AI Capex Backlash

That was some savage selling on Friday.  Disappointing tech earnings met month end selling, vol control de-risking, and leveraged ETF rebalance selling.  These leveraged ETFs in volatile sectors like SOXL are absolute poison in choppy markets as they have to sell weakness and buy strength.  

Friday looks worse than it really is because the market rallied from Monday to Wednesday, right into all the tech earnings.  If you look at the daily chart, the Nasdaq chart looks bad, but the SPX is just chopping around in a narrow range, mostly between 7600 and 7800.  

The market has sold off into the FOMC meetings in July and September, and rallied strongly afterwards.  So you probably had some eager buyers jumping the gun, thinking the worst of the selling was over.  But tech is just too weak.  It trades like investors are overloaded in the sector and suffering badly, not wanting to triple down.  You have now seen 3 straight weeks of rallies from Monday to Wednesday being met with vicious selling on Thursday and Friday.  It feels like a combination of pre-weekend selling (ongoing Iran war fears) as well as weekly opex forces in a weak market.   

The earnings reactions in tech were bad.  The market is now screaming at the hyperscalers to stop going crazy over AI capex.  The stark difference between the earnings reactions for MSFT and GOOG tells you everything.  Investors are now punishing big AI capex plans and any disappointments from AI adoption (weaker search growth revenue).  GOOG went down hard on this, when it announced negative free cash flow (worse than expected) and huge AI capex spending plans for 2027.  MSFT is keeping its AI capex growth under control to maintain positive free cash flow, taking away dilution fears.  What is eye opening is that GOOG was already trading weak going into earnings, and MSFT was trading strong.  Even with the low expectations going into GOOG, it still cratered.  

GOOGL

MSFT

Then you had the negative earnings reactions in INTC and SNDK after their earnings.  There wasn't a big blow up in the earnings numbers for either company, just a little lighter guidance for INTC.  But the expectations for the semiconductor and AI hardware names are sky high.  Anything but monster  earnings beats are being met with disappointment.  

INTC

SNDK

A continuing source of pain will be tech equity supply for the next few months.  The float in SPCX continues to expand as lock up expirations gradually expire.  META dropped a dilution bomb right after its earnings, saying they will issue up to $95B in stock over the next few months, trying to get ahead of other hyperscalers trying to raise capital.  Anthropic filed its S-1 and likely to do its IPO in mid to late November.  That IPO could be for up to $100B.  With all of this tech equity supply coming down the pike, fund managers will be hesitant to add more tech to their portfolios.  

Retail trading activity has been down this year, as is normally the case when speculative breadth weakens.  Its been ongoing since the speculative small cap bubble hit its peak in October 2025.  There are lots of retail bagholders in speculative tech, waiting to sell at break even or until the pain becomes so great that they capitulate.  It shows you how crazy the retail speculation got in 2025.

Mag7 exposure is very high among hedge funds.  

QQQ short interest has been increasing why SPY short interest has been declining.  

Vol control funds are still holding high equity exposures because of the low realized vol in SPX over past few months.  

Aggregated equity positioning (still overweight) and across fund categories.

Cyclical - Defensive ETF flows have reached extreme negative levels.

5 year CDS for various hyperscalers and AI semiconductor companies

Funding spreads are a concurrent indicator of speculative index futures activity.  It usually peaks before the market does.  They are coming down after spiking in the summer.  Still at high end of range historically.  Not a bullish sign.  Similar drops in funding spreads seen in mid 2018, early 2025, and early 2026 led to serious weakness 2 to 4 months out.  

Not much going on in bonds, slowly grinding lower in yields as the AI trade weakens, even as crude oil keeps going higher ahead of Iran re-strike fears post midterm elections.  Treasuries are no longer an inflation trade, but the anti-AI trade.  

Covered the small short position on Friday, and entered into a small long position in SPX.  Not looking to get aggressively long, just looking for a technical bounce post-election, perhaps a 1-2 week rally.  Its been nearly 3 weeks since the hot CPI number launched the start of the selling in SPX.  We've had 3 waves of selling, each hitting a short term low on 3 consecutive Fridays.  This last wave was the swiftest and strongest.  It felt like some funds were throwing in the tech towel on Friday.   

Seasonally we are exiting the stock buyback period and entering a strong part of the year from end of October into year end.  Coinciding with mid term elections, a post event relief rally is the most likely scenario.  I don't expect a strong rally because there hasn't been a strong selloff (outside of tech), and tech has led the selling, which is a bad sign for the intermediate term.  The price action in October is a foreshadow of things to come, so rallies in SPX will be shortable if it gets above the top of the range (7800).  Its rare to see heavy selling in November and December in a bull market when you've already had a few weeks of selling in October.  So expect more chop until year end, and then 2027 should come out with some real fireworks to the downside.