We are experiencing a market regime change due to the shortage of financial capital due to the AI capex cycle. This has massive implications for asset prices, as capital has been overabundant for so long. The web 2.0 and SaaS paradigms that powered the 2010s market boom were super capital light, allowing an excess of capital to flow into speculative assets.

I had a lightbulb moment while discussing the market landscape yesterday. I believe this is one of the most differentiated posts I've written in a long time. I'll walk through how it all works piece by piece.

There are parallels between AI capex and government fiscal stimulus that help illustrate the underlying mechanics.

In fiscal stimulus, the government issues treasuries, and thus the private sector absorbs duration, and then the government takes that cash and deploys it. This cash circulates through the real economy and gains a multiplier. The net effect on financial asset prices is positive, due to the multiplier effect.

In AI capex, a hyperscaler either issues bonds or sells treasuries (or other assets), and thus the private sector absorbs duration, and then takes that cash and deploys it. This cash circulates through the real economy and gains a multiplier. The net effect on financial asset prices is positive, due to the multiplier effect.

This flows smoothly as this is pulling from dry powder in the economy. It works great and pumps everything. This has been the paradigm for the last couple years, AI capex felt like incremental stimulus that juiced the economy and markets. The issue is that once the dry powder is gone, any dollar going into AI capex needs to come out of something else. It forces a convex scramble for capital. When capital is scarce, it forces an evaluation process of where it is the most useful, and the cost of capital (market-based interest rates) go up.

I'll reiterate: when there is a shortage of money, it drives a weeding out process between assets. The most speculative assets disproportionally lose out, just as they disproportionally benefit when there is an abundance of capital and a shortage of productivity uses for it. In that sense, AI capex has served as a form of inverse QE with negative portfolio balancing effects.

Fiscal stimulus rarely faces this because the Fed generally ends up being the end absorber of the duration, so it avoids crowding out other uses of capital.

The word money here can be used interchangeably with liquidity. The word liquidity can be confusing because it is used in many different ways.

I'll draw the following analogy: money or liquidity is water. You need a higher level of water in the tub to make financial assets (the floating rubber ducks) go up. There are a few ways to do this. You can either increase the total volume of water (rate cuts/QE), unclog the pipes flowing in (plumbing actions like the current RMP), or decrease the amount of water draining out of the tub.

Most discussion around liquidity in the economy always focus around the supply of money. However the demand for that money is equally important. We are facing too much demand, and thus a crowding out effect.

There have been press reports that the deepest pockets in the world, the Saudis and Softbank, are largely tapped out. Everyone in the world has gorged for the past decade and is stuffed with assets. Let's walk through what this means. Altman goes to them with his hands out and begs them to follow through on past committments. Unlike past windows when they had dry powder, they now have to sell something in order to give him the money. What do they sell, hypothetically? They go through their portfolio and select lower conviction plays. They sell some BTC because it hasn't been performing well, some SaaS software bags since they face disruption, redeem from hedge funds that have been showing poor performance. Those hedge funds have to sell assets to meet the redemption. Asset prices fall, lowering confidence and tightening availability of margin, which begets more selling elsewhere. These effects cascade through the financial markets.

On top of this, Trump selected Warsh. This is especially problematic because he believes the problem is that we have too much money, when in actuality we are facing the opposite issue. That is why all of these shifts in the market have been accelerating since his selection.

I had been trying to understand why DRAM / HBM / NAND manufacturers like SNDK and MU were doing so much better than any other stock. Of course the underlying prices are ripping. More than that though, it's because these companies are overearning now and in the near future, even though it's clear that earnings are cyclical and will eventually decline. When the cost of capital goes up, this raises the discount rate. Long duration speculative assets are punished, while assets with near term cash flows benefit.

Crypto naturally gets annihilated in this environment, as the tip of the spear for liquidity conditions. This is why it has felt bottomless.

Highly speculative retail momentum stocks have been unable to hold any gains, and even sectors that improving fundamentals are struggling.

Sovereign and credit yields rise given demand for money exceeds supply.

This is not a time to stay complacently super long. It's a time to play defense, be very selective about what you own, and manage risk. I am not telling you to dump everything, this piece is not a trading call. Take this as background context to help you make sense of what is going on.

I am mostly in cash after selling gold and silver at the top. I'm not in a hurry to buy anything. I believe there will be extraordinary opportunities this year if you are patient.

Shout out to my brilliant homies in the gc who talked this out with me, including @AlexCorrino @chumbawamba22 @Wild_Randomness