Why ‘Buying the Dip’ May Have Run Its Course

“This time it’s different.” These can be the four most dangerous words that any investor can utter.

The phrase can trip up the unwary in myriad ways. “These valuations seem unsustainable,” one might contend. Don’t worry, this time it’s different. “This technology has failed every time it’s been tried before.” No problem, this time it’s different. Any of us can attempt to justify all sorts of wild schemes or nosebleed prices on the idea that they aren’t subject to the norms that have applied before.

But here’s the rub—sometimes it really is different. Major turning points occur when there is a secular change in the economy’s fortunes or a notable development that affects a company’s long-term prospects.

Think back to early 2020. The global Covid-19 outbreak was indeed something different, and markets fell precipitously. The massive monetary and fiscal stimuli that were offered in the crisis’s wake were something different as well, causing asset prices to leap. Enormous opportunities were available to those investors who astutely recognized the seismic shifts.

If we acknowledge that monetary and fiscal stimuli were key factors in the great bull run of the past 18 months, how do we reckon with the possibility that both may be coming to an end? Federal Reserve Chairman Jerome Powell recently acknowledged that the central bank would be tapering its $120 billion monthly bond purchases “soon” and would likely end them completely in a matter of months.

The Fed may be taking its foot off the monetary gas pedal, but it won’t yet be tapping the brakes by raising interest rates. It isn’t clear how markets will react to a less expansive monetary policy, even though one is likely to be upon us soon. Furthermore, investors appear uncomfortable with a Congress whose lack of progress on the debt ceiling, budget reconciliation, and infrastructure bills have turned fiscal policy from an economic tailwind to a potential headwind. And, after a long absence, inflation seems to be rearing its ugly head.

It should thus be no surprise, then, that volatility has returned to major U.S. indexes. Uncertainty begets volatility. Volatility ebbed when it was clear that market-friendly policies were in place and pushed higher after the Fed’s stance began to morph.

Each of the past three weeks has featured at least two days with over 1% changes in the S&P 500 index and at least one 2% decline in the Nasdaq 100. When the S&P hit an all-time high on Sept. 2, its 10-day historical volatility was 8.09. On Oct. 5, just over a month later and after four sequential 1% up and down days, that measure had nearly doubled to 15.76.

While implied volatilities on S&P 500 options have risen across the board, we recently noticed a significant change in the relative valuation of out-of-the-money options, or “skew.” Early this week, implied volatilities had risen most for options that are about 5% below market and barely budged for options that are 10% above market. This tells us that traders are focused on hedging a decline that would signify a normal correction and less eager to speculate on a significant short-term bounce.

Markets in general, and the options market in particular, are telling us that we should be concerned about how events could play out in the coming weeks. Contrarian traders who are risk-tolerant and well-capitalized could attempt to take advantage of the pricing disparity described above by selling put options to finance call-option purchases. But I would also suggest that investors consider whether their risk exposures are appropriate and use options to manage them in the face of a changing monetary policy and fiscal uncertainty.

Quite frankly, this time looks different.

Steve Sosnick is the chief strategist at Interactive Brokers.

Austin, Texas, company Core Scientific went from bankruptcy to stock market darling this year by betting on two technologies: Bitcoin mining and AI data centers. Shares are up 400%.

But if given the choice of whether to invest more in one business over the other, executives answer without hesitating: the data centers.

“We really just value long-term, stable cash flows and predictable returns,” Chief Operating Officer Matt Brown said in an interview. The company began life as a Bitcoin miner. Even though Bitcoin has been a great asset lately, it’s very volatile. By comparison, Core Scientific can earn steady profits for years by hosting servers owned by companies that sell cloud services to AI providers, Brown said.

This year, you couldn’t go wrong betting on either. Bitcoin is up 116%, and data centers are in high demand because tech companies need them to power their AI applications.

The two technologies seem to have little in common, but they both depend on the same thing: access to reliable power. Core Scientific has a lot of it, operating nine grid-connected warehouses in six states with access to so much electricity they could serve several hundred thousand homes. Other Bitcoin miners have similarly transitioned to data center hosting , but few with quite so much success.

Core Scientific’s business didn’t look quite so good at the start of the year. The company started 2024 under the shadow of bankruptcy protection. It had too much debt on its balance sheet after going public through the SPAC process in 2022 and succumbed to a Bitcoin price crash. But the company’s fortunes quickly turned around after it emerged from bankruptcy on Jan. 23 with $400 million less debt.

The company started the year focused entirely on crypto mining, but quickly pivoted as it saw demand surge for electricity for AI data centers.

In June, the company signed a deal with a company called Coreweave to lease data center space for AI cloud services. Coreweave has since agreed to lease 500 megawatts worth of space. Core Scientific says it will get paid $8.7 billion over 12 years under the deal.

Privately held Coreweave is one of the fastest-growing companies behind the AI revolution. It was once a cryptocurrency miner, but has since transitioned to offering cloud services, with a particular focus on artificial intelligence. It’s closely connected to Nvidia , which has invested money in Coreweave and given the company access to its top-end chips. Coreweave expects to be one of the first customers for Nvidia ’s upcoming Blackwell GPUs.

Core Scientific’s quick success in this new world has surprised even the people who are driving it.

“Every once in a while I need to pinch myself, to see I’m actually not dreaming,” Brown said.

Core Scientific’s success does create a high bar for the stock to keep rising. The company is expected to lose money this year, largely because of a change in the value of stock warrants—an accounting shift that doesn’t reflect underlying earnings. Analysts see the company becoming profitable in 2025, when more of its data center deals start to hit the bottom line. They see EPS jumping tenfold by 2027. Shares trade at about 13 times those 2027 estimates.

The data center opportunity should only grow from here, as tech companies build more powerful AI systems. Of the 1,200 megawatts worth of gross power capacity Core Scientific has contracted, about 800 megawatts are going to data center computing deals and 400 megawatts toward Bitcoin mining.

Brown said the company has good relationships with its power suppliers and can potentially add more capacity without having to buy more real estate. It expects to be able to secure about 300 more megawatts worth of power at existing sites, perhaps by the end of the year.

It’s also in the hunt for new sites, including at “distressed” conventional data centers that have lost their tenants. Core Scientific has figured out how to quickly spiff up bare-bones data centers and turn them into high-tech sites with resources like liquid cooling equipment and much higher levels of electricity.

A single server rack in a standard data center might need 6 or 7 kilowatts of power. A high-performance data center can use as much as 130 kilowatts per rack; Core Scientific is working on increasing capacity to 400 kilowatts. The company likens the process of upgrading the warehouses to turning a ho-hum passenger vehicle into a Formula One racing car.

Core Scientific’s transformation from a broken-down jalopy to a hot rod has been a wild story. Its fate next year will depend on just how quickly the AI revolution unfolds.

Why ‘Buying the Dip’ May Have Run Its Course

Why this time it looks different.