Good morning investors,
The S&P 500 broke through 6,900 to close at a record 6,901 while Oracle's 14% plunge cost Larry Ellison $30 billion as AI spending fears resurface. Disney stunned markets investing $1 billion in OpenAI to license characters for Sora, creating a new form of AI powered merchandising. Broadcom crushed earnings with AI chip sales doubling to $8.2 billion but fell 6% premarket as margin concerns overshadow growth. Small caps continue their breakout exactly as I predicted at Thanksgiving, with the Russell 2000 hitting fresh all time highs as rotation from tech to value accelerates.
Opening Bell: AI Hangover Continues
Dow ($DIA ( ▲ 0.23% )) futures up 82 points while S&P ($SPY ( ▲ 0.5% )) futures slip 0.2% and Nasdaq ($QQQ ( ▲ 0.75% )) futures fall 0.5%. Broadcom ($AVGO ( ▲ 0.29% )) tumbles 6% premarket despite beating Q4 estimates and guiding AI chip sales to double, as CFO warns margins will fall 100 basis points from higher AI revenue mix. Lululemon jumps 9% on CEO Calvin McDonald's departure after founder Chip Wilson's frustration with marketing. The Russell ($IWM ( ▲ 0.36% )) is up around 0.1%
The divergence continues: value and cyclicals surge while AI names struggle with spending concerns. Yesterday's 1.3% Dow gain versus Nasdaq's 0.3% decline perfectly captures this rotation I've been highlighting.
Oracle's $30 Billion Disaster
Oracle's 14% collapse wasn't about demand, it was about cost. Raising capex guidance from $35 billion to $50 billion shocked markets already nervous about AI's circular dealmaking. The company's heavy reliance on OpenAI creates massive concentration risk, especially after Sam Altman's "code red" memo acknowledging Google Gemini's threat.
Bank of America lowered Oracle's target from $368 to $300 but maintained their thesis: "If you build it, they will come. But you have to build it first." The problem is building costs more than anyone imagined. With Oracle's debt already at concerning levels, markets question sustainability.
Disney's Billion-Dollar AI Bet
Disney investing $1 billion in OpenAI while licensing characters for Sora represents strategic brilliance disguised as capitulation. This isn't about AI content creation, it's next generation merchandising. Instead of toys and backpacks, Disney monetizes synthetic images and videos while maintaining "responsible use" control.
The deal protects Disney's IP from unauthorized AI use while creating engagement pathways back to theme parks and streaming. If someone creates something magical, Disney can feature it. The company simultaneously sent cease and desist letters to Google about unauthorized character use, playing both offense and defense.
Broadcom's Margin Warning
Broadcom delivered everything bulls wanted: Q4 EPS of $1.95 versus $1.86 expected, revenue of $18.02 billion versus $17.49 billion, and Q1 guidance of $19.1 billion versus $18.3 billion consensus. AI chip sales doubling to $8.2 billion proves custom silicon gaining serious traction against Nvidia.
Yet shares fell 6% as CFO Kirsten Spears warned margins would drop 100 basis points from AI revenue mix. The $73 billion backlog over 18 months shows demand isn't the issue - profitability is. Markets want growth AND margins, not either/or.
Small Caps Validate My Call
The Russell 2000 hitting all-time highs confirms my Thanksgiving prediction perfectly. I called for small cap outperformance as Fed cuts provide relief to floating-rate borrowers. With ISM manufacturing below 50 for months, these companies desperately needed easier financial conditions, now they're getting them.
This rotation from narrow tech leadership to broad participation typically marks sustainable advances, not tops. The Dow's 1.3% gain yesterday while Nasdaq fell shows money rotating, not leaving markets.
Trump's AI Preemption Play
Trump's executive order creating single federal AI framework while threatening states with funding cuts marks massive tech victory. The order establishes AI Litigation Task Force to challenge state laws, preventing California and New York from imposing burdensome regulations.
Tech giants OpenAI, Google, and Andreessen Horowitz lobbied hard for federal preemption. States not adhering could lose $42.5 billion in broadband funding. The 90-day timeline for Commerce Secretary to specify conditions shows urgency.
Costco's Steady Excellence
Costco beat with Q1 EPS of $4.50 versus $4.27 expected on revenue of $67.31 billion. Digital sales jumping 20.5% and Black Friday generating $250 million in non-food orders shows omnichannel working. The September membership fee increase provides durable revenue as younger members accelerate signups.
One-third of U.S. sales from imports creates tariff exposure, but Kirkland alternatives and category shifts provide mitigation. The stock's YTD underperformance looks like opportunity given consistent execution.
Final Thought
Yesterday perfectly captured the market's current personality split: Oracle's AI spending fears crushing tech while the Dow surged to records on value rotation. The S&P breaking 6,900 masks this dramatic divergence underneath where winners and losers couldn't be more distinct.
We're witnessing classic late cycle rotation where markets punish profitless promises while rewarding proven cash flows. Oracle burning $50 billion on AI infrastructure gets punished. Costco generating steady profits gets rewarded. Small caps breaking out while mega tech struggles confirms broadening participation, not topping action.
My AI thesis remains intact but with crucial evolution. US stocks will hit new highs as AI drives double digit earnings growth next year, but only for companies proving efficiency gains translate to profits. We're still early in AI adoption with smaller companies lagging larger ones. As borrowing costs fall and bond markets calm, these companies will make meaningful AI investments driving the next earnings wave.
The combination of healthy nominal growth, fading tariff drags, and continued earnings strength supports my year end surge call. Yesterday's late day bounce despite Oracle's disaster showed underlying strength. Small caps leading exactly as predicted validates the rotation thesis.
The Santa Claus rally remains on track with leadership shifting from speculation to fundamentals. This is healthy market evolution, not breakdown.
As always, feel free to reach out with questions about navigating this rotation.
Best regards,
Dan Sheehan
This newsletter is for informational purposes only and should not be considered as investment advice. Please consult with your financial advisor about your specific situation.