Why Market Weakness Could Be a Chance to Add AI Exposure

Sam (0:00)

Let's bring Marley back in and turn our attention to the macro environment and its impact on equities with Zach Hill, head of portfolio manager over at Horizon. Good afternoon, Zach. What do you make of these markets, given everything that's been thrown at it right now?

Zach Hill (0:14)

Well, we certainly have thrown quite a lot at it, since the start of the fourth quarter. I mean, the price action last week was just really, really challenging. And actually, as I sit here today, we have seen a nice rebound across markets, but I actually would have thought we would be higher, just given some of the hedging dynamics and the lack of activity in the Middle East over the weekend. And so, we're watching what's going on in earnings this week and next week, and also keeping in mind the calendar, where we are. We have elections in two weeks. And so, I do think some of that nervousness, all that's kind of brewing together has us a little bit cautious in the near term here.

Marley (0:53)

A little cautious in the near term, we're about to hear from some pretty heavy hitters in terms of the earnings we're getting this week and next. How are you looking at them as a part of this equation?

Zach Hill (1:04)

Yeah, I mean, for us, especially on the hyperscaler side, they're the spenders of CapEx. And broadly speaking, as we're looking at the market and the economy, AI CapEx spending is the most important thing that we have going on right now. More important than consumer and anything else we have in other sectors of the economy. And so, that's really, really important from a headline perspective. In terms of those forecasts. And then I think just as important to that is how the market reacts to those CapEx numbers.

Last earnings season, we did see some upside surprises to CapEx, but also companies were able to show their revenue generation and margin expansion from that CapEx spending. That's something that we're going to be looking for here, because again, that just makes the entire AI ecosystem stronger and more resilient. And certainly, given what's been going on in the last couple, you know, class couple sessions in the Neo clouds, some strength would very much be needed, you know, to stabilize market sentiment here.

Sam (2:00)

Was there anything we took away from last week, given obviously this collapse in the semis, that made you rethink how AI proof the portfolio needs to be for your clients? I mean, what are you telling them right now about where to run? Or had you already been, you know, talking to clients about being, you know, well diversified to hedge against potential risks like we saw?

Zach Hill (2:25)

Yeah, Sam, that's a great question. And we're having those client, those conversations with a lot of different clients and everyone approaches a little bit differently. But, you know, broadly speaking, what we've been saying is we think this AI trend, this AI capex spending and then permeation into the rest of the economy has a long way to run. And so, you know, we're not telling people to run for the exits. In fact, we were adding exposure, you know, to that part of the market and the sell off in July and would look to do so again, if we continue to see a sell off here.

But that being said, you know, realizing how concentrated the market is and how concentrated the economy is, it's been an upwardly self-fulfilling spiral over the last couple of years. But we have to look about things, what if it were to reverse? And so what are some things that we can do in the portfolio that maybe adjacent to it, but not directly involved, that would work really well in a different state of the world. With higher interest rates, we do think adding a little bit of duration to portfolios, especially real yields, given they're at 30 plus year highs. We think that's quite attractive. And we did see when the AI trade took a pause last week, you did see a pretty strong rally in bonds, even though we had a much hotter than expected CPI print. So I think that's very telling, kind of from where the rotational energy is within the market, as we said today.

Marley (3:43)

And Zach, I want to pull out one of the calls that you're making. You're looking at a possibility of a 5-10% pullback in the wake of one of those potential converging storm clouds you mentioned, which is the midterms. So I'm curious, you say you'd be an aggressive buyer of that dip. What are you going for first if we get that pullback? And how are you determining whether that sell-off is an opportunity or perhaps the start of something deeper?