DAILY STRATEGY: Capex commentary from Meta, TSLA, and MSFT suggests AI idio, which is driving current factors and themes (Earnings Mo, Earnings Growth and Price Momentum), will continue. The AI theme, and who benefits from the AI capex going forward, remains the largest driver of factor and market cap calls (we are long this theme). The macro backdrop is supportive of a broadening out of returns, but the main driver of returns has been related to AI themes.
By extension, IF 10yr yields were to increase to 4.5% or above, we would not necessarily fade small caps or riskier factors. The Integration of AI into physical products has favored industries in smaller caps and Deeper Cyclicals – power providers, semis, cap goods, and tech hardware. While that support remains, and capex plans indicate it does, we would not abandon the broadening out trade just because the 10yr yield moved up to 4.5% or above.
A few key points on this:
- From 1/1/2024 through 10/31/2025 the main driver of Hyperscale’s returns was the residual or idio. Not factor or industry group exposure. 10/31/2025 through yesterday, residuals have worked against the Hyperscalers (performance lagged). Within small caps, idiosyncratic risk, rather than industry group and factor exposures, is responsible for all outperformance.
- Small cap beta to 10yr yields is very volatile; the lack of a stable relationship implies an uncertain impact from higher yields. The beta is positive right now (higher yields = small cap outperformance).
- The volatility in large AND small caps explained by the 1st principal component – our proxy for macro impact – is near recent lows. Macro doesn’t seem to explain the volatility.
If Mega cap stocks AND Capex related names outperform together, being long small caps should not work as well on a relative basis. If mega caps outperform, it would indicate that investors think that Hyperscaler earnings are more certainty, or that differentiating between winners and losers with-in Hyperscalers and other Tech related AI names is easier. If that happens Banks/Retail (we are long both) would likely suffer SOME relative.
Investors have highlighted to us the desire to diversify away from Hyperscalers and broader tech AI names as picking winners and losers has become more difficult. It is reasonable to assume Retail, Banks, and Staples benefit from that diversification at the start the year. We would stay long Retail and Banks but remain relatively short Staples. The fundamental case for Banks and Retail is still compelling (see HERE and HERE)
Charts…
Small cap beta to yields is very volatile; the lack of a stable relationship implies limited impact. And the beta is positive right now (higher yields = small cap outperformance).
Macro influence on index returns is low right now. The volatility in large AND small caps explained by the 1st principal component – our proxy for macro impact – is far off levels hit over the tariff announcements and aftermath, for reference.
Idiosyncratic risk, rather than industry group and factor exposures, is responsible for all of the small cap outperformance of large caps since the AI hyperscaler trade started diversifying in the fall. From 2024 through 10/31/2025 idio was the major driver of Hyperscaler outperformance.
Source: FactSet, 22V Research
Source: FactSet, 22V Research
For macro trades, generally, focus on the industries with the highest PCA. Banks have a high PCA and the macro backdrop supports banks.
Hardware and Semis are crushing Software and Telecom services YTD.
We like EPS Momentum vs Price Momentum longer term
