Market Thoughts: Eye of the beholder…

I told a friend recently that market bubbles, like love, are in the eye of the beholder. Election outcomes too are in the beholder’s eye. Perspective matters. For investors, gridlock won the election. Divided government hopefully viewed as ‘good’ for business. We’ll see.

Politics makes for strange bedfellows. Pre-election, pundits were shilling concern a Democratic sweep is bad for markets. Investors were already worried about the accelerating ramp-up in hyperscaler borrowing fueling a slow-building bubble.

We’ve cycled from fear to greed. We’re back to fear. Markets are jumpy. Pragmatically, midterm elections serve as an emotional clearing event for investors to refocus on policy scope and direction.

I don’t expect ‘big-bang’ change in Federal Government policy. I do expect a great deal more noise. A veto pen held at the ready to counter legislative action. Heated clashes await. Regarding actual election results, to borrow a phrase: “It’s the economy, stupid.”

The immediate focus for Congress should be on a government funding extension. The current one expires December 11th. It’s that or another shutdown. Theatre of the absurd. Urgency and drama in the moment, over and over again. A need to raise the debt ceiling lies in the offing. Do your job.

An expected post-election State level moratoria on data center construction was initially reacted to with a sigh of relief by investors. With free cash flow pressured and ‘fast action’ hyperscaler borrowing viewed with increasing concern, a slower buildout can help calm jittery nerves.

A headline that caught my eye this week? ‘Dems will save the AI spenders from themselves.’ A longer investment cycle slows the money grab happening to build quickly. But I’d point out that any meaningful slowdown increases the cost of buildouts. That’s worth keeping in mind.

Over the past few weeks we’ve seen an indiscriminate race by hyperscalers to be first to market in raising funds. That dash-for-cash seeded alarm. If you don’t care what you’re paying to issue debt, that’s a sign for investors to hit pause. They have.

For anyone with a few market scars, there’s never a better warning signal than issuers willing to pay up to raise funds quickly. If borrowers perceive ‘being first’ the most important thing to winning, they may not care about returns. Investors do… questioning when, how much and sustainability.

A slowdown in data center construction helps markets price the expected return on capital. In theory, investors wary of debt-burdened infrastructure buildout can better gauge future profitability. It lets exuberance pause to catch its breath as well. We’re seeing that currently.

Tension continues to build across global equity markets. Companies tied to AI infrastructure and inputs hit hard. Semiconductors, neoclouds and data centers are under tremendous pressure. Hyperscalers, the relative winners (so far) in this selloff. Their infrastructure’s established, with asset values well-defined.

In the interim, third-quarter earnings keep rolling in. For the S&P 500, in round numbers, revenues are up +10-15%. Earnings are growing +25-30%. The median S&P 500 company is growing earnings by +10-15%. Remarkably strong results again.

Forecasts for next year have S&P 500 earnings growth at about half what we’re seeing. Penciling in a target of +15% is nothing to sneer at. But it’s not 30%. That lends pause to current spin from pundits that markets are ‘cheap’ because multiples have de-rated. Time will tell.

I expect we’ll see valuation levels gradually move higher as investors do the math on future earnings. I don’t say that as a negative. The ‘painful’ adjustment will be on return expectations. Investors have to ‘vibe-code’ their unique threshold of pain for multiple expansion. When is enough too much?

Markets have offered a wild ride this year. Animal spirits were right to have anchored on earnings. I believe it’s with less enthusiasm next year. If something good comes from current turbulence, it’s that positioning will be more balanced. Gross and net deleveraging has been significant.

Risk-taking is quickly being recalibrated. When everyone owns the same thing and needs to sell at the same time, bad things happen. The survival trick? Resize concentrated risk positions and manage leverage actively.

We’ve been hyper-focused this year on diversifying the risk we’re taking in portfolios. Looking ahead, the market cycle feels like it can run longer – with wobbles more pronounced.

What makes a market? Greed and fear, in the eye of the beholder.