Concerns about AI financing are compounded by macroeconomic disturbances! Xiaomo turned bearish in the short term: the market sell-off is likely to last longer

The Zhitong Finance App learned that J.P. Morgan Industrial Sales Analyst Sam Edmonds said in a research report released on October 18 that the past week has been quite difficult, and he still has an empty stance in the short term. He believes this sell-off is likely to last longer.

Since this year, several market fluctuations in the data center sector have been driven entirely by macro factors, but the CoreWeave (CRWV.US) problem is a real micro-level problem. Edmonds has previously expressed concern that the data center construction boom is too fanatical, and has also feared that something will happen in the financing market, thereby interrupting the momentum of this investment theme. Considering that CoreWeave can be said to be one of the leading new cloud service providers (neocloud), it is really surprising that it is now in such a difficult situation.

As Hwang In-hoon said last Thursday, things may be fine; despite the poor trading price performance of CoreWeave bonds, their weighted average cost of capital (WACC) may still be declining. But this is certainly something to worry about. Although Hwang In-hoon's reassuring remarks about CoreWeave did reverse the market trend, the bond market did not agree with his statement that “CoreWeave doesn't need to be refunded.” If CoreWeave does need an injection of capital, the market is bound to be hit again before this actually happens.

Edmonds doesn't think the economy is about to fall into a downward cycle, and there are good reasons to think that properly cooling down the data center construction boom will be a very healthy thing — both in terms of the sustainability of the industry cycle and from the perspective of actual infrastructure construction costs. However, the market often extrapolates changes in second-order derivatives to the effects of first-order derivatives, and continues to worry about economic recession until the second-order derivative improves again.

He anticipates that sell-side research institutes will publish more and more reports analyzing what happens when the economic environment weakens. The best reports of this kind should try to do three things right. First, identify which stocks are most likely to outperform the market, including companies with excessive profits, high leverage, and low profit margins; second, find the most defensive targets, including companies with high aftermarket business, high profit margins, low sensitivity to GDP growth, and low leverage; and third, estimate the profitability and reasonable value of a company in the middle of the cycle, so as to identify stocks worth buying when the market inevitably falls excessively.

Regarding the issue of excessive profits mentioned earlier, Edmonds believes that the market may list gas turbines, optical fiber, and diesel engines as segments where prices have been drastically raised. As for aftermarket business and lower GDP sensitivity, investors are likely to focus on Assa, Kone, Schindler, and Atlas Copco (Atlas Copco). In the capital goods sector, Atlas Copco remains the analyst's most confident investment target.

Edmonds believes that it is still a long way from being able to buy at a valuation multiple at the bottom of the cycle and get a reasonable value in the middle of the cycle. One reason why this round of sell-off made him think it might last longer is because of the interaction between the stock market and the interest rate market. Macro market commentators have been stressing the continued excess performance of stocks compared to bonds for most of this year. However, the consumer price index (CPI) data released last week changed this situation: the data initially drove up 10-year US Treasury yields, then triggered a round of “risk aversion”. From that moment on, the bond market began to rebound, while the stock market continued to decline.

Capital goods sector

Edmonds mentioned the third-quarter revenue data released by Schneider Electric (Schneider). Despite the good performance of the data, it also raised some new “questions” about the company's business growth momentum. According to the median calculation of the company's fourth-quarter results guide, organic sales growth (OSG) will reach 8%, which means that the growth rate will slow significantly. However, companies that give this guidance have always had the habit of exceeding expectations and raising the guidelines. Furthermore, the “three-digit increase” in data center (DC) demand is no longer just from the US, but has now risen to the group level as a whole. The driving factor behind this change is the significant acceleration of growth in the Chinese market. The performance of the Industrial Automation (IA) business also surpassed expectations. However, Aveva's performance in the industrial software business is in a negative growth range, which is not a favorable factor.

Overall, these data suggest that the capital goods sector's performance in the third quarter earnings season is expected to be quite strong, but the market's scrutiny of the company's outlook guidelines will be more strict than usual.

Chemical sector

For European industrial stocks, this change has led to a rebound in interest rate sensitive stocks. Both the Building Materials Unit and the Defence Unit benefited from this.

Interest rate sensitive stocks are not the only ones rising. The market has also bought all targets seen as “growth independent of AI.” This boosted the civil aerospace sector, but due to the influence of Rolls-Royce (RR)'s power systems division, the company underperformed the overall sector; at the same time, chemical stocks also attracted buying.

Givaudan (Givaudan), which is covered by the Xiaomo Consumer Products team, reported stronger than expected growth for the third quarter — and the market's previous expectations themselves were already quite high. The company notes that the beauty and fragrance business is an important driver of growth, with the strongest growth in Southeast Asia and the Middle East. This performance is a reference for Croda and DSM Firmenich (DSM-Firmenich).

However, the basic commodities sector also performed quite well this week. Against the backdrop of investors' concerns about slowing economic growth, this seems a bit abnormal. Komo expects the overall performance of the third quarter earnings season, but there are still doubts about the growth momentum's performance at the end of the quarter.

However, it seems that the sector was bought, at least in part, because the market wanted the EU to introduce measures to protect the European chemical industry. Discussions on this issue have continued for some time, but some progress has been made this week: the EU Critical Chemicals Alliance (CCA) has drawn up a list of molecules that are not exhaustive, and believes that these chemicals should receive additional protective measures to guarantee their production in Europe.

This is not as simple as protecting the steel industry, because the chemical industry's supply chain is more complex, and European chemical companies are more susceptible to China's countermeasures. In fact, both BASF (BASF) and Evonik (Evonik) have reportedly asked to weaken the language in the relevant documents. Furthermore, industry-wide gas price subsidies — which would be a real panacea to the problem — have been clearly excluded from current discussions.

If Europe wants to preserve a certain degree of manufacturing autonomy, the chemical industry is certainly critical. The US government's recent actions in response to Russia and its invasion of Ukraine are also a strong reminder of why this is so important. Therefore, progress on relevant policies is helpful, but it is unlikely to be reflected in profit data published by companies in the short term.

The EU is looking for ways to reduce its trade deficit with China, and the chemical and automotive industries are at the center of related efforts. Unfortunately, announcements relating to import caps and chemical molecule protection lists for plug-in hybrid vehicles (PHEVs) are currently insufficient to give people confidence that the industry's profit margins will begin to recover.

Defense sector

The performance of defense stocks this week is worth careful analysis. In recent weeks, Edmonds has mentioned many times that the defense sector has become the least popular sector in the market among the sectors he covers. Its valuation has become cheaper, but it is currently unclear what catalyst is needed to re-attract buyers. It should be pointed out that this week did not see widespread large-scale purchases across the sector, so so far, this is more like a round of rebound that investors are unwilling to participate in.

Edmonds believes that defense stock performance this week was mainly driven by three factors. The first factor is position adjustment. As the market as a whole reduces its overall risk exposure, some short positions may have been closed. Analysts suspect that most of the trading activity here is driven by synthetic trading strategies, such as buying a basket of defense stocks or making up positions that have shorted the basket of defense stocks.

The second factor comes more from fundamentals. OHB was the first stock to rise in this round. Earlier, it was reported that the US restricted Ukraine's right to use Starlink (Starlink). Subsequently, on Friday evening, US President Trump signed an executive order suspending the implementation of the “Graham Act” (Graham Act) sanctions against Russia. Trump seems to want to end the war as soon as possible by any means and to re-view Ukraine as a party he can influence in an attempt to force Ukraine to surrender.

Regrettably, Ukraine will not be able to give in as easily as Trump had hoped. If Ukraine decides to continue fighting, then it will need European support. In a sense, the situation has not actually changed. Since Trump was re-elected, America's support beyond intelligence sharing has been quite limited — but now, this may be even more obvious.

Germany is also beginning to express its position more clearly on the issue of supporting Ukraine. The market is at the beginning of Europe's rearming cycle. This also led to a third factor driving the rise in defense stocks: the overall performance of the European defense sector's third-quarter earnings report should be quite strong. Furthermore, the decline in 10-year treasury bond yields is also clearly beneficial to defense stocks.