ROI-Three midweek thoughts — dodging AI, uber bulls and intervention flub: Mike Dolan
ROI-Three midweek thoughts — dodging AI, uber bulls and intervention flub: Mike Dolan The opinions expressed here are those of the author, a columnist for Reuters.
By Mike Dolan
LONDON, Aug 19 (Reuters) - This week's market headlines have been dominated by Iran war rhetoric, long-bond blues and a sudden tech stock wobble.
But strategists looking beyond the breaking news are digging deeper into recent developments to figure out how best to diversify away from AI, how to cope when everyone's bullish and whether the recent U.S.-Japan currency intervention raised more questions than it answered.
LOSS OF CONCENTRATION
Megacap "Big Tech" concentration in benchmark equity indexes has long been a headache for portfolio investors and passive index trackers, but direct exposure to the single theme of AI takes it to another level.
Despite considerable uncertainty about AI's eventual payoff and impact, investors simply buying what is billed as a diversified S&P 500 stock index .SPX now take on 50% exposure to AI-linked firms — hyperscalers, chipmakers and AI infrastructure companies central to the theme.
Insulating portfolios from an AI accident with bonds and fixed income may once have been a plain-vanilla solution. But concentration is also rife there, as hyperscalers borrow like there's no tomorrow and command a growing share of U.S. investment-grade (IG) credit indexes.
AI-related bond issuers account for a third of all net issuance year-to-date, and Apollo's credit team estimates the five big AI hyperscalers alone could grow from less than 5% of the IG index today to nearly 10% by 2030.
Put another way, it expects the five big hyperscalers plus SpaceX SPCX.O to have a bigger share of IG indexes than the top five U.S. bank issuers by the end of the decade.
So, tilt to the junk-bond market instead? Caution is warranted there, too. Apollo points out that data-center financing is now one of the fastest-growing segments of the high-yield market, and borrowers such as Core Scientific CORZ.O and TeraWulf WULF.O are raising capital to transform existing bitcoin-mining facilities into AI data centers.
"Almost overnight, direct data center exposure in the HY (high yield) market has gone from virtually zero to nearly 5% of the index, which, as a stand-alone sector, would make it the sixth-largest sector constituent in HY."
And that's before we get to GPU-backed financing in the leveraged loan market or huge swathes of AI financing in private markets.
The upshot is that investors accustomed to diversifying across asset classes and sectors that traditionally perform differently in periods of acute stress are now taking on large chunks of the same risk wherever they go. Chipmaking, real estate, power and construction are all now loaded with the same theme.
"A portfolio with hyperscaler bonds, data center debt, power infrastructure, semiconductor exposure, GPU-backed financings, or AI-related equity issuance may appear diversified but contains assets highly related to the same underlying factor," Apollo said.
AI better not be a bubble, because there aren't many places left to hide if it pops. Carving out individual stocks and sectors may be necessary, and paper investments with no exposure to AI at all may, conversely, be bid up by funds desperate to diversify.
UBER INVESTED
Whatever investors are doing to diversify, they are not going to ground or retreating into cash — not yet, at least. That much was crystal clear in Bank of America's latest global fund survey. Aggregating the responses from 180 funds around the world with some $525 billion under management, the survey showed that cash levels fell in August to what BofA described as an "uber low" 3.5% — down from 3.6% in July.
With almost 60% seeing no landing for the U.S. economy on the horizon and more than 70% seeing no cut in AI-related capex forecasts this year, there was barely a bear in sight. And, of course, that's always a bit unnerving.
That cash level was the sixth-lowest in the 28-year history of the survey and in the zone BofA reckons is "sell" territory. A 56% net overweight to global equities was the highest since 2021.
"Positioning continues to recommend investors retreat or rotate within risk assets rather than reload," they concluded.
It wasn't all stress free, however. The funds still see "long semiconductors" as the most crowded trade, an "AI bubble" as the biggest tail risk, and the most likely source of a systemic credit shock is hyperscaler capex debt.
BACKFIRING INTERVENTION?
Japan's yen JPY= has quietly slithered back to levels not seen since the U.S. Treasury reportedly sold euros for yen on July 31, in what was billed as a historic joint intervention after the Bank of Japan sold dollars for yen the previous day to support its ailing currency.
Given the firepower — or at least the optics — of the coordinated action, why hasn't it had more durable impact? Currency analysts have pored over the issue, with some suggesting doubts about the BOJ's willingness to follow up yen buying with a series of interest-rate rises are a key factor behind renewed yen selling.
But Deutsche Bank's FX strategist George Saravelos has a different take — arguing that the choreography of the action and the revelation of its limitations made it "not only ineffective, but counterproductive."
By steering Japan toward the Federal Reserve's FIMA repurchase facility — and reportedly urging the Fed to expand it — the U.S. Treasury showed clearly that it was uncomfortable with Japan liquidating any part of its Treasury bond holdings to raise dollars for the currency sales. The FIMA facility simply allows Japan to post its Treasuries as collateral to raise dollar cash.
"It is unrealistic to expect Japan to intervene by borrowing dollar cash at penal FIMA rates and therefore the bar for further intervention went up," Saravelos wrote.
Second, data from the Fed's System Open Market Account (SOMA), its huge portfolio of domestic and foreign assets used in monetary-policy operations, show that barely any money was spent on the U.S. side.
"The implicit signal is that neither the U.S. administration was willing to deploy US taxpayer dollars to buy Japanese assets, nor was the Fed especially keen to participate."
For many currency traders, there's only one way to test whether that's actually true, and it has pushed the yen's exchange rate sharply lower again.
(The opinions expressed here are those of Mike Dolan, a columnist for Reuters.)
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(By Mike Dolan; Editing by Marguerita Choy)
((mike.dolan@thomsonreuters.com; +44 207 542 8488; Reuters Messaging: mike.dolan.reuters.com@thomsonreuters.net/ @))
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