We’ve already made the point that we believe this sell-off is a buying opportunity, and the AI trade will return to leading the bull market soon.

 

However, we wanted to talk on this a little bit more as it pertains to market sentiment. A big reason these selloffs are an essential part of a bull market is because they reset sentiment so it becomes a tailwind rather than a headwind.

 

They allow kinetic energy to build up in the opposite direction, like pulling on a rubber band, eventually pushing stocks higher once again.

 

Of course, this isn’t always the case – eventually there will be a bearish reversal and stocks will enter a proper downtrend.

 

But the bearish reversal is far rarer than a bull market climbing out of a sell-off to resume its uptrend – and there is nothing to suggest, across everything we track, that this is a major reversal.

 

One of those things is sentiment…

 

Major tops in bull markets come at moments of extreme bullish sentiment. What you’re typically looking for is a point where market participants begin to discount negative news en masse.

 

If you want a great example of this, you can look at the support most mainstream commentators gave financials when they started to decline in 2007 after a strong period of outperformance…

 

Many people were effusive…

 

I recall one commentator saying that a 30% sell-off in Goldman Sachs in August 2007 was like an opportunity to “get Dolce and Gabbana on sale”…

 

It may have seemed like that over the next few months as Goldman Sachs did rally sharply… before collapsing more than 80% in value!

 

A similar thing happened near the peak of the Dotcom bubble…

 

However, in the present day, the August sell-off has engendered too much negativity for it to be a market top. When a sell-off happens and nobody (or barely anybody) panics – that’s what we’re looking for!

 

Instead, during this sell-off, we’ve seen bearishness pick up quickly, and sentiment reset to levels that will help drive the bull market higher from here. So we restate: what happened over the last five weeks or so is bullish, in price and sentiment…

 

Since we’re on the topic, we want to lay out what we believe will happen over the next few years in terms of sentiment, technological developments and the market.

 

This isn’t an official prediction so much as the scenario we have in our mind to work off as a guide for the future. We like to try to cast our mind forward 12-36 months and ponder, in detail, what things might be like…

 

This helps with investing in two ways: it helps us identify investments that may do well, and it also helps us weather any volatility in the assets we hold by setting expectations.

 

So here goes…

 

“No matter who wins the 2024 election, markets will take off in the latter part of the year. We will see global liquidity pick up and risk assets rise virtually across the board.

 

There will be broad participation across sectors – financials, industrials, consumer discretionary, tech, gold, small caps, materials, crypto… even staples and utilities will be doing well.

 

The fact the market overcomes the sharp sell-off in August means market participants will begin to feel a higher degree of confidence in the bull market.

 

Nowhere will the growth in confidence be more apparent than in the AI trade, mainly in semi-conductors – but also in AI software stocks like Palantir and at some point, Tesla.

 

As the semi-conductor ETF SMH, and Nvidia, hit new all-time highs the myopic “mind of the market” will begin looking further afield at what the next upward price targets may be.

 

This will excite market participants with the prospect of high returns on the near horizon.

 

Also, with interest rates coming down, the incentive to chase a higher return than you can get holding cash will return. There is nearly $6.5 trillion in money market funds right now, which is a record.

 

If this pool of cash begins to funnel into the stock market, even just some of it, it will provide even more liquidity for the stock rally. Even then, it’s not needed to juice markets – as central bankers around the world will have moved into “easing” mode…

 

They need to bring interest rates down and roll over debt, so they will expand their balance sheets. All major central banks will do this: US, Euro, Japan and China…

 

Further, because the Fed will have been seen to conquer inflation through an “immaculate disinflation” from 2022-2024 (i.e. where inflation is moderated without a hit to employment or economic activity) people will feel a renewed confidence in the ability of central bankers.

 

Central bankers will also begin to feel more confident in their ability to control the economy. They’ll feel a weight come off their shoulders as declining interest rates bring down interest payments on the national debt.

 

The backdrop to all of this will be the outperformance of financials, and particularly, banking and the continued rise of real estate values. Market participants will even see regional banking stocks doing well, the area that sparked the most fear in 2023 (and again for a brief moment in 2024)…

 

The success of this sector will be the icing on the cake, building even more confidence in financial markets and the economy.

 

Overall, people will start to become more comfortable and will begin to take greater risks.

 

A grand vision of the future – driven by AI – will dominate the “mind of the market”, where the expectations of market participants will become ever more optimistic.

 

This could be propelled by something like a highly compelling demonstration of Optimus, the Tesla humanoid robot, or Tesla’s self-driving tech may hit popular consciousness in a new way. A small sub-narrative here is that Tesla will eventually make the full transition from being considered a car company into an AI company.

 

Another thing that adds to this “grand vision of the future” could be an amazing application of AI video generation, which makes a big leap. Or a health breakthrough with AI, big data and genomics. It may be a leap in the ability of LLMs, or a combination of these things, or even some other surprise.

 

We believe we’ll also see the AI and crypto narrative intersect and become a larger focus for investors, rather than the fringe who are thinking about it now.

 

Both are cutting-edge areas of tech where the highest returns are being made, so the combination of the two will result in explosive gains.

 

Overall, the returns in crypto during this period will be FOMO-inducing. “Meme coin season” will hit full swing, concentrated on the Solana chain.

 

Even more importantly, the trend of institutional money coming into the space will continue and even pick up pace.

 

The work done during the prior crypto bear market, with banks like BNY Mellon creating the ability for institutions to custody crypto at scale, alongside the newly introduced ETFs, means that the architecture for large inflows of money is in place…

 

An architecture which didn’t exist in any prior crypto bull run.

 

As at the peak of the last bull run in 2021, crypto will again catapult into mainstream awareness as less sophisticated retail investors join institutional money in chasing the trend higher.

 

In 2025, the market will climb out of any sell-off and each time confidence will rise even higher.

 

As the stock market nears its peak, certain investments will become disconnected from fundamentals. At this point, picking winners is less about what Warren Buffet likes to consider when selecting stocks, and more about how much liquidity there is in the system to direct towards the investments people are feeling the most FOMO around, because they’ve been rising spectacularly. And there will be A LOT of liquidity.

 

Value investors will bemoan the “crazy” PEs of these investments.

 

AI will be the rationale for why we’ve entered a new normal, and the mental foundation for those who rationalize away the markets divorce from fundamentals.

 

In some ways, it’s hard to blame them. As hyper-sophisticated humanoid robots look ready to enter the market, and AI generates increasingly compelling media on its own – it’s easy to see how people will be carried away by this…

 

Yet many of the most ambitious and exciting applications of AI will be largely unrealized in earnings and legitimized through hopeful projections for the future.

 

At this point, financials will have begun declining in the background, with real estate values declining also, but because of how markets soared out of the “banking crisis” in 2023, people won’t be overly worried about these developments.

 

They will believe the Fed and banks have it under control.

 

Similarly, when inflation begins to pick up again, the Fed will at first hope its fleeting. As it persists, there will be a strong “second wave” narrative and much consternation… yet many will also feel inflation is not as much of a threat as the last time it reared its head, because they feel an “immaculate disinflation” is not only possible, it’s likely.

 

The Fed will begin raising interest rates and initially markets will stumble, but then they will start climbing again. Market participants have seen this story play out recently – and it ended with the Fed being seen to manage things well, so many will remember that.

 

Eventually the Fed will come up against enough poor economic data, especially rising unemployment and issues with banking and real estate, that they will announce a rate cut. Markets will respond positively to the cut, but this will mark a significant turning point…

 

When the Fed makes its cut we know the market has likely peaked, or is very close to it. Yet because the AI narrative is still intact for most people, and the cut has just happened, and there is still a profound mood of optimism, most people will still be wearing their “bull market goggles”…

 

Many will call it a dip-buying opportunity, just as they have with increasing confidence all the way through the bull market. But this time it won’t be. In fact, markets will have begun a historic slide, which will result in the S&P 500 losing around 50% of its value or even slightly more.

 

At some point after the peak as markets decline, the AI narrative will crack. It will happen for the same reason it always does in these situations; it will become clear firms can’t make good on the optimistic revenue projections their current elevated prices are based on.

 

As firms cut back on AI expenditure, demand for Nvidia GPUs will decline and Nvidia will begin falling. When it becomes clear it’s not merely a sell-off, and something bigger, the extension of the selling will spark a broader fear.

 

Yet the biggest issue for the economy will come from the banking sector. What seemed like a small issue in banking begins to pick up steam as banks begin to have liquidity issues sparked by the declining value of their collateral (i.e. real estate).

 

The deeper cause is always the same: declining land values.

 

Banks will begin to call in loans to try to rebuild their balance sheets, causing a broader liquidity crunch that will impact employment and economic growth.

 

An inflection point will occur sometime in 2026 or 2027 – where a banking failure or other issue in the financial system will spark calamity. At this point, the shit will have officially hit the fan and the selling will be ferocious.

 

The issues in the banking system will spark a deep recession with lingering unemployment that will foment social unrest along with a rapid shift in the Overton Window.”

​

So that's it...

 

Our mental model for the future up until the peak and crash as far as markets and investments are concerned.

 

We haven’t covered the period after the crash, which we also have rough thoughts on. And we also have a rough mental model for what we think will happen along political and societal lines while all this unfolds, but we haven’t written either model out in their entirety.

 

When we do, we might share it on THE RECORD.

 

Onto oil and XES…

 

In our recent entry on Monday September 9th, we said that oil may slide down to $65, where it will hit support and then bounce.

 

The “oil slide to $65” part of that scenario has happened, and we took that opportunity to rotate ~5% of our portfolio into XES – which, thanks to the further slide in oil, hit the entry level we planned to get in at ($78).

 

We mentioned a few months ago that the sell-off in oil over the coming months would provide opportunities to build out an oil position at better prices than what we got in at earlier this year.

 

That seems to be playing out – so we’re happy to see our read come to fruition…

 

Of course, the price could go lower still, but that’s cool as we’ll treat it as an opportunity to lower our cost basis on XES.

 

We plan to eventually have ~15% of our portfolio allocated to the oil theme – but as this is a trend that will run longer, we won’t get to that full allocation until perhaps mid-to-late 2025, when some of our other investment themes get long in the tooth.

 

Let’s see!

 

Final point, on our “coiled spring” comments from July.

 

We just wanted to make a quick point our comment on THE RECORD in July that markets felt like a “coiled spring”.

 

We stand by that statement, even with the sharp sell-off in August.

 

This sell-off has been over-represented at the index level because the S&P 500 and Nasdaq are so heavily weighted towards the sectors that sold off: tech and semi-conductors.

 

However, when you look at the rest of the market, its doing very well.

 

For example, the equal-weight S&P 500 climbed out of the sell off and hit new all-time-highs with breathtaking speed, where it’s currently consolidating.