or second inning, uh, the, uh, and I think a lot of that's going to shift to open weight, by the way, they're going to do it at the most cost-effective way. And they're going to be basically, uh, fund to funds for, for AI models. And it's just basically going to, you're going to put in your task, like perplexity computer, you're going to put in your task and rather than it farming it to the best LLM, the expensive models for 99% of tasks, it's going to say, Oh, by the way, uh, for 50% of what you're paying for a token, we can farm it to the best open weight model, uh, to perform the same task with 99% efficacy. And, uh, businesses are going to take advantage of the technology that has all been distilled from the, uh, uh, large language models already. That's already done. And, uh, and businesses are going to do it at half the cost, get double the productivity, double the margin. So the point is the way you insulate is let's say the LLMs and the semiconductor trade and all this stuff, uh, and the hyperscalers, the capex vendors persist for another five to seven years. Okay. How do you miss that and still outperform? Because your, your downside is not protected. If you just chase that crowded trade, your downside could be huge. If John Paul, uh, Paul Tudor Jones is correct, but if he's incorrect, how do you still make a ton of money if he's wrong and ride the benefit of the AI wave without having the downside. And that is buying the AI beneficiaries that are not involved with the capex that are not in the commodity, uh, AI infrastructure providers that high prices cure high prices, and they're going to flood the market with capacity, the Chinese, Japanese, and Koreans. And by the way, people say, well, the administration will never let us companies use, uh, Japanese, Korean and Chinese memory or semiconductors. Okay. Then you'll lose the AI race because they're all going to be using it. And if we can't provide enough domestically, and we don't take it from the lower cost producers in China, Japan, and Korea, then China will win the AI race. So you can say, we won't accept their exports. We accept that we're going to lose the AI race. And I don't see that happening. So if that's the case, high prices cure high prices. You're going to see the market flooded, flooded with cheap memory and semiconductors till the cows come home. And if you think the deep seek moment when everyone shifted from GPUs to CPUs was dramatic, wait till you see the next phase when they figure out how to do it even less expensively because necessity is the mother of invention. So bullish on AI, increasing productivity, increasing standard of living, increasing GDP growth, increasing, uh, prosperity, uh, in the long term, not bullish on ones financing all the build out, uh, taking on all the debt benefit on all the ones applying it in their normalized businesses to increase margins and productivity. [00:43:14] Speaker 2: Excellent. That was great. Learned a lot. Thank you, Thomas. Where do we learn more from you? [00:43:18] Speaker 1: Uh, you can find me on X at hedge fund tips is the handle my YouTube channel, just put in, uh, hedge fund tips in YouTube. You get our, uh, top ranked in the hedge fund category, uh, podcast hedge fund tips with Tom Hayes. Every week we go through positions in our portfolio. We go through questions from the audience. People who have questions about certain stocks, uh, it's all opinion, not advice, but that's been very successful for seven years for people interested in investing and markets and individual stocks. Um, and then the blog is hedge fund tips.com. And we, uh, what we do for a living is we manage money for ultra net worth and family offices and small institutions. And that's great hill capital.com. [00:44:01] Speaker 2: We'll put the links down below. So make sure to follow hedge fund tips and great hill capital.com. Hedge fund tips has a lot of analysis and charts that you can take a look at as well. We didn't go over all of them. So, uh, please do take your time to look over them yourself. Thomas. Good to see you as always. We'll have you back again soon. Take care for now. Thanks for having me. And thanks for watching. Please do like, and subscribe follow Thomas in the links down below and use my code Lynn L I N. When you sign up to Kalshi, remember new users who use my code can get $25 in app credits. When you sign up and trade $25 link down below or scan the QR code here. [00:44:42] Speaker ?: you