DING! DING! DING!

October was a volatile month with lots of economic and corporate news, but overall, the stock market maintained its upward trend. The US government remained shut down during the month due to the funding dispute between the two political parties, so we did not get the usual bundle of government statistics. The one we got was the Consumer Price Index (CPI) for September, which at 3.0% (year-over-year) was a bit higher than August’s 2.9%. This was released just in time for the Federal Reserve (FED) decision to lower the Federal Funds rate by 0.25% and announce the end of Quantitative Tightening (QT) policy. It is strange how an uptick in inflation leads the FED to loosen monetary policy, but we will talk more about this later in the newsletter. What makes it even stranger is that the Bureau of Labor Statistics (BLS), which releases the CPI data, announced that most of the components in the CPI calculation were “imputed” (meaning, wild guesses) because of the government shutdown. At any rate, the FED decision did not seem to have any effect on the stock market, as the action was telegraphed well in advance during the past four weeks and was fully priced in. It is amusing to think that a FED claiming to be data-dependent for its policy decisions knew what it would do weeks before any new economic data actually became available!

Immediately after the FED decision we got some trade developments resulting from President Trump’s participation at the Asia Pacific Economic Cooperation (APEC) meeting in South Korea. While there were some good deals signed with South Korea and Japan, which will help the US regain some of its lost ship building capabilities, the outcome of the meeting with Chinese President, Xi, was a dud. No significant deal was reached, other than a trade “truce” for 12 months. What an unfortunate choice of words to be used for the outcome of the meeting. It implies the US and China are engaged in economic warfare, which that may be true, but the goal of diplomacy should be to de-escalate and de-emphasize war and focus on cooperation. So, in exchange for the US reducing some recently announced (but not imposed) astronomic tariffs on Chinese products, China promised to resume purchases of US soybeans, relax its recently imposed rare earth metals export controls, and attempt to control the exports of chemicals used in fentanyl production. What happens when the US inevitably deems these promises are not kept? What if the flow of rare earths to the US is slower than desired? What if the harmful chemicals are exported to another Asian country and from there to the US? Will the US go back reinstating astronomical tariffs on Chinese goods? Meanwhile, there were no specifics about the US export ban of chips to China, the Chinese purchases of Russian oil, or the ever-present sore topic of Taiwanese independence. Taking all that into account, can we say we are now getting more concessions out of China than before the April 2 tariff storm, otherwise known as ‘Liberation Day’? We think not. We did make some good deals with Vietnam, South Korea, Japan, and Australia, but China was a tough nut to crack.

By far, the most bizarre thing that happened in October was the regularity (almost every other day) of new Artificial Intelligence (A.I.) investment announcements between technology companies. It felt like there was an artificial excitement build up for investors to keep pouring more capital into these tech companies. The deals themselves felt somewhat inappropriate even if they are “legal”.

Here are a few examples: Advanced Micro Devices (AMD) will issue 160 million shares (representing 10% of its total shares) and sell them to OpenAI (the maker of ChatGPT) for $0.01 per share, which will then sell them in the open market (at $256.12 per share as of Friday 10/31/2025) and use the $40 billion in gains to then buy AMD chips. In other words, AMD will sell its own shares to raise funds to buy its own chips. Recording sales of its products that it purchased itself would otherwise be illegal, but using OpenAI as an intermediary makes it “legal”. It just feels dirty, doesn’t it?

Nvidia (NVDA) will buy a $100 Billion ownership stake in OpenAI, which will then use the funds to buy cloud services from Oracle (ORCL), which in turn will buy NVDA chips to provide cloud services. Again, the same circular flow where NVDA will be providing funds to record additional chip sales. Moreover, if NVDA will own a piece of OpenAI, who will then own a piece of AMD, then NVDA also owns a piece of AMD. These circular deals are an absolute nightmare for any analyst trying to evaluate any of these companies.

NVDA will also lend $20 Billion to Elon Musk’s ‘xAI’ so it can then buy NVDA chips. Again, a chip maker uses its own money to fund buyers of its own products.

There are way too many of these circular transactions to list here, but the core argument for these (incestuous) deals is that there is such “insatiable” demand for AI services that the chip makers must enter into such agreements to satisfy the “insatiable” demand for chips used to process AI models. If that is true, how can we then explain that NVDA disclosed deals with CoreWeave (CRWV) and Lambda (both are data center operators) to lease back their excess capacity of NVDA chips until 2032? If the demand for AI and chips is indeed “insatiable” why does NVDA need to backstop the losses of its customers, who apparently cannot find users for their NVDA chips? The truth is there is no “insatiable” demand for AI or chips. It is simply the narrative of the companies selling these products to create (and continue) a buzz around their businesses.

Case in point, Oracle (ORCL) announced third quarter earnings with a $100 Million loss from renting NVDA Blackwell chips (the ‘latest and most powerful’ in the market), while its capacity utilization was closer to 60% rather than 90% – 100%. Another example is offered by Perplexity AI, which used to charge $200 per month for its AI browser. But now it is offering it for free! Apparently, there is no demand from paying clients for its AI services. Obviously, Perplexity AI will produce revenue the old fashion way: Selling the user data to advertisers. In this case, AI is not the product, the users are the product. Alphabet (GOOGLE) and Meta Platforms (Facebook and Instagram) have become part of the Magnificent 7 following this business model where the user is the product. However, investors need to be very careful when they hear business leaders talking about “insatiable” demand for their products, it is their job to be the chief sales people for their businesses and create excitement.

Speaking of the Magnificent 7, six out of the seven reported third quarter earnings already and from a distance they seem fine. Take a closer look however, like analysts are supposed to do, and you get a different feeling.

Specifically: Both Meta Platforms (META) and Netflix (NFLX is not in the Magnificent 7 but still a half a Trillion dollar firm) took a hit after they announced lower than expected earnings. The miss on earnings was due in both cases to having to pay back taxes to some countries that they had tax disputes with for years. So, their earnings in prior quarters/years were artificially inflated by not paying taxes. Microsoft (MSFT) also declined after reporting good earnings and a plan to spend even more for AI development. The stock was so expensive prior to the earnings release that nothing short of curing cancer would have pushed the price higher. Tesla (TSLA) went up initially after reporting lower earnings and margins. However, the drop in earnings and margins was expected. With emissions offset credits eliminated, EV tax credits expired, vehicle prices lowered a couple of times during the year. Then Elon Musk reported on future TSLA flying cars and robotics, and investors forgot all about the company’s lackluster results or the $1 Trillion compensation Musk demands to stay with the company. Frankly, TSLA investors behave like cult members, following Musk’s visions with religious fervor.

Alphabet (GOOGL) also moved higher after reporting great demand for its AI service (Gemini) in Google searches. It is not clear how Alphabet reached that conclusion, because when you do a Google search you automatically get an AI summary with the search results. You do not have to ask for it, it’s provided anyway. This is like a Mexican restaurant saying there is good demand for its tortilla chips, which come free with every meal. There is no justification for incinerating hundreds of billions of dollars developing an AI service which is offered for free. We still do not see where the payoff from this spending is coming from.

Apple (AAPL) pushed higher after reporting early signs of better demand for iPhone 17 compared to the not so well performing iPhone 16. We have been critical of AAPL as its last major innovation was back in 2015. During the last decade it has been content just installing better cameras on its phones, while completely missing the Electric Vehicle revolution, the self-driving technology, the robotics revolution, and of course the AI craze. Ironically, AAPL may actually come ahead of the Magnificent 7 group simply because it has not (yet) incinerated its capital chasing AI dreams like the others have.

Amazon (AMZN) saw an increase in its stock price as well after reporting no increase in Operating Income from last year despite spending tens of billions of dollars developing AI tools. The only increase in the earnings came from reporting its investment in Anthropic AI valued at $9 billion more than last year. Anthropic is a private company so without public data it is difficult to actually assess its valuation. Moreover, AMZN provided evidence of its success with incinerating funds for AI by quoting “gigawatts of electricity consumed” and billions of dollars spent. Silly us, actually believing the return on capital expenditure should be measured in earnings produced. AMZN believes it can be measured in ‘resources consumed’. Frankly this is very reminiscent of the 1999-2000 Dot Com bubble, when companies with little to no revenue and no earnings were reporting their quarterly results in ‘website clicks’ or ‘clicks per visit’. It was crazy then and it is crazy now.

Only after the bubble bursts investors like to find excuses for pursuing these crazy fads. “How could we have known this was a bubble?” While it is true there are no bells or alarms going off at the exact peak of a bubble, there are alarming warnings along the way. But greed and stupidity together form an intoxicating brew of FOMO (fear of missing out) causing investors to ignore these signs. So, while we cannot know the exact time a bubble will burst, we do have warnings. For instance, pay attention when companies or whole sectors are reporting their progress in terms of money spent (or resources consumed), instead of actual money made. This is a warning: DING! DING! DING!

Nvidia (NVDA) has not reported earnings yet for the most recent quarter, but all the AI deals mentioned earlier have created a frenzy for the stock that has pushed the company’s valuation to more than $5 Trillion, making it the most valuable company in the world. For context, during the Dot Com bubble, Cisco Systems (CSCO) was the most valuable company in the world, and its valuation reached 3.9% of the US GDP back in 2000. Today, NVDA’s valuation is equivalent to 17% of the US GDP! Pay attention: DING! DING! DING! The market capitalization (stock price times the number of shares) of the Magnificent 7 companies is equivalent to 78.5% of the 2025 US GDP. Pay attention: DING! DING! DING!

Aside from the relentless promotion from Wall Street and financial media, another reason for the persistent over-valuation of some tech firms is the erroneous usage of passive investing. This is the model of investing for the masses, introduced by John Bogle at Vanguard, investing in cheap index funds and “set it and forget it”. It worked well in the 1980s and 1990s when most funds were managed by portfolio managers, who actually valued companies based on their fundamentals and were buying the companies appearing to be undervalued while selling those appearing to be overvalued. Index funds copying the professional portfolio managers’ choices were “free loading” on the work and analysis of professionals but at least they were copying sound choices. However, as professionally managed pension plans have for the most part turned into employee managed 401(k) retirement accounts, passive investing now dominates the investment field. Index funds receiving the monthly employee and employer retirement contributions allocate these funds based on market capitalization. In other words, the firms with the biggest valuations receive a greater proportion of each dollar invested. Put simply, the most overvalued stocks receive the most amount of new funds, thus becoming even more overvalued. That’s exactly how we get bubbles. There is no reason for AAPL to be valued at $4 Trillion and be in the Magnificent 7, other than it was at the top of all company valuations a few years back, and because of passive investing it has continued receiving disproportionate amounts of investment dollars every month. Remember, “set it and forget it” means the passively held index funds never sell (that’s the “forget it” part), until of course it is too late. Passive investing is promoted as low risk, but it leads to fantasy valuations. And at some point, fantasy meets reality and bubbles burst— that’s where the risk lies.

What could bring such a fateful meeting with reality?

Lots of reasons; from geopolitics, economics, exposed fraud, or a credit market freeze. Usually, the trouble starts at the credit markets, which when they freeze, the flow of funds to all other markets (stock, commodity, real estate) collapses and price declines quickly ensue.

What do Credit Markets currently signal?

Well, they signal trouble ahead. Loan delinquencies are rising and for some loan types they even match or exceed the 2008 Great Financial Crisis levels. For instance, the delinquencies for Commercial Mortgages are at 11.8%, Multi-family Real Estate Mortgage delinquencies are at 7.1%, Credit Card Loan delinquencies are at 12.27%, Auto Loans are at 5.0%, and Student Loans are at 10.2%. Pay attention: DING! DING! DING!

Bankruptcies are also on the rise, and some are due to alleged fraud. For instance:

• Tricolor, a car dealer in several southwest states, filed for bankruptcy. 80% of its loans were found to be issued for illegal aliens.
• First Brands, an auto parts producer, filed for bankruptcy. The company cannot say what it did with the $2 Billion in borrowed funds or whether it actually received the funds, of course fraud is alleged.
• Prima Land, a subprime car loan lender also filed for bankruptcy.
• Carriox Capital II LLC and BB Capital SPV LLC, private capital firms, both filed for bankruptcy after losing $500 Million to $1 Billion in Broadband Telecom and Bridgevoice loans. Fraud is suspected again as the borrowers allegedly fabricated receivables to borrow against.

When lenders lose money from bad loans due to delinquencies or outright bankruptcy filings, they stop lending until they have a clearer understanding of the situation. In October, the Repo facility (where banks lend their excess reserves to other banks overnight) was drained and banks needing to borrow funds overnight had to use the FED’s Discount Window facility. It is never a good sign when banks refuse to lend to other banks. Pay attention: DING! DING! DING!

More examples include:

• Eagle Bank Corp (a regional bank) lost 10% of its capital from bad commercial real estate loans.
• Santander (a Spanish bank) lost $55 Million from First Brands loans. Three more commercial banks have reported losses from First Brands loans.
• Lloyd’s of London reported a $1 Billion loss from its auto loan portfolio. Private Credit Funds recently disclosed they accepted “payment in kind” for loan payments due. This means issuing more loans to cover the previous missed payments, so they don’t have to report bad loans on their financial statements or to their investors. How can this be legal? It is as if they disclose it in some press release maybe the investors will not see it.

In this context, the FED loosening monetary policy, when inflation came hotter than expected, can be interpreted as a sign that it sees credit markets stressing and trying to avoid a freeze up. Pay attention: DING! DING! DING!

What should investors do now?

1. Avoid the ticking bombs: overvalued companies and those with no earnings or cash flows.
2. **Be selective: **pick quality assets, good businesses with good valuations and cash flows.
3. **Research: **Understand the valuation of your holdings instead of blindly following the herd.
4. **Avoid the passive, “set it and forget it” index funds: **they are full of ticking bombs.
5. **Keep some cash available to capitalize on coming opportunities: **While everyone dislikes market corrections, only those with available liquidity are presented with great buying opportunities.

As always, we are here to assist you in your investing journey. Please reach out with your questions. We are happy to hear from you!

Stay Fierce!