On Top of a Powder Keg

Its getting late in the game.  It feels like the bull market will last forever, as all corrections have been immediately bought up since October 2022.  Equity investors must feel invincible, seeing the SPX and NDX blast up to new highs despite the Strait of Hormuz still being closed, now coming up on nearly 3 months and counting.  The AI names have gone up so much, that they are dragging the index up with it, despite a bunch of lagging names.  It is what you saw in the later stages of the dotcom bubble.  

SPX component stock correlations to the index are at their lowest since 2000.  These dips lower in correlations over the past 10 years have been around market tops: mid 2018, late 2021, early 2025.  

Retail investors continue to pour in record amounts into both stocks and options.  The flows have been elevated since Trump got elected in November 2024. They have reached an even higher level in 2026.  Recently on CNBC, they said that retail investors are now the smart money.  Amber flashing lights going off in the background.  

Its not just retail that's very long.  Asset managers are near their all time highs in SPX net longs as a percentage of open interest.  

A big portion of semiconductor stocks in the SOX have inverted put/call skew (calls more expensive than puts).  Historically bearish for SOX over the next few months.

AI is becoming a huge part of the financial markets.  YTD net issuance of IG bonds and venture capital show how much is going to AI.  49% AI for IG bonds, 87% AI for VC.  

There are a lot of AI adjacent stocks out there.  AI is basically all that matters now.

It seems like OpenAI has speeded up their IPO plans from 2027 to September 2026, according to the Wall Street Journal.  Trying to feed the ducks while they are quacking.

So Space X will be doing the biggest IPO in history in June, with a accelerated lockup expiration that will release a big chunk in August after earnings, not the traditional 180 day lock up period. Open AI is trying to get public as soon as possible.  And Anthropic will be following soon after.  SpaceX estimated IPO valuation: $1.75 trillion.  Open AI private market valuation: $800B+.  Anthropic:  $900B+.  Usually private market funding rounds are at lower valuations than the public IPO valuations, so that is some serious supply coming.  If those valuations hold up after 180 days being public, that's releasing a potential $3.5 trillion of supply on to the US stock market by early to mid 2027.  

 The US and Asian stock markets are now just big bets on AI.  It will be interesting to see what happens when the AI capex tops out.  It is a big bear catalyst that is looming in the horizon.  But its a hidden bull catalyst for bonds which the market is ignoring due to the war.  

With the Strait being closed for nearly 3 months now, inflation is rising, and Fed is getting more hawkish.  

You are hearing more worries about the bond market in financial media, as the 10 year yield broke out above the 4.5% barrier.   For AI skeptics, this is setting up an opportunity to make a good risk/reward bet on the AI bubble popping pushing the US economy into a recession, like 2001.  

There is still the bull catalyst out there, the carrot in front of the donkey in the form of a Iran War deal.  It is what helped push oil prices lower on Thursday and Friday, helping the markets.  It is surprising that the market still reacts so strongly to these mostly bogus headlines.  One of these days, the headlines will be true and you could get a big squeeze higher in stocks and bonds on that day.  That is what keeps me from putting on index shorts.  And makes being long bonds a better bet than shorting stocks at this point.  

Small speculators have rapidly reduced their long exposure in 5 year Treasuries, and as of May 19, have become net short.

5 Year Treasury Note Futures Small Speculator Net Positions

We got a 3 day pullback from last Friday to Tuesday based on bond market fears.  As I said before, I don't believe you should short the index due to a weaker bond market.  That is a 2022 playbook.  I am going with the 2000-2001 playbook.   

While investors have fully bought in to the positive stock/bond correlation, I expect that correlation to go negative like it did in 2001.  Bond yields should top out before the SPX tops out.  For bears, buying Treasuries (short duration) is probably the safer play than shorting the index.  On the sidelines waiting.  Over the next few weeks, I see more opportunity in the bond market than the stock market.