Or, more accurately, the index funds in your retirement account will.
First up, from Neue Zürcher Zeitung's TheMarket.ch, May 27:
"These Monster IPOs Expose the Dark Side of Passive Investing"
SpaceX, OpenAI, and Anthropic are rushing to go public. Larry McDonald, founder of «The Bear Traps Report» and New York Times best-selling author, warns that their accelerated inclusion into indices like the S&P 500 amounts to market manipulation. He explains why he prefers to bet on commodities and traditional Old Economy companies.
The impressive stock market rally seems virtually unstoppable. Higher energy prices, rising interest rates, and mounting signs of excess in sectors like the semiconductor industry leave investors unfazed. Fueled by the artificial intelligence boom, the benchmark S&P 500 index continues to hit one record high after another.
With the announcement of SpaceX’s IPO, tech stocks are moving even further into the spotlight. Elon Musk is reportedly planning to list his space company in New York within a matter of weeks. OpenAI and Anthropic, the two largest private AI firms, are likewise forging plans for an imminent debut. These three transactions are expected to break all Wall Street records.
Larry McDonald views this with a sense of unease. «I fear there’s a good chance the market gets overwhelmed,» says the founder of the research service «The Bear Traps Report» and author of the bestseller «How to Listen When Markets Speak». In every cycle, he notes, there is a spectacular deal or IPO that marks the peak. That could be the case now. Furthermore, he points out that AI stocks currently account for nearly 50% of the S&P 500’s market capitalization.
«If these new heavyweights are added, everyone’s 401 (k) is almost certain to face a deathly overdose.»
The veteran investor and former Lehman trader is particularly troubled by the fact that SpaceX, OpenAI, and Anthropic are slated to be fast-tracked into major indices like the S&P 500 and the Nasdaq 100. In an in-depth interview with The Market NZZ, which has been lightly edited, he explains why he believes this amounts to a raid on the portfolios of many investors. He also outlines why he still anticipates a major rotation of capital into the energy, commodities, and industrials sectors.
The stock market continues to forge ahead undeterred, despite higher energy prices and rising interest rates. How do you explain this impressive rally?Once again, the stock market is drunk on a narrative. Artificial intelligence is the new everything, and you see it everywhere: on newspaper front pages, at cocktail conversations, and on the balance sheets of Big Tech corporations, which are bloated by massive capital investments. Potential earnings of future years are being prematurely priced in. Investors are betting that AI will yield exponential returns, while the risks such as friction or competition are largely ignored.The headlines currently revolve around the planned mega-IPOs of SpaceX, OpenAI, and Anthropic. What do these three transactions signify with regard to the broader environment?I fear there’s a good chance the market gets overwhelmed. Every cycle features a marquee deal or IPO that defines its peak. In the credit boom of the 1980s, it was KKR’s takeover of consumer goods giant RJR Nabisco; in the tech, media, and telecom bubble of the late 1990s, it was the mega-merger of AOL and Time Warner; and during the excesses of the housing market, it was the record-breaking sum Sam Zell secured in early 2007 by selling his real estate empire.And today’s counterpart could be these three IPOs?It certainly wouldn’t surprise me. These monster IPOs amount to a coup of the century. If you do the math, the valuations of these three companies have exploded in a short period. A year ago, they were valued at roughly $760 billion combined: SpaceX at $400 billion, OpenAI at $300 billion, and Anthropic at $61 billion. Those were already hefty figures, but SpaceX’s valuation is now estimated at $1.5 trillion, while Anthropic and OpenAI stand at $1.1 trillion and $825 billion, respectively. That brings the total to around $3.5 trillion. Basically, they tripled in a year, which is pure madness.Why?Because a group of billionaires is attempting to seize the moment to dump their stakes onto the public at these bloated valuations. What is particularly scandalous is that these companies are to be admitted into major indices through an accelerated entry process. To be included in the flagship S&P 500, for instance, a company must typically be publicly traded for at least a year and report a cumulative profit over the previous four quarters. That these mandates, including standard free-float thresholds, are now being waved is almost criminal.SpaceX just reported a $4.3 billion net loss for the first quarter alone according to its IPO prospectus. Is a company like this even fit for an IPO?As usual, Wall Street analysts will brush aside such concerns with plenty of wishful thinking. SpaceX’s stated goal is to build a de facto monopoly on space-based data centers; essentially a modern rail system for the AI era. Such a dominant market position would imply immense pricing power, which is intended to make the entire enterprise highly profitable someday and justify the valuation. How realistic this business model is remains to be seen. But the timeline for its realization is quite grotesque.SpaceX founder Elon Musk speaks of two to three years.Exactly. Even Amazon founder Jeff Bezos, who runs his own aerospace company, concedes that it will likely take twice as long – and even that appears highly optimistic. The fundamental issue, however, is that potential delays will push expected profitability far out into the future. From my perspective, investing in SpaceX right now is akin to buying Amazon in the spring of 2000 at the peak of the dot-com bubble: back then, investors prematurely priced in enormous future earnings potential. Amazon ultimately did turn out to be a phenomenal success story, but its stock initially lost more than 90% during the dot-com crash.According to index providers, however, the fast-tracked inclusion of mega-caps like SpaceX ensures that a widely followed benchmark like the S&P 500 accurately reflects the broader market. How valid is this argument?That is a nice PR phrase, but my criticism targets a more vital aspect: the dark side of passive investing, as I call it. In my book, «How to Listen When Markets Speak», I devoted an entire chapter to this issue. Today, there are countless funds tracking the S&P 500 and other major indices. Passive investment strategies have reached such a massive volume that the market becomes gameable. If a company is included in a major index, it is practically guaranteed that the stock price will rise sharply ahead of time because passive funds are forced to buy the shares. A textbook example is sportswear manufacturer Lululemon. When its inclusion in the S&P 500 was announced in October 2023, the stock shot up over 10% the next trading day.So you’re saying that an expedited inclusion process for SpaceX, OpenAI, and Anthropic would virtually guarantee sufficient demand?Throughout my career in the markets, I have witnessed scandals time and again. If you pay close attention, you can usually spot that something is amiss beforehand. Yet, the scandal is only revealed after the fact, public outrage never occurs until it is already too late. A classic case is the Ponzi scheme of Bernie Madoff, one of the biggest scandals in financial history. It only unraveled in late 2008 in the turmoil of the banking crisis.How would an accelerated index inclusion affect SpaceX stock?Based on its current valuation, SpaceX would debut among the top ten largest constituents in the S&P 500. Projections suggest that under a fast-track framework passive funds tracking the index would have to buy roughly 19% of the publicly traded shares within six months. Furthermore, funds tracking the Russell 1000 and the Nasdaq 100 would likely absorb another 5.5% just weeks after the IPO. If you throw in active mutual funds benchmarked to these indices, passive strategies would have to hold nearly half of all SpaceX shares in public hands. It is mind-boggling, and yet hardly anyone loses a word over it.Why do you fear this story will not end well?With accelerated index inclusion, the retirement savings of broad swaths of the population – particularly in the U.S – are effectively being hijacked. A disturbingly large portion of American household wealth is already concentrated in AI stocks. This is a classic setup that will culminate in a major scandal during the next market downturn, as the public will be left holding the bag. Before the collapse of Lehman Brothers in the fall of 2008, the financial sector accounted for about a quarter of the S&P 500, which was already considered unhealthy at the time. Today, AI-related tech stocks account for nearly 50%. If these new heavyweights are added, everyone’s 401 (k) is almost certain to face a deathly overdose.Is there even enough liquidity to absorb these three giants IPOs?That’s precisely my point. Word is that some large sovereign wealth funds in the Middle East are wounded due to the war. In the U.S., various banks have overextended themselves with share buybacks and leveraged buyouts, with Citigroup and Bank of America being particularly heavily exposed. These IPOs could place the system under even greater stress. I therefore believe that this is going to be the story of the year: the ripple effects of these IPOs and LBOs on banking liquidity....
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And at Hedgeye, May 29:
When Passive Money Meets Mega IPOs | Protect the Pile Episode 13
In this episode of Protect the Pile, the team covers liquidity-driven market strength, record S&P levels, resilient global equities, and oil’s strange weakness despite tightening inventories. Patrick Kent, Sam Rahman, David Salem, and new HAM portfolio manager Brooks Cutwright discuss index mechanics, free-float rules, profitability tests, and how massive IPOs could reshape passive buying. Sam shares takeaways from Bernstein’s conference, including AI data-center delays, power constraints, and semiconductor momentum. The panel also debates whether energy markets are mispricing crude shortages, potential demand destruction, and late-summer fuel risks. Brooks introduces his index-rebalance background and explains why index inclusion matters....
....MUCH MORE (video)
