What Rising Rates Mean for the Mag 7 Safety Trade

Sam Vardis (0:00)

Welcome back to Market on Close. I'm Sam Vardis on the floor of the New York Stock Exchange to discuss the past trading month and outlook into year end. Let's welcome in our next guest, Christopher Davis, partner at Hudson Value Partners. Christopher, nice of you to join us. Thank you so much for your time today. So we closed out the month looking mixed. We saw the S&P 500 scratching out a narrow monthly gain here. The NASDAQ composite outperformed, the Dow Jones tumbled. So obviously, we had a little bit of a stumble into the close here with some of the things that Google has been saying about grappling with internal skepticism over Gemini 4 performance. I'm just wondering how you're tying it all together because we had AI slow down fears, we had a tenure that obviously was pushing north of five and a quarter, we had oil prices fluctuating.

All in all, equities held in there are okay. What was your assessment?

Christopher Davis (0:58)

Yeah, I mean, you hit the nail on the head there. We had basically every type of bad news category thrown at the market in the past month and ended up with basically a return that rounds to flatten down slightly for some strategies and some indexes out there. So I think we still have to work through all of this bad news, and right now we're in this period where I think the market can handle a few of these factors all at once, but it's probably one or two too many for us to get some true forward momentum going for the market. That said, in the past quarter, to me, I think the biggest story was the resilience of equities markets in the face of dramatically moving fixed income markets where rates moved up in some of the quickest rate increases we've seen in years, maybe even decades.

SPEAKER_3 (1:53)

So Christopher, how do you interpret that resilience, particularly given how weak market breath has become?

Christopher Davis (2:00)

Yeah, market breath is a real story. I mean, the stock came out today, that 20% of the S&P 500 was down, 10% or more in the month of September. And 60 or 70% of stocks right now are 20% or more below their recent highs. So for all the investors out there that have been waiting for a correction or thinking about some sort of pullback, I think that pullback is here.

Some people talk about rolling corrections. I think this is just more under the hood. We've seen strength in technology continued, but in the everything else, there's been a real pullback. And I think that creates opportunities. Like you're talking about Micron, which had a great result, but is having trouble finding some forward momentum. With some of the AI story right now, the question is, who's left to buy?

It is probably the biggest part of everyone's portfolio three years into this AI bull market story. And CapEx bulled out story. And I think investors right now, as we get past some of these bad news headlines that we're gonna work through, whether it's through the war, energy prices, inflation, the midterms are coming up, we're gonna get through another earning season. They're probably gonna look at what the market has left behind. And there's probably some opportunities in there that'll continue into 2027

Sam Vardis (3:13)

Yeah, I mean, AI has certainly been debated since the summer. I mean, particularly when you take a name like Micron, which has kind of traded sideways since that run up that we saw into June.

I think obviously memory is important, but the market has clearly been questioning just how sustainable these margins are. We've got a little bit of a glimpse of that into the adjusted Q1 outlook here. But we have, to Marley's point, I mean, that bad breath seen that re-establishing of leadership from the Mag 7, I mean, which hit a record high last week. Meta just had its best month since 2022 What do you make of that rotation back into the large cap tech?

Christopher Davis (3:56)

Well, I think for some, it's a safety trade, especially in the face of rising rates. In the past, those companies, the Mag 7 have proved themselves to be from an earning standpoint, more immune to higher rates.

But this time might be a little different in that those companies are now some pretty big borrowers. If you look at where the Alphabet bonds or where some of the other bonds of the big tech issuers like Oracle out there are trading, those spreads over treasuries are really starting to widen out in some areas of corporate bonds. But I do think that there is a rotation that is happening and probably will continue to happen where it's not so much chasing the hottest IEI names, but going back into some of those Mag 7 names, whether it's Meta, which is a fantastic advertising business, or Alphabet, which is a fantastic advertising business. And when we underwrite that type of business, even if all the AI spending turns out to be mal investment, which I think is a ludicrous worst case scenario. But even if it did, they still have tremendous franchises in advertising and their main businesses that are free cash flow generative.