Issue #137, Volume #2
A Hedge Designed For 10x Returns… And Peace Of Mind
This is Porter’s Daily Journal, a free e-letter from Porter & Co. that provides unfiltered insights on markets, the economy, and life to help readers become better investors. It includes weekday editions and two weekend editions… and is free to all subscribers.
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Out-of-control capex spending… The financial model doesn’t work… Hyperscalers sending the S&P higher and higher… There will be a collapse… Positioning your portfolio… A mixed bag for Black Friday… The tariff bonanza… |
Editor’s note: With the market trading at superinflated valuations – and the potential of a market collapse imminent – Porter turned today’s Daily Journal over to Trading Club analyst Ross Hendricks. Ross explains the dynamics of how the artificial-intelligence (“AI”) boom is driving the overall market higher… and what might happen next. More importantly, though, Ross offers insights into how you can protect yourself from this collapse.
Here’s Ross now…
An AI bubble and real tech innovation can co-exist… and that is what’s happening right now.
At the heart of any tech revolution that promises to change the world is game-changing innovation – causing investors to go all-in. But inevitably, investors take it too far. As the speculative frenzy builds, too much capital floods into an industry chasing increasingly marginal investments. The boom eventually gives way to a devastating bust – and the good players remain while the marginal ones fade away.
It’s the most familiar pattern in finance.
We saw it in railroads in the 1800s, electrification in the 1920s, and with the internet in the 1990s. Each episode delivered major leaps forward in technology that eventually changed the world. But the promise to make investors rich quickly led to unchecked speculation, with all of the predictable consequences.
Today, we’re seeing the same pattern repeat in the AI boom.
Like all those that preceded it, the AI bubble is rooted in truth: a disruptive new technology that will transform the world as we know it.
The AI Boom Begins
ChatGPT took the world by storm in November 2022, racking up a million users within just five days. Two months later, in January 2023, the number had exploded to over 100 million users. It was the fastest adoption rate of any consumer product in history, exceeding the internet by a wide margin:
With nearly 1 billion ChatGPT users today, there’s no denying the power of this revolutionary new technology. And it has already begun to change the world. But the rampant enthusiasm about the promise of this technology has inspired a full-fledged speculative mania.
Leading the charge to win the AI race are the four hyperscalers – Microsoft (MSFT), Meta (META), Alphabet (GOOG), and Amazon (AMZN) – cloud-computing giants that own the data-center infrastructure required to run AI models.
These four companies alone will sink nearly $350 billion into capex this year, mostly directed at data centers to power the AI revolution. This reflects a 10-fold surge in their capex budgets from a decade ago. And over the next five years, this investment craze will exceed $2 trillion, equal to the size of the entire Canadian economy:
These investments are now the single biggest factor propping up the U.S. economy.
The truth is that the underlying U.S. economy has been on the verge of recession all year. The ISM manufacturing index has declined for eight consecutive months. But the hundreds of billions in spending from Big Tech companies has prevented the economy from slipping into recession.
The AI trade is also propping up the overall U.S. stock market. The average non-AI stock in the S&P 500 is up a meager 24% in the three years since the launch of ChatGPT in November 2022. The vast majority of the 75% gains in the overall market have come from the outperformance of AI-related stocks which have gained 165% over that same period:
And thanks to the massive outperformance of AI stocks, just 41 companies in the 500-company index now make up nearly 50% of the index’s weighting. This includes the Big Tech companies investing into data-center infrastructure, the semiconductor manufacturers like Nvidia (NVDA) providing the chips that power these data centers, along with a handful of utility companies supplying the energy.
With less than 10% of the companies in the index making up half of the index weighting, the U.S. stock market has never been so concentrated on a single investment theme.
So both the U.S. economy and the stock market have become one massive, all-in bet on AI. And in order to sustain all of this AI-fueled stock-price appreciation, hundreds of billions of dollars must flow continuously into new data-center infrastructure each year.
But here’s the problem… the companies on the other end of this boom aren’t generating anywhere near the revenue needed to earn a return on this investment.
This includes the leading AI applications like ChatGPT, owned by OpenAI – a company only making an estimated $13 billion in annual recurring revenue. Across all AI applications, the total revenue this year will add up to around $30 billion, and is estimated to reach just $85 billion over the next four years.
A report from MIT showed a staggering 95% of the companies that have adopted AI aren’t seeing any meaningful results from it yet. Worst still, another report found that 42% of businesses had already scrapped most of their AI initiatives… up drastically from 17% last year.
So what we’re seeing is all the classic signs of over-exuberance right now.
With $500 billion flowing into an industry that won’t even crack $100 billion in revenue by 2029, it seems we’ve topped out on expectations. But it gets worse when we look at the economics of AI.
Let’s zoom in on industry leader, OpenAI. As a private company, there’s limited public information about its finances – but publicly traded Microsoft owns 27% of OpenAI. By looking at Microsoft’s financial statements, we estimate that OpenAI itself lost $11.5 billion last quarter (for the period ending September 30). On an annualized basis, that’s a whopping $46 billion loss each year… for a business generating $13 billion in annual revenue.
In other words, these numbers indicate OpenAI is losing $3.50 for every dollar of sales. And this cash flow firestorm shows no sign of ending. Based on internal reports leaked to the press, OpenAI currently expects to lose an incredible $115 billion through 2029.
The same is true for the number-two AI application, Claude, owned by private company Anthropic (which counts Amazon and Google as significant investors). Industry analysts estimate that Anthropic also racks up billions in operating losses to generate its $7 billion in annual recurring revenue.
In order to transform these businesses from cash-burning machines into profitable enterprises, research firm Bain & Company estimates that AI companies will need to find another $2 trillion in revenue by 2030. But this scenario looks increasingly impossible.
The vast majority of consumers using AI products are not paying for the privilege. According to industry analysts, OpenAI has only managed to convert approximately 35 million of its 800 million users to its paid plans – that’s less than 5%.
Meanwhile, OpenAI only has about 5 million business users. The big promise of the AI industry has long been the prospect of replacing expensive, white-collar workers with AI applications. But these promises have so far fallen well short of the hype.
A report from MIT showed a staggering 95% of the companies who’ve adopted AI aren’t seeing any meaningful results from it yet. Worst still, another report found that 42% of businesses had already scrapped most of their AI initiatives… up drastically from 17% last year.
With trillions of dollars of investment flowing into an industry generating only tens of billions in revenue, and burning mountains of cash, the AI math simply doesn’t add up. It’s the dot-com bubble all over again.
Today’s AI bubble is even more fragile than the dot-com days, because the entire financial structure rests upon the whims of a single company, OpenAI, which, remember, burns through tens of billions in cash to generate its $13 billion in annual revenue. This single company is responsible for over $1.4 trillion in future capital commitments that the entire AI complex is banking on to sustain its growth.
Our basic premise is that there’s a massive and underappreciated risk that these commitments never get made. And if that scenario unfolds, the future outlook for revenue and earnings growth among America’s leading technology companies will collapse… and with it, the overall U.S. economy and broader stock market.
And that’s how we could see a repeat of the dot-com collapse, which we believe presents the number-one risk to today’s investor.
How The Nasdaq Could Drop 75%
The bull market in AI-related stocks has pushed the technology-heavy Nasdaq 100 Index into extremely high valuations, currently trading at a 45x price-to-free cash flow multiple. The index has only traded above this level at one other time in history: at the peak of the dot-com bubble. In March 2000, the Nasdaq reached a valuation of 50x free cash flow… and we all know what happened next. The dot-com boom went bust, sending the Nasdaq 100 into free-fall, dropping 35% in a span of three weeks. And it was just the start of a brutal two-year bear market that culminated in a 78% collapse that took 16 years to recover from.
But there are ways to position your portfolio against this impending market collapse… particularly in the Nasdaq 100.
I’ve recently shared with Trading Club members a safeguard – in the form of a well-placed hedge. Choosing the right instrument to express this hedging trade is critical. That’s why we’re selecting the Invesco QQQ Trust (Nasdaq: QQQ), which is an exchange-traded fund (“ETF”) that tracks the performance of the Nasdaq 100.
But we are not recommending shorting the QQQ ETF, which is what most investors think about when hedging against the collapse of a stock or ETF. The problem with short selling is that it requires impeccable timing. If you’re too early in taking on a short position, and prices continue soaring higher, the potential losses are unlimited. And even if your timing is perfect, the most you can make from a short sale is 100%.
We’ll be sharing the details of this on Tuesday, December 2. This trade will involve risking a small and limited amount of capital in the event that we’re wrong (or early), while offering upside of as much as 10x or greater returns.
The real value of the hedging strategy we’ve laid out here is the peace of mind it provides. And with that in place, we can remain invested in the market even despite the growing risks of an extreme market event that causes prices to crash. We’ve taken the worst-case scenario off the table, and with that, we can continue putting capital to work without trying to time the market or predict exactly when the next crisis will emerge.
This trading approach has served members of The Trading Club well over the last month, with our live tracking portfolio returning 7.8% despite the increased volatility in the broader market. We launched The Trading Club with a $100,000 real-money portfolio on May 30, with the goal of growing this account to $1 million, and showing subscribers every step along the way. We’re just getting started, with the account up 16.1% in the last six months.
Jim Rickards: “One Executive Order Changes My Entire ‘Birthright’ Thesis…”
In his original “Birthright” presentation, Jim Rickards conservatively projected this $150 trillion mineral boom to transpire over four years… But Trump has just completely accelerated this timeline. What happens next will shock most Americans. Jim just recorded an urgent interview with all the new details. Watch his full analysis of The American Birthright: Phase II HERE.
Three Things To Know Before We Go…
1. Black Friday sales rose 9% to a record level, even as order volumes fell 1%. Consumers are spending more to buy less – a 9% year-over-year (“YOY”) sales increase but a 1% decline in number of units purchased – driven by tariff-induced price increases and persistent inflation. So while in aggregate the consumer appears resilient, a deeper look at order-level data reveals shoppers are becoming more price-sensitive during the busiest shopping period of the year.
2. Tariff revenue surges, but the bond market isn’t buying it. Tariff receipts jumped 281% YOY in October to $34.2 billion and totaled $96.8 billion over the past three months, shifting tariffs from a marginal funding source to one of the fastest-growing contributors to U.S. federal government revenue. Yet the bond market has barely reacted… 10-year Treasury yields are essentially unchanged near 4%. The muted response reflects market doubts that the tariff windfall will last, as higher trade barriers drive up prices and reduce import volumes. In short, the near-term boom in tariff collections doesn’t meaningfully alter the long-term U.S. fiscal trajectory – or the government’s growing reliance on issuing more debt.
3. Silver is breaking out. Following years of underperformance versus gold, silver may now be taking the lead. Over the past week, the precious metal has broken decisively above its prior all-time high near $50 per ounce, and is quickly closing in on $60 per ounce. As of this morning, silver has gained more than 100% year to date versus “just” 60% for gold.
Tell us what you think of today’s Daily Journal or anything else that is on your mind: [email protected]
Good investing,
Ross Hendricks Houston, Texas
