Sep 30 Update: Breadth kept on narrowing

The Mag 7 outperformed, and the S&P 500 fell just 0.25%. The equal-weight index, meanwhile, is on track for a seventh straight weekly decline.

To use my analogy from yesterday, the wind outside keeps getting stronger, and the damper is carrying more of the load.

The Dow fell 0.86% and the Russell 2000 fell 0.39%, and only Apple and Amazon kept the index from falling further. Bloomberg also compared today's mix of a calm index and very volatile single stocks to 2000.

Core PCE came in below expectations and the odds of an October hike fell again, yet 10-year and 30-year yields still climbed to their highest levels since 2002. A new $6 billion Treasury buyback announced the same day didn’t hold down the long end either. This is bad news for breadth. Stocks outside the leaders are valued mainly off long-end rates, so a dovish Fed won’t help them unless oil or the term premium comes down first.

One caveat: part of the PCE miss came from a BLS methodology change. That is a one-time drop, not a change in the inflation trend. Personal income rose only 0.2% in August, below expectations, while spending rose 0.9%, which means households are dipping into savings to keep spending.

Credit: AI financing turns to Big Tech guarantees

Wednesday’s news ties directly to my earlier theory that . Three evidence:

• Low-rated AI borrowers are finding it harder to raise money. Goldman counts $88 billion of AI-related issuance from low-rated companies this year. Lenders are demanding more compensation and proof that future revenue can cover the debt. This is the first of my signals: new AI debt has to pay more to get done.
• Data center operators are asking for Big Tech guarantees. CBRE warned AI startups that without a strong partner guaranteeing lease payments, they will struggle to secure new sites.
• KKR warned that an AI downturn could cause significant volatility in credit markets.

There's an easy-to-miss shift here: Risk is flowing from credit markets back onto the hyperscalers' balance sheets.

Lenders don't want direct exposure to AI startups, so they ask Google, Meta and others to guarantee the leases. An FT investigation estimates Big Tech already carries about $300 billion of AI infrastructure exposure off balance sheet, through special purpose vehicles (SPVs) and guarantee arrangements. These guarantees often kick in only after a data center is built and the lease starts, so bondholders carry the risk during construction.

This means the damper and its power supply are turning into the same balance sheet. The more the leaders guarantee other companies' obligations, the harder they get hit when credit markets break. That fits what CDS is saying: hyperscaler CDS widening relative to banks may reflect these off-balance-sheet guarantees, not their reported debt. (Did you understand Michael Burry's short thesis yet?)

AI: money stays where the payoff is clearest

• Cerebras fell 8.9% after a report that OpenAI’s new model runs on Nvidia GPUs, not Cerebras chips.
• Jabil fell 10% despite beating estimates and raising guidance, because expectations were already high.
• FormFactor rose 9.6% after becoming the second-source supplier of probe cards for Nvidia GPUs at TSMC.

Companies that can show a direct link to Nvidia or the hyperscalers went up, and the rest were sold. It’s the same logic as credit markets asking for Big Tech guarantees:

Money only flows to whatever sits closest to the damper.

Micron beat and raised after the close. Quarterly revenue was $54.23 billion, up 379% year over year, and adjusted EPS was about $33.42, both above estimates. The company also said:

• Long-term customer agreements increased by $10 billion.
• Most of its 2027 HBM supply is locked in, at significantly higher prices.
• Memory supply will stay tight through 2028.

A couple of points that weren’t in my earnings review note: First, Micron raised its 2027 capex, but the extra spending goes more to construction than to equipment, which helps semiconductor equipment makers less than it helps memory. Second, rising worker compensation will squeeze margins. S&P futures rose 0.36% after hours. Options imply a move of about 6.5% either way through the end of the week. Whether the stock beats that move in tomorrow’s regular session is my fourth signal: can a stock still rally on good news?

Consumer and financials

The weak end of the market is starting to crack. Pool supplies retailer Leslie’s filed for Chapter 11, as the market had expected. It is a textbook CCC-type borrower: heavily indebted and dependent on discretionary spending. Financials fell for a second straight day, with regional banks on Tuesday and money-center banks, investment banks, insurers and payments companies on Wednesday. That fits credit stress spreading, but two days of data isn’t enough to draw a conclusion.

Key takeaway from today’s recap:

AI financing increasingly depends on guarantees from the market leaders. The damper isn’t just absorbing shocks. Its balance sheet is also taking on other companies’ risk, most of which sits off balance sheet and hasn’t been priced by the market.