Kevin Muir: As successive layers of the AI funding narrative give way, why shift focus to Canada and Brazil?

Author: Maggie Lake (Interviewee: Kevin Muir)

Compiled by TechFlow

TechFlow Brief: Beneath the seemingly calm surface of the S&P index, the U.S. stock market is experiencing a perilous underwater scene: the Goldman Sachs AI Winners vs. Losers basket plummeted 55% within six months, while the Magnificent 7 were pushed skyward by risk-off capital clustering together. Severe negative correlations among individual stocks have artificially masked the underlying volatility of the index.

Seasoned macro hedge fund veteran Kevin Muir keenly points out that the market narrative surrounding AI infrastructure capex is undergoing successive breakdowns and concessions: it initially claimed to be paid for by ample free cash flow, then devolved into low-interest debt-driven expansion, and now with borrowing costs soaring, the market has lulled itself into believing equity issuance can cover financing—a classic dangerous sign of a late-stage bubble. Meanwhile, micro-trading mechanisms represented by multi-strategy quant hedge funds (Pod Shops) and Tax-Aware Long/Short (TALS) strategies are subjecting a large number of shorted stocks to the relentless sawing of never-closed short positions.

In this distorted macro chess game, smart money should not blindly gamble in the overvalued tech frenzy, but instead focus on physical assets with more asymmetric odds: embracing Canada, which is enjoying an economic renaissance and a surge in capital expenditure, and Brazil, whose market was unfairly punished by election sentiment but holds global key commodity reserves and pro-cyclical energy elasticity.

For financial markets, this is an exceptionally critical week: a massive wave of heavyweight earnings reports is about to be released, and the Federal Reserve's rate meeting arrives on schedule. High drama struck right at the start of the week, with frontier AI giant Anthropic formally filing its IPO application (sending tech stocks rejoicing), while President Lula's unexpected victory in the Brazilian general election triggered fierce market reactions (Brazilian stocks clearly did not appreciate it).

Fortunately, renowned macro analyst and author of “The Macro Tourist,” Kevin Muir, joined our “Talking Markets” podcast yesterday to help us cut through the fog and clarify the complex logic behind it all…

Honey Badger Market

Figure: Honey Badger Don't Care

"Looking around, there are already a million tiny warning signals flashing red across the market, yet people seem to constantly find one excuse after another to turn a blind eye," Kevin stated. "In my view, this is an extremely worrying market. I am utterly shocked that everyone remains so blindly complacent in the face of all this."

One of the most typical examples is the evolution of the narrative regarding the funding sources for AI infrastructure construction:

"Once upon a time, the mainstream market view was that the bubble simply didn't matter, because it was all being funded by massive free cash flows…"

"Then, this rhetoric devolved into 'it doesn't matter because they can borrow at extremely cheap rates by issuing bonds'… And now, as the window for cheap borrowing has closed, they've started comforting themselves saying, 'It still doesn't matter because they can finance through equity issuances.'"

Huge Sector Rotation Within the Market

Kevin recently wrote an in-depth research report (click here to read the original article), where he highlighted the following key facts:

On June 22 this year, the Goldman Sachs AI Winners vs Losers Basket, compiled by the bank, had surged as much as 94.2% year-to-date. Meanwhile, over the same period, the Nasdaq Composite rose 21% and the S&P 500 gained 10%.

However, since then, this Goldman Sachs basket has plunged 55% from its highs, while the Nasdaq has only fallen 4% and the S&P 500 is essentially flat… Meanwhile, the U.S. Magnificent 7 tech stocks continue to "scream higher."

"Therefore, the environment we're currently in has undergone a massive internal sector rotation," Kevin explained. "There is turbulent, choppy movement beneath the surface, yet broad-based indices have remained almost completely unchanged over the past six months."

In other words, inter-stock correlation has plummeted to extreme lows. It's akin to a white swan appearing graceful and undisturbed on the surface, while its feet churn wildly underwater, stirring up countless sprays of sand and water.

"This extremely strong negative correlation among individual stocks has ultimately suppressed the overall actual volatility of the index," Kevin noted. "We have witnessed so much turmoil and severe divergence, yet the index itself has hardly budged."

So, what exactly caused this severe breakdown in correlation? Kevin listed several different market theory hypotheses, including:

AI is a transformative revolutionary technology, and disruptive major technologies often "ultimately give rise to extremely divergent market structures." Kevin only slightly agrees with this viewpoint, but he places greater weight on…

…multi-strategy quant hedge funds (Pod Shops): "There are now a massive number of market participants trading in ways fundamentally different from the past few decades. Suddenly, traders are no longer just going long; instead, every long position they take must be strictly matched with a corresponding short position."

TALS (Tax-Aware Long/Short): An AI bot provided a highly accessible explanation:

Figure: Explanation of the operational mechanism of the TALS (Tax-Aware Long/Short) strategy

"When one of their long stocks drops, fund managers promptly sell it, instantly locking in a capital loss to offset taxes, and immediately replace it with another highly correlated benchmark stock," Kevin said. "And when one of their short stocks rises, they buy to cover and similarly replace it with another new short target."

If you've noticed certain stocks continuously "drifting lower," it is very likely because they are carrying "an extremely high proportion of short positions that have never been truly covered, and the delay in covering them is partly due to the portfolio rebalancing mechanism of the TALS strategy."

Kevin emphasizes that the core issue lies in how this operating model is "creating various severe microstructure distortions in the market."

Canadian Economic Renaissance?

Over a year ago, Kevin wrote an article outlining the core thesis for a bullish stance on Canada (click here to read).

His analytical logic at the time hinged on the fact that regardless of whether Mark Carney or Pierre Poilievre is elected to lead, "the country's political and economic pendulum is swinging rightward, and it will more seriously and earnestly push forward economic reforms and take all pragmatic necessary measures," Kevin pointed out.

"And indeed, this is the case. Mark Carney is by no means a detached, purely radical environmentalist. The previous leader was merely a middle school teacher by background, whereas Carney is a heavyweight figure who truly masters finance and capital operations."

"Over the past year, the Canadian market has practically stormed ahead," Kevin said. "Many people simply do not realize that the actual performance of the Canadian stock market has comprehensively outperformed the S&P 500 index."

"Undeniably, geopolitical conflicts have undoubtedly boosted energy stocks, but the deeper reality is that Canada is fully implementing the reforms necessary to activate its own economy… The nation's business environment is becoming increasingly corporate-friendly."

However, he maintains a relatively negative view on Canada's banking sector, as he believes the current valuations of bank stocks are excessively detached from fundamentals.

"Therefore, short or sell Canadian domestic banks, go long on basic materials and the real economy, while continuing to buy dips in energy and related targets," Kevin advised. "If you want to construct a perfect pairs trade in the Canadian market, this strategy's appeal today is arguably unprecedented."

Key Takeaways from Kevin

"Often, people very easily confuse a good company with a good investment… There is a fundamental difference between the two."

"When did we start naively assuming the government can really control the market at its whim as it claims? The power of the market is far greater than anyone realizes, not even exempting the president… I absolutely do not believe that if a crash occurs in the future, the government will extend a helping hand to bail out AI concept stocks."

Lula's electoral victory definitely caught the market off guard, but "the balance of power among elected congressmen has already tilted significantly to the right… Admittedly, it would naturally be ideal to have a leader who fully embraces free markets at the helm, but the prevailing macro trend is evolving in that direction…"

"I view today's panic sell-off as an excellent opportunity to buy the dip. In fact, I stepped in and bought heavily right at the open today."

"I remain firmly bullish on the energy sector attracting unexpectedly strong buying interest over the coming period, particularly in crude oil," Kevin stated. "As global geopolitical dynamics become increasingly volatile and unpredictable, sovereign nations will need to drastically increase the scale of their strategic inventory reserves."

"This is precisely the core logic for allocating Brazil and Canada in a portfolio, as both countries possess and continuously produce the critical commodities that the world will need to stockpile aggressively in times of future uncertainty."

"This indicator measures pension fund funding adequacy, and we are currently at the highest level of funding adequacy since 2007." Chilling. Click here to view the detailed data report.

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Disclaimer: This article is for informational purposes only and does not constitute any investment advice. Please consult a qualified professional financial advisor to assess your risk tolerance, investment objectives, and overall financial planning.