The collapse of the "consensus trade" and the birth of a new consensus! Goldman Sachs Group, Inc. (GS.US) answers: Why are institutions significantly reducing their AI positions right now?

Title context: The collapse of the "consensus trade" and the birth of a new consensus! Goldman Sachs Group, Inc. (GS.US) answers: Why are institutions significantly reducing their AI positions right now? Text: The previously extremely crowded "long AI, short everything else" trade is undergoing a painful unwinding, and under record selling pressure, hyperscalers face a "monetization test." On October 22, Rich Privorotsky, head of European FICC & Equities trading at Goldman Sachs Group, Inc. (GS.US), was interviewed on the podcast "The Markets" from the Goldman Sachs Group, Inc. (GS.US) trading floor in London. Privorotsky revealed a striking data point: "Last week, we saw the largest technology stock selloff ever on our Prime book." Amid this wave of selling, the ongoing third-quarter earnings season appears particularly critical. The market's focus has shifted from simply "telling a story" to strict performance delivery. Privorotsky noted that the market expects AI capital expenditure (Capex) to reach as high as $1.1 trillion next year, but that is no longer enough to get investors to pay up. "Just saying you're spending a lot of money is not enough; you also need to prove that backlog orders are converting into substantive revenue," Privorotsky emphasized. "They must demonstrate the returns on that spending while pushing capex higher. This is not an easy situation." He said that cloud business growth, monetization capability, and the speed at which free cash flow reaches breakeven will have a major impact on the currently extremely sensitive credit market. Dual constraints from infrastructure and funding: a "40-50 gigawatt" power gap next year Behind the cooling of AI enthusiasm are hard constraints in the real world on infrastructure and funding pools. The market is currently grappling with three core issues, the first of which is the spillover effect of capital costs and power supply. Privorotsky pointed out that the more highly leveraged areas of the AI trade (such as emerging cloud service providers) are facing a severe financing test: "Will these companies encounter difficulties in finding financing to deliver on AI spending?" The more realistic physical bottleneck lies in power delivery capacity. He presented a set of key figures: "Next year's power gap is roughly 40 to 50 gigawatts. If you can't get the energy that actually powers data centers, can you still consume the chips you've already ordered in advance?" These concerns have pushed investors into "risk-off mode," lowering growth expectations by shorting AI and AI capex trades, while capital floods into the bond market as a safe haven. Macro paradigm reshaping: from "savings glut" to "spending glut" From the perspective of the macro cycle, Privorotsky painted a picture of a profound paradigm shift. He said his entire career had been spent in a "savings glut" environmentthere was so much money in the system that no one knew what to do with it. But now, a "seismic shift" has occurred. "Over the past year, we expect to spend more than $1 trillion on AI capital expenditure, while most governments around the world are running fiscal deficits. We are in an era of 'spending glut.'" This shift has pushed up the cost of capital and naturally crowded out marginal, lower-quality borrowers. He observed that this pressure is reflected not only in the sharp widening of CCC-rated credit spreads but has even spread to the sovereign debt space (such as French government bonds facing large fiscal deficits). Combined with persistently high energy prices, overall market risk appetite is being significantly weakened. Market sentiment is polarizing: "AI giveth, AI taketh away" Amid the complex interplay of macro and micro factors, investor anxiety has shown a peculiar "polarization" phenomenon. Privorotsky shared what he heard from investors this week: "I met some investors who said, 'I'm worried we won't be able to deliver compute capacity, and that scares me'; then I met another group of investors who said, 'I'm worried we'll over-deliver compute capacity, and that scares me.' Somehow, two completely mutually exclusive outcomes together make up the sum of market concerns." Because energy prices have a major impact on the economy (although the S&P 500 has been steady, the median stock has actually fallen more than 10%), the financial conditions index (FCI) has tightened sharply, forcing the Federal Reserve to do more. Privorotsky once firmly believed that "as goes oil, so goes everything else," but he now admits that in the current market context, the logic has evolved into "as goes AI, so goes everything else." Despite near-term pressure, Privorotsky is not entirely pessimistic. He believes spot market compute prices are hitting new highs every day, and demand remains "greedy and endless." On trading strategy, he said that although conviction is not high at present, "electrification"-related assets that have suffered major downgrades, civil aerospace assets, and some transportation sectors now offer considerable margins of safety and deserve cautious optimism. Below is the full translation of the podcast conversation: Chris Hussey 00:00 This is "The Markets." I'm Chris Hussey, and it's Thursday in October. I'm joined from the Goldman Sachs Group, Inc. trading floor in London by Rich Probarowski, head of European equity trading within FIC and equities at Prevo. Thank you very much for joining us. Thanks for having me. Hussey, let's get straight into it, because, you know, I've read everything you've written, and you made a great pointearlier this summer, the pain trade, the trade everyone had to chase, was long AI, short everything else. It had kind of become a very big trade. Now as we head into third-quarter earnings season, that trade seems to be falling apart. What exactly is happening? How do you think it will evolve from here? There has been extremely severe concentration in the equity market, and I have to say, the past few weeks have been especially painful for this kind of consensus trade. Rich Privorotsky 00:48 Positioning is highly concentrated in AI, semiconductors, and hyperscalers. I would say the market is currently grappling with roughly three different issues. First, obviously, we have spillover effects in the cost of capital. I think this is visible almost everywherewhether it's CCC spreads, European sovereign spreads, or the more highly leveraged, most cutting-edge parts of the AI tradewith Neo clouds particularly prominent. So this becomes a supply problem. You know, will these companies struggle to find financing to deliver all this AI spending? The second point is also about supply: whether we actually have the ability to power up and deliver gigawatt-scale electricity. The market has doubts about this, with next year's range roughly 20 to 40, 50 gigawatts. So if you can't get the power to actually energize data centers, can you really, can you really absorb the chips you've already ordered in advance, so. Rich Privorotsky 01:38 These are the concerns hanging over the market, and all of this combined has pushed everyone into a risk-off mindset; the specific manifestation of that mindset is lowering growth expectations through the AI trade and AI capex trade. And on the other side, as growth expectations are revised down, bonds have been rallyingsomething that was completely not in anyone's script. Rich Privorotsky 01:56 Okay, there's a lot of information there. But let's focus on the not-too-distant future, which is really the presentthird-quarter earnings season. We're already in it, some large tech stocks have reported, but there are many more to come. What are you watching most closely during third-quarter earnings season? Yes, I think we're about to enter the core part of hyperscaler earnings, and I think what really matters is not just seeing capex stay elevatedthe market consensus expects $1.1 trillion next yearbut most importantly, seeing, you know, continued monetization of the cloud business. So just saying you're spending a lot of money is not enough; you also need to prove that backlog orders are meaningfully converting into revenue. So I think that will be very critical for the market. I think, how quickly they achieve that transition to free cash flow breakevenrelative to market expectations. It could have a major impact on the credit market, which has become extremely sensitive. So for me, really, there's a lot to look at. I would say, from other parts of the economy. But I think the market's focus will really land on the hyperscalers, and then on the quality of delivery, not just the spending. It's too hard for these companies to get over this hurdle. They have to keep pushing capex higher while also showing you the returns on that capex. This is not an easy situation, is it? Yes, it's not. But look, I mean, the current backdrop is this: you're seeing compute prices hitting new highs every day in the spot market. Demand for what they're selling is insatiable, so I would say. Chris Hussey 03:23 From a slightly more optimistic perspective, they should have a pretty good story to tell. Okay, Rich, it's been a while since we've had you on the show. Your last appearance was in January. But throughout this year, you've been one of the people holding to that mantraas goes oil, so goes everything else. Is that still the mantra? Yes, I think we've encountered an extremely difficult environment in energy. And, you know, I think. Rich Privorotsky 03:46 The market, the equity market, I think, has done its best to ignore and isolate the rise in energy prices in a corner. But that's not really fair, because the S&P index has done a good job of isolating this, but the median stock has actually fallen well over 10%. So this has had an impact on rates. It has also affected the FCI. In fact, we experienced a massive FCI tightening, which in a sense also forced the Fed to do more. And we repriced an entire rate-hiking cycle. So I think energy accounts for a large part of this. I think we are still carrying a lot of risk premium because of energy. Obviously, how these things evolve over the next few weeks will be very critical for risk assets overall. And my optimistic view is that we will get some form of resolution within the next few weeks. But I must admit, I thought this should have happened two months ago, and I was a bit off on that call. I think we all were. Of course, when you say FCI, you mean the financial conditions index, which is. Chris Hussey 04:35 Sort of a measure of whether the economy, or all economic impulses, are tightening or loosening. It's not just about interest rates. When you look at an FCI, sometimes it can be oil, sometimes it can be equities. Okay, that's a good point. On the oil front. Chris Hussey 04:48 But related to that oil trade, there's also something you said at the beginning of the year, which was: I want to be long nominal assetsin a world of strong GDP growth, and an expansion that still looks very strong, and with high inflation, I just want to be long this kind of thing, meaning a lot of commodities. How do you view that nominal asset trade today? Is it still a place worth allocating to? Rich Privorotsky 05:11 I think to answer that question, I first have to answer the trillion-dollar question, which is: what happens next with AI spending, and how sustainable is it relative to market expectations? Rich Privorotsky 05:19 Because the reality is, as we were repricing it, we repriced everything, including commodities, including nominal assets. My instinct is that we've somewhat thrown the baby out with the bathwater, and we've clearly started worrying about every dimension of it. To be specific: this week I met some investors who said, "I'm worried compute capacity won't be delivered, and that scares me." Then I met another group of investors who said, "I'm worried we'll over-deliver compute capacity, and that scares me." Somehow, we've ended up with two mutually exclusive outcomes that at the same time together make up the sum of market concerns. Rich Privorotsky 05:50 So I think, from a big-picture perspective, nominal assets are still where you want to be, unless we fall into a disinflationary collapse, meaning capex slows, everyone has to pull back, and we enter a real credit cycle. Three months ago I would have said that risk was low; now it is undoubtedly much higher. But my instinct is that over the medium to long term, that is still where you want to be. However, I think adding a bit more barbell strategy to the portfolio may be wiser now. What I hear you saying is that before it might have been as goes oil, so goes everything else, and now it'sas goes AI. Chris Hussey 06:22 So goes everything else. Is that right? I think, at the risk of oversimplifying, that's probably right. Yes, Rich, thank you for being willing to oversimplify. I'm "Mr. Oversimplification" myself, so I'm glad you've come around to that. Of course, part of this will be a big credit cycle, and three months ago you weren't worried about a credit cycle, and now you're a bit more worried. Talk to us about that. Are you seeing cracks in credit? Are you referring to what's happening in European sovereign debt, or more to the credit issues we're seeing on the corporate side? Rich Privorotsky 06:51 My entire career, I could say, has been spent in asavings glut. You know, there was so much money in the system that we didn't know what to do with it. And just over the past year, our expectation is to spend more than $1 trillion on AI capital expenditure. Rich Privorotsky 07:05 Most governments around the world are running fiscal deficits. We are now in a spending glut. In terms of how things work and what the cost of capital will become, this is a very massive structural shift. So I think this naturally crowds out those marginal borrowers whose credit quality is not the best. I think you can already see this in CCC spreadsto be fair, given the composition of the events happening there, this is somewhat idiosyncratic. But they have indeed moved a lot, and it has slightly spilled over into the broader credit market. And then obviously, you also have concerns about French sovereign debt, namely: as a sovereign nation carrying a huge fiscal deficit in this environment, they too will all be crowded out. So I think all of this is having an impact, and at the same time, going back to the oil tradeas long as energy prices remain high, it will suppress risk appetite. And, I think for this kind of asset, it now feels somewhat like a buyer's market. Yes, from savings glut to spending glut, that's a brilliant distillation. That's absolutely right. And that savings glut was only five years ago. The speed at which we've shifted is truly astonishing. Chris Hussey 08:04 Okay. A lot has happened. You've just told us all about it. Let's wrap up. How do you do this trade now? Rich Privorotsky 08:10 The picture is a bit messy, and I have to say conviction is not particularly high, but I think there are some sectors in the electrification space that we think look interesting. Their valuations have been significantly marked down, and I still think visibility for A27 is ample enough to give you a large margin of safety. I think a lot of aerospace assets have pulled back, especially on the civil aviation side, which is also very attractive to us. And then even some areas of the transportation sector, frankly, if the energy problem can somehow be resolved, given how low net positioning has become and how much selling we've seen over the past few weeks, there is a lot of, I would say, convexity in that trade. For example, last week the tech selling in our prime brokerage business was the largest ever. So, I think there is ample reason to remain concerned, and I don't want to overly dismiss these risks, but I still lean toward being cautiously optimistic at this point. Okay, Rich, let's fast-forward to next week. What things next week that could affect the market are you watching? I think the key is in those numbers, the hyperscaler numbers we discussed. I think, you know, let's look at monetization, let's look at the capex numbers. I think that will be very critical for the tape. And I think, you know, how this progresses will determine how people think about credit, how they think about underlying demand, and the other data points we get from the various labs and suppliers. Rich, you bring a tremendous amount of information every time. Thank you very much for joining us today. Thank you. So. Chris Hussey 09:30 That's it. This episode of "The Markets" is over. I'm Chris Hussey. Thanks for listening.