Author: Maggie Lake (Interviewee: Kevin Muir)
Compiled by: Shenchao TechFlow
Shenchao Introduction: Beneath the seemingly calm surface of the S&P index, US stocks are staging a thrilling scene of furious underwater kicking: the Goldman Sachs AI Winners vs Losers Basket has plunged 55% in half a year, while the Magnificent 7 have been pushed to the sky by safe-haven funds flocking together, and the sharp negative correlation among individual stocks artificially masks the underlying volatility of the index.
Veteran macro hedge fund manager Kevin Muir keenly points out that the market narrative around AI infrastructure capital expenditures is undergoing layer upon layer of collapse and retreat: initially it was claimed that ample free cash flow would pay for it, then it degenerated into low-interest debt-driven financing, and now that borrowing costs have soared, the market has anesthetized itself with equity issuance financing—a typical dangerous characteristic of the late stage of a bubble. At the same time, micro trading mechanisms represented by multi-strategy quantitative hedge funds (Pod Shops) and tax-sensitive long-short hedging (TALS) are causing a large number of heavily shorted stocks to suffer a slow, unrelenting death by a thousand cuts that will never be covered.
In this distorted macro chessboard, smart money should not blindly gamble in the overvalued tech frenzy, but should lock its sights on real assets with more asymmetric odds of success: embrace Canada, which is welcoming an economic revival and a capital expenditure boom, and the Brazilian market, which has been wrongly killed by election sentiment and possesses globally critical commodity reserves and pro-cyclical energy elasticity.
For financial markets, this is an extremely critical week: a massive wave of heavyweight earnings reports is about to be released, and the Federal Reserve's interest rate meeting is also arriving as scheduled. The week began with climaxes: frontier AI giant Anthropic officially filed for an IPO (tech stocks cheered this), while President Lula's unexpected victory in Brazil's election triggered violent repercussions (the Brazilian stock market clearly did not take it well).
Fortunately, renowned macro analyst Kevin Muir, author of "The Macro Tourist," joined our "Talking Markets" podcast yesterday to help us clear the fog and sort out the complicated logic behind all this...
Honey Badger Market
Image: Honey Badger Don't Care
"Looking around, a million tiny warning signals flashing dangerous red lights have already appeared in the market, but people always seem to find one excuse after another to turn a blind eye," Kevin said. "In my view, this is an extremely worrying market. I am very shocked that, in the face of all this, everyone is acting so blindly complacent."
One of the most typical cases is the evolution of the narrative around the funding sources for AI infrastructure construction:
"Once upon a time, the mainstream market view was that the bubble did not matter at all, because all of this was being paid for by massive free cash flow..."
"Then that argument degenerated into 'it doesn't matter because they can borrow money by issuing bonds at extremely cheap costs'... and now that the window for cheap borrowing has closed, they have begun to comfort themselves by saying, 'it still doesn't matter because they can raise financing by issuing more shares.'"
A Massive Sector Rotation Has Occurred Within the Market
Kevin recently wrote an in-depth research report (click here to read the original), in which he highlighted the following key facts:
On June 22 of this year, the Goldman Sachs "AI Winners vs Losers Basket" had risen as much as 94.2% year-to-date. During the same period, the Nasdaq rose 21% and the S&P 500 rose 10%.
However, since then, the Goldman Sachs hedge basket has plunged 55% from its high, while the Nasdaq has fallen only 4% and the S&P 500 is basically flat... At the same time, the Magnificent 7 US tech giants have continued to "scream higher."
"So the environment we are in now has experienced a massive internal sector rotation," Kevin explained. "Beneath the surface there is violent turmoil churning the seas, while over the past six months the broad indices have barely moved."
In other words, the correlation among individual stocks has fallen to an extremely low point. It is like a white swan appearing elegant and calm on the surface of the water, while beneath the water its feet are frantically paddling and kicking, stirring up countless mud and splashes.
"This extremely strong negative correlation among individual stocks ultimately suppressed the actual volatility of the index as a whole," Kevin said. "We have witnessed so much bloodshed and violent divergence, yet the index itself has barely budged."
So what exactly caused this severe lack of correlation? Kevin listed several different market hypotheses, including:
AI is a transformative revolutionary technology, and disruptive major technologies often "ultimately give rise to extremely divergent markets of a similar shape." Kevin's degree of agreement with this view is "only a little bit," but he places greater weight on...
...multi-strategy quantitative hedge funds (Pod Shops): "There are now a large number of market participants trading in ways completely different from the past few decades. Suddenly, traders are no longer simply going long; instead, every long position they take must be strictly matched with a corresponding short position."
TALS (tax-sensitive long-short hedging): The AI bot gave a very plain explanation of this:
Image: Explanation of the operating mechanism of the TALS (tax-sensitive long-short hedging) strategy
“When one of the long individual stocks falls, the fund manager will decisively sell it, instantly locking in a capital loss to offset taxes, and immediately replace it with another highly correlated benchmark stock,” Kevin said, “and when one of the shorted stocks rises, they will buy to cover, and similarly replace it with another new short target.”
If you notice that certain stocks keep “grinding lower without end,” that is very likely because they carry “an extremely high proportion of short positions that have never truly been covered, and the reason the shorts have been slow to cover is partly due to the rebalancing mechanism of the TALS strategy.”
Kevin emphasized that the core of the problem is that this operating pattern is “creating all kinds of severe microstructure distortions in the market.”
A Canadian Economic Renaissance?
More than a year ago, Kevin wrote an article on the core logic for being bullish on Canada (click here to read).
His analytical logic at the time was that regardless of whether Mark Carney or Pierre Poilievre ultimately wins office, “the country's political and economic pendulum is swinging to the right, and it will pursue economic reform more seriously and earnestly, taking all pragmatic and necessary measures,” Kevin pointed out.
“And that is exactly what happened. Mark Carney is by no means some out-of-touch, pure radical environmentalist. The previous leader was nothing more than a middle school teacher by background, whereas Carney is a truly heavyweight figure who deeply understands finance and capital operations.”
“Over the past year, the Canadian market has been charging ahead,” Kevin said. “Many people simply do not realize that the actual performance of the Canadian stock market has comprehensively outperformed the S&P 500 Index.”
“Admittedly, the boost to energy stocks from geopolitical conflict has certainly played a major role, but the deeper reality is that Canada is genuinely carrying out the changes necessary to revitalize its own economy... the country's overall business environment is becoming more business-friendly.”
But he holds a relatively negative view on Canada's banking sector, because he believes bank stocks' current valuations are so high that they have detached from fundamentals.
“Therefore, short or sell Canada's domestic banks, go long on basic raw materials, go long on the real economy, and continue to buy energy and related targets on dips,” Kevin advised. “If you want to construct a perfect pairs trade in the Canadian market, the appeal of this strategy right now is perhaps unprecedented.”
Excerpts of Kevin's Core Views
“Very often, people are extremely prone to conflating a good company with a good investment... there is an essential difference between the two.”
“Since when did we naively begin to think that the government can really control the market as it pleases, as it claims? The power of the market is far greater than anyone, even a president... I absolutely do not believe that in the event of a future crash, the government will extend any rescue to AI concept stocks.”
Lula's election victory indeed caught the market off guard, but “the forces of the lawmakers elected to Congress have long since tilted significantly to the right... Admittedly, it would naturally be even more ideal to have a leader who fully embraces the free market at the helm, but the real macroeconomic trend is evolving in this direction...”
“I regard today's panic-driven plunge as an excellent opportunity to buy on dips. In fact, I already entered and bought heavily at today's open.”
“I am firmly bullish on the energy sector seeing unexpectedly strong buying over the coming period, especially in crude oil,” Kevin said. “As the global geopolitical landscape becomes more turbulent and unpredictable, the scale of strategic reserves that sovereign nations need to hold must increase substantially.”
“This is precisely the core logic for allocating to Brazil and Canada in a portfolio, because these two countries possess and continue to produce the key materials that the whole world will have to stockpile with all its might when uncertainty strikes in the future.”
“This indicator measures the funding adequacy of pension funds, and we are currently at the highest level of funding adequacy since 2007.” Chilling. Click here to view the detailed data report.
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Thank you to all the viewers who watched the livestream! We will return on Wednesday together with Dale to give everyone an in-depth review of the Fed's latest interest rate decision.
Disclaimer: This article is for informational purposes only and does not constitute any investment advice. Please consult a qualified professional financial advisor to assess your risk tolerance, investment objectives, and overall financial planning.
