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Introduction

It Was the Best of Times...

Borrowing from Charles Dickens, the phrase feels particularly appropriate for today's market. It has been the worst of times for growth investors overweight the Momentum Factor, yet the best of times for value investors positioned in many of the market's long-neglected laggard sectors.

We've discussed the historic unwind in the Momentum Factor over the past month in our prior reports, and that decline has only accelerated. The Goldman Sachs Momentum basket is now down an astonishing ~45% from its recent highs.

Marking the current environment as the worst drawdown in history.

This is not isolated to the U.S. market, but rather to any market where the AI infrastructure trade has dominated. Look no further than South Korea, where the unwind has created utter chaos in its equity market.

What makes this environment even more perplexing is that the average stock is breaking out, as evidenced by the Equal Weight S&P 500, which recently recorded a new all-time high before pulling back. The question now is whether the major indexes will revert higher, or whether the rest of the market will catch down.

Meanwhile, NYSE Net New Highs have rebounded back to the top of their recent range.

The Equal Weight S&P 500 continues to significantly outperform the Semiconductor Index.

Which makes the pair trade we highlighted in our June 28 report look particularly compelling, now outperforming by more than 2,200 bps.

We get asked all the time what will reverse the slide in growth stocks. Ultimately, it comes down to positioning. Only when the sellers have exhausted themselves can the healing begin.

The AI infrastructure trade fueled a crowded and parabolic advance in growth stocks, largely at the expense of the rest of the market. That dynamic set the stage for the historic unwind we are now witnessing.

The narrative has also turned decidedly negative. It has shifted from one centered on years of sustained earnings and cash flow growth to one arguing that capex has peaked and that the rate of earnings growth will begin to slow. The truth is likely somewhere in the middle. For some companies, earnings may have already peaked, while others remain in the midst of one of the largest infrastructure buildouts in history. Sifting through the rubble is where the real opportunities will emerge, and that is what we will be looking for as sellers eventually run out of ammunition.

The other issue plaguing the market is the surge in CDS risk across the ecosystem, suggesting default risk is rising. This could prove to be the other proverbial shoe to drop for the AI infrastructure trade and is another reason to remain cautious.

Look no further than Oracle, whose stock has experienced a stunning collapse over the past two months. The recent increase in its CDS has been equally noteworthy. The cost of insuring Oracle Corp. against default reached a multi-year high this week, rising to more than 215 basis points, up from roughly 145 basis points at the end of last year.

Outside of the usual AI-related developments, the FOMC met today and delivered a fairly hawkish message, despite bond traders lowering their expectations for a Federal Reserve rate hike in September. Markets are still pricing in roughly a 60% probability of an additional increase.

While the 2-year Treasury yield, a proxy for short-term interest rates, declined following the announcement, long-term yields moved sharply higher, with the 30-year Treasury reaching its highest level in 19 years.

This likely explains the abrupt reversal in the S&P 500, which surrendered nearly 2% from its intraday high.

After the bell, we heard from two of the hyperscalers, with Meta taking the disappointment prize. The stock traded down roughly 10% after hours following a weaker revenue outlook. On the positive side, the company did not raise its capex forecast, which could also weigh on the AI infrastructure names. Microsoft fared better, but we question whether its results will be enough to rescue the growth trade from the abyss.

As our readers can attest, we began turning increasingly cautious roughly a week and a half ago in our report titled Rough Air. In that report, we explicitly advised caution and suggested that any rebound attempts would likely be sold. Since then, the Nasdaq 100 has declined another ~6%.

That begs the question: is it time to buy?

Let's check the charts.