DAILY STRATEGY: The two most prevalent market internal regimes* have been Risk Averse and Everything Rallies over the last 12 weeks. With the last 3 weeks being dominated by Risk Aversion. If we are going to get a shift back to an Everything Rally regime (Momentum would be a leader) fundamentals are likely to be a major driver. Most investors we surveyed (HERE) expect the level of Hyperscaler capex in 2027 (median $1.1T) will support the AI buildout trade. As noted last week, any short-term call on the Price Momentum basket needs to be held with low conviction given the unusually high volatility of the basket.
FYI – If larger than expected 2027 AI Capex numbers are driven by inflation, that would be considered a negative for the hyperscale’s. In which case, the S&P 500 would have some downside risk. We are not saying that will happen, but that is a fear amongst investors we talk to. 22V options Strategist Jeff Jacobson has some ideas on hedging S&P 500 risk now. He notes S&P 500 puts are “CHEAP” to QQQ puts on a historical basis, making SPY puts a better risk/reward hedge in his view (HERE).
Market to Market What We Think Matters for the AI Buildout Theme Longer Term – What all companies say about AI related value creation – is the stock indicating positive margin outlooks and productivity gains related to AI – is one of the most important longer term determinants of AI capex spend. Put simply, the more value creation at the enterprise level the higher the AI demand.
What we heard from banks last week was positive on the margin and AI value creation fronts. Margins are trending higher across Bank, but names with higher AI adoption have seen margins improve more rapidly than those of other Banks this year. The strong margin trend is another sign that AI is moving from strategic narrative to operational reality. Margin Results Sentiment (how Banks sounded about this quarter) ticked up, reaching its highest level since 2023. Forward looking Margin Commentary Sentiment ticked down from its recent high, it remains above any level seen prior to 2025.
Airline Trade Idea LUV: Each earnings season the 22V quant team ranks companies due to report to identify companies that could see outsized moves (both higher and lower) based on positive or negative earnings quality and sentiment. Stocks with a lower Earnings Turbulence ranking, higher Earnings Quality ranking and Earnings Sentiment score have better fundamental readings and are more likely to beat earnings, and vie versa. Lists in the chart section below. These lend themselves to options plays. Jeff Jacobson, 22V’s Derivatives specialist, likes the set up to hedge LUV the best. FYI, reach out to JJ for structures for any of the other names.
Trade:
Buy LUV July 24th 47/42 put spread for ~ $1.20 (LUV 48.08 Fri close ref)
*The market internal regime is a quantitative classification used to measure how various investment factors—such as Value, Growth, Momentum, and Quality—trade relative to each other at any given time. The internal regime identifies which specific segments of the market are leading or lagging in the short term.
Charts…
The two most prevalent market internal regimes* have been Risk Averse and Everything Rallies over the last 12 weeks. With the last 3 weeks being dominated by Risk Aversion.
Margins are trending higher across Bank, but names with higher AI adoption have seen margins improve more rapidly than those of other Banks this year.
Currently, margin sentiment expressed by Bank management is supportive, reflecting strong bank confidence in current operating margins and the near-term outlook. While forward looking Margin Commentary Sentiment ticked down from its recent high, it remains above any level seen prior to 2025. Margin Results Sentiment ticked up, reaching its highest level since 2023.
The cash return factor relative performance has improved and Financials have the largest exposure to the cash return factor.
The beat list…
The miss list…
From JJ…
“Looking at LUV options, the current implied move of 6.2% actually looks “cheap” when we consider the 10% average 1-day move over the last 4 reports (3 lower), which also included an 11.2% decline for this quarter 1-year ago. The fact that the current implied move trades at a discount to the recent realized moves is another reason I suggest owning the weekly put spread as a tactical short bet play.”
Trade:
Buy LUV July 24th 47/42 put spread for ~ $1.20 (LUV 48.08 Fri close ref)
Trade Details:
- Buying the weekly put spread that captures earnings on 7/22
- Airlines had rebounded sharply from their March declines as oil spiked, starting to see weakness as oil is back on the rise
- DAL and UAL both reported and traded lower, LUV is also less exposed to the business traveler which could impact earnings
- Options implying a 6.2% 1-day move, which actually screens “cheap” to recent realized moves
- Put spread starts just over 2% lower, is capped ~ 11% lower (same decline shares had a year ago), and offers a 4x to 1 max payoff on the limited-risk trade
- Please reach out to me or the 22V sales team for updated pricing and execution capabilities
