"The Scene from 1999 is Replaying"

Author: Wall Street Insight

The S&P 500 is just a step away from its historical peak, but beneath the surface, there are turbulent currents: 60% of its constituent stocks have fallen into a technical bear market, leaving only the seven tech giants to hold the fort. This inevitably brings to mind a scene from 1999.

Paul Tudor Jones, founder of Tudor Investment and a legendary hedge fund manager, has issued a rare comprehensive bearish signal for U.S. stocks: the current market conditions are reminiscent of 1999, the year before the bursting of the dot-com bubble in 2000. He predicts that 2027 will be "the worst year for the stock market since 2002," and he plans to short U.S. stocks throughout the year.

Prior to this, reports from Goldman Sachs, Morgan Stanley, and BTIG pointed to the same year. Notably, both bulls and bears are referencing the year 2000.

Index at Highs, Yet 60% of Stocks in Bear Market

Michael Cembalest of J.P. Morgan Asset Management presented a set of numbers: 60% of S&P 500 constituent stocks have fallen more than 20% from their respective historical peaks, while the index itself remains near its highs, a rare occurrence since 1990. Over the past three years, only 30% of the constituent stocks have outperformed the index, the lowest since 1991. The last time such a reading occurred was between 1999 and 2000. Goldman Sachs was more direct; strategist Tony Pasquariello's report aimed to defend the bulls, yet he wrote: "The median stock in the S&P 500 is currently down 15% from its 52-week high, the worst reading since the dot-com bubble."

The Last Leg: The Seven Giants

The index is still rising because a small handful of stocks are driving the gains.

Another set of numbers from Michael Cembalest: since January 2024, 42 AI-related stocks have contributed approximately 67% of the price return of the S&P 500, 58% of the earnings growth, and 81% of the growth in capital expenditures and R&D spending. About forty stocks are shouldering two-thirds of the index. BTIG's Jonathan Krinsky titled his report "The Last Gatekeeper." The judgment is clear: the seven tech giants are the only sector in the S&P 500 that has not shown signs of fatigue, and they are also the most crowded positions; if they turn, it could likely trigger a continued decline in the index. The numbers are on his side. The Roundhill Magnificent Seven ETF (MAGS) has already reached an all-time high, while surrounding sectors are generally retreating.

On Tuesday, against the backdrop of another drop in semiconductor stocks, the seven tech giants rose about 1%, single-handedly supporting the S&P 500 index. Hedge funds are using these seven as a safe haven, avoiding geopolitical risks and yields on U.S. Treasuries above 5%; too many people are hiding here, leading to record concentration—these seven giants account for about 22% of Goldman Sachs' main brokerage exposure to U.S. stocks.

Goldman Sachs' Rich Privorotsky succinctly stated: "The market is extremely overbought in one corner while effectively shorting everything else." Is a risk asset that everyone holds still considered a safe haven? The Philadelphia Semiconductor Index has now fallen for five consecutive trading days, marking the longest losing streak in nearly 17 months.

It sounds dire, but as of Monday's close, the Philadelphia Semiconductor Index is still up about 72.8% this year, and Micron has risen over 240% this year. After five days of decline, it remains at a high—this is probably what 1999 looked like.

Jonathan Krinsky also overlaid the Philadelphia Semiconductor Index (SOX) from 1999 to 2000 for comparison, and the degree of correlation is "disturbing." The SOX has now fallen nearly 18% from its June peak; while this doesn't seem significant on its own, it looks bad when placed on the curve from 1999 to 2000. By his analogy, the semiconductor sector will first experience a brief rebound (with CPI as a catalyst), followed by an accelerated decline in late October. When is late October? It is the window when major cloud computing giants report their earnings.

Earnings Also Peaking, But No One Wants to Admit It

Goldman Sachs has calculated that S&P 500 earnings growth for the third quarter will be between 27% and 28%, marking the peak of this cycle, with a slowdown expected in the following quarters.

Pasquariello stated that 2027 "will be a complex year." Profits are still concentrating in one direction. Since March 2023, the rolling earnings of 55 "AI supply chain companies" have increased by about four times, while 190 "AI highly adopted" companies have only grown by about 25%.

Those selling shovels are making a fortune, while those mining haven't struck gold yet. This script was played out in 1999.

The tech sector's contribution to U.S. GDP growth has risen from nearly zero in 2022 to about one-third, but the planned capacity for data center pre-construction has fallen from a peak of about 62 gigawatts to about 49 gigawatts. The only capital expenditure engine that is expanding is beginning to shrink its plans.

The Real Killer Move is in 2027

The story of 1999 has a second half, which is the real force that pushed the market down—supply. The bull market of the past four years has had a rarely mentioned pillar: corporate buybacks and mergers have continuously compressed the circulating shares. This logic now needs to be reversed.

Paul Tudor Jones stated plainly on CNBC that the current supply-demand dynamics in U.S. stocks are "the worst since 2002," similar to 1999, the year before the bubble burst. Major IPOs from Anthropic and OpenAI are on the horizon, and SpaceX's issuance has just been completed. Additionally, many companies will launch secondary offerings to raise funds for AI development. Jones believes that these factors combined will create significant stock supply pressure in 2027.

He announced plans to short U.S. stocks for the entire next year—"there's really no value to speak of." Goldman Sachs' internal report on U.S. stock supply and demand for 2027 provided a magnitude for this round of supply: $600 billion in primary market issuance, including $175 billion in IPOs; buybacks and mergers providing about $2 trillion in buying power; but lock-up expirations could release $1.7 trillion in supply.

$600 billion plus $1.7 trillion equals $2.3 trillion, while the other side only has $2 trillion. The net increase in supply for U.S. stocks could be the largest since 2000.

If most insiders choose to cash out after the lock-up expires, the buyback power that has historically supported the market during downturns may for the first time be overwhelmed by supply. The last time such a magnitude of net supply occurred, Pets.com was still in business.

Money itself is also becoming more expensive. Tencent Holdings issued U.S. dollar bonds and dim sum bonds in Hong Kong on Tuesday, with the issuance guidance yield for 10-year U.S. dollar bonds about 1.15 percentage points higher than U.S. Treasuries; SoftBank issued $4.5 billion in high-yield bonds last month, with the highest interest rate reaching 9.75%; Firmus, in which NVIDIA holds shares, postponed its planned $5 billion IPO in Australia last week.

BlackRock's research department on Monday simply downgraded its outlook for U.S. stocks to "neutral," turning instead to favor short-term U.S. Treasuries; Broadcom's CEO Chen Fuyang stated that capital could become one of the biggest constraints on the growth of the AI industry.

The First Reaction in the Bond Market

The yield on 10-year U.S. Treasuries has already surpassed 5%. If yields do not come down, the rationale for defensive funds to stay in the seven large stocks remains valid; once they fall, the rationale diminishes. Goldman Sachs' short-term strategy is to short fixed income.

On the U.S. stock side, the short-term judgment is not so pessimistic. Goldman Sachs believes that "the tactical positioning environment is net positive," and there is still room for technical improvement before the midterm elections. Jones is looking at 2027, with a different time scale. Another market signal is the switch between semiconductors and software.

The relative strength ratio of software to semiconductors (IGV/SMH) has re-established itself above the 200-day moving average for the first time in 16 months; if it continues to break through the summer highs around 0.20, the leadership will shift from semiconductors to software, which is not currently the heavily weighted direction in the market. Oil is a rare clear bull in this round.

Jones holds long positions, reasoning that the U.S.-Iran conflict is unlikely to be resolved in the short term: "I think it can rise another $20 to $25." WTI is currently around $94 per barrel; if it rises another $20 to $25, it will break through the closing high of about $113 in 2026.

He warned that if oil prices indeed move in this direction, the stock market will "completely and utterly despise it." When will the market turn? There are two thresholds. The trigger conditions are the earnings reports from cloud computing giants in late October; if capital expenditure guidance slows down or the scale of lock-up expirations exceeds expectations, the seven giants are likely to experience a correction.

The invalidation condition is if third-quarter earnings exceed expectations, fourth-quarter guidance is not downgraded, and actual net supply is significantly lower than estimated; then this narrative of "supply overwhelming buybacks" would need to be overturned.

Focus on Cloud Giants' Earnings Reports

In the next two weeks, the focus should be on the earnings season of cloud computing giants, especially capital expenditure guidance, as it is the source of the entire AI profit chain. Another easily overlooked factor is the bond issuance rates. The coupons paid by Tencent and SoftBank serve as a thermometer for AI financing costs. Not all signals are pointing in one direction. After Meta released its new model on Monday, its stock price rose about 3.4% against the market trend; what the market is rejecting is not the indiscriminate betting on infrastructure but rather AI itself. At the end of Pasquariello's report, another picture is painted:

Since the low point in March 2009, the total return of the S&P 500 has increased 16-fold. During this period, there has only been one recession, lasting about two months.

Despite this, the reading from the University of Michigan's consumer sentiment survey today is lower than in March 2009—the recently released data (46.3) is the second-lowest reading on record since 1952.

Pasquariello described this divergence as "shocking and somewhat perplexing." During the same period, stockholders have gained 16 times. Another group of people has faced rising housing prices, rents, and food prices, and the reality that every mortgage has become a luxury after the yield on 10-year U.S. Treasuries broke 5%...

What 1999 left for those who came after is not the phrase "the bubble will definitely burst," but rather that in the year before the bubble burst, the vast majority of people were still bullish.

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