Someone just ordered a CODE RED | WAYT?

Key Concepts: Broken Compounders, Active Management (ETF), Systematic Investing, Dead Cat Bounce, Market Breadth, Equal-Weight S&P (RSP), Sector Dispersion, Sector Correlation, Rig Count, Crack Spread, Ascending Triangle (technical analysis), Code Red (OpenAI), AI Disruption, Ecosystem Lock-in, Subscription Model Transformation, Share Buybacks, Forward P/E, Net New Annual Recurring Revenue (ARR), Vertical AI, Liquidity Story (Bitcoin), MNAV (MicroStrategy), Cash Flow Valuation (Vanguard philosophy).

Introduction and Sponsor Spotlight

The episode of "What Are Your Thoughts?" hosted by Josh and Michael Batnik, begins with a shout-out to their sponsor, Eaton Vance. Eaton Vance's short-duration income ETF, EVSD, is highlighted for its active management approach in today's market, where passive investing may not suffice. EVSD aims for better risk-adjusted returns by actively selecting short-term bonds, investing across diverse fixed-income sectors (US government, corporate, mortgage, asset-backed securities) to provide diversification beyond traditional strategies. Investors are advised to consider the fund's objectives, risks, charges, and expenses by reading the prospectus at eatonvance.com/evsd.

Guest Segment: Adam Parker on "Broken Compounders"

The show features a surprise guest, Adam Parker from Tvector Research. Parker clarifies the distinction between his two research efforts: Triari Research serves institutional investors (asset managers, hedge funds, corporations, law firms) with bespoke services, while Tvector Research is tailored for individual investors and financial advisors, offering insights, ETF analysis, and a "quirky interesting newsletter" for $100/month (with a free first month for new sign-ups at tvectorresearch.com).

The "Broken Compounders" Research

Parker's recent research focuses on "broken compounders"—stocks that were once beloved, steady performers but have recently experienced significant declines. The research aims to determine if and when to "buy the dip" in such stocks.

Methodology and Definition: A stock qualifies as a "broken compounder" if it meets the following criteria:

Prior Performance: Up at least 100% over the previous five years with "somewhat low volatility."
Significant Decline: Drops by 30% or more in a single month (e.g., after earnings or other bad news).
Exclusions: Biotech stocks are excluded due to their unique risk profile (e.g., drug safety/ineffectiveness issues often cause sharp drops).
Systematic Approach: The study uses a systematic, rule-based approach to identify these stocks, avoiding anecdotal cherry-picking.

Timeliness and Data: The research is particularly timely, as the year 2025 (in the video's context) has seen the third-highest number of broken compounders, comparable to periods after the Global Financial Crisis (GFC) and the rate-hiking cycle of late 2021. The study analyzed approximately 520 stocks over a 20-year period.

Key Findings and Characteristics:

General Underperformance: The overall basket of broken compounders is "not a good asset class." On average, these stocks continue to underperform their industry peers by another 10% over the next year after the initial 30%+ drop. This relative comparison to industry groups (e.g., S&P 25 industry groups) helps avoid inherent sector biases.
Concentration: This phenomenon tends to occur more frequently in the most expensive stocks, particularly within the technology and consumer discretionary sectors, which naturally have higher expectations built into their valuations.
Quality vs. Junk: While there's a higher proportion of "junk" stocks among broken compounders, a significant portion (255 out of 520) were classified as "top half quality." Even when analyzing only high-quality broken compounders, the basket still underperforms.
Worst Attributes: The stocks with the highest forecasted earnings growth, which are often correlated with high valuations, tend to experience the longest tails of underperformance after disappointing.
"Dead Cat Bounce": For high-quality or mega-cap broken compounders, there might be a short-term bounce (1 week to 1 month), but this typically fades over a 6-12 month horizon.
Momentum: Adam Parker suggests that if one is short a stock before it breaks, there's often "no reason to cover" immediately, as momentum can lead to further declines.

Examples of Recent Broken Compounders (as of November 17th list): The discussion highlights several names, including Synopsis, Hims & Hers, Elf Beauty, Super Micro, Riot, Nara (Bitcoin-related), and Oracle. Oracle, despite initial confusion, was confirmed to be on the list, with its decline attributed to increased debt and negative free cash flow, impacting its "quality" tag.

Actionable Insights:

A 30%+ drop in a previously loved compounder is generally not an immediate buying opportunity.
Avoid stocks with extremely high earnings expectations that have just disappointed.
If considering a purchase, understand the likelihood of continued underperformance relative to peers.
For those betting against these names, the data suggests there may be further downside after the initial break.

Market Commentary and Observations

Apple's Resilience

Apple hit a new all-time high with a market cap of $4.2 trillion, up 14.5% year-to-date, despite recent management changes related to the failures of Siri and Apple Intelligence. The hosts emphasize Apple's immense "ecosystem lock-in" and strong security as reasons it is unlikely to become a "broken compounder," suggesting that only a "massive security issue" affecting billions of devices could cause such a catastrophic drop.

Market Breadth and November's Unusual Leadership

The S&P 500 recently closed at a new all-time weekly high, with the highest 5-day advancer count in over 10 months, indicating strong market breadth. The equal-weight S&P (RSP) is also confirming this strength, nearing its previous highs. November was an "unusual month" where the market was positive, but healthcare was the leading sector, not tech (which was negative). This suggests a rotation of capital from faltering tech leadership into other large-cap sectors like Communication Services (Google), Financials (JPM, Morgan Stanley), and Staples, rather than a shift to cash. This is interpreted as a characteristic of a bull market where investors seek new growth opportunities.

The "Weird Year" of 2025

The year 2025 is described as "weird" because it has seen more 1% down days than 1% up days, despite the market being up 15% year-to-date. This contrasts with typical bull markets, which are often characterized by a "slow grind higher" with fewer explosive up or down days (e.g., 2017, which saw low volatility and was deemed "problematic" by financial media). This observation highlights that market behavior can be unusual in different ways each year.

Case Study: Adobe (ADBE)

Josh reveals he bought Adobe (ADBE) stock, presenting his thesis that the company is "understandably being punished but to extreme levels" due to AI disruption fears.

Arguments for Adobe:

Central to Creative Work: Adobe is positioned as the "operating system for creative work," a sector at the epicenter of AI disruption.
AI Beneficiary: Josh believes Adobe will be a "massive beneficiary" of AI transformation, integrating AI tools into its existing Creative Cloud and Firefly products, rather than being replaced by chatbots. Professionals will likely stick with their established workflows.
Strong Financials vs. Valuation: The company reported a record quarter with all-time high Earnings Per Share (EPS), yet its forward P/E ratio is at a decade low, indicating extreme market pessimism about the sustainability of its earnings.
Aggressive Share Buybacks: Adobe has a new $2.5 billion buyback agreement and $8.4 billion remaining from a prior $25 billion authorization, potentially buying back $11-12 billion worth of stock into a multi-year low, significantly shrinking its share count (down ~25% from 500 million to 420 million).
History of Reinvention: In 2014, Adobe successfully transitioned its entire business model to a subscription service, becoming a market compounder. This demonstrates its capability to remake itself under pressure.
Analyst Support: Despite the stock's decline, Wall Street analysts maintain high price targets (average $452, high $605) and mostly "buy" or "overweight" ratings, noting progress in AI-first Annual Recurring Revenue (ARR).
Technical Entry: Josh sees the current price as a "relatively low-risk entry" with a stop loss at $275.

Concerns and Counterarguments:

Competition: Figma (partnered with Google) is a significant competitor, and other options are emerging, potentially leading to price cuts.
User Dissatisfaction: Some users complain about Adobe's interface, login process, and perceived "ripping off" of professionals.
Underperformance: Adobe has underperformed the iShares Expanded Tech Software Sector ETF (IGV) and Salesforce since the launch of ChatGPT, indicating market skepticism about its AI strategy.
AI Integration Challenge: Unlike Google, which "neutralized and leapfrogged" the AI threat by inventing its own solutions, Adobe may not be able to "invent its way out" and relies more on integrating others' tools.

Inflation Meme: 1966 TIAA-CREF Ad

A viral 1966 TIAA-CREF ad designed to scare people into saving for retirement made remarkably accurate price predictions for 30 years later (1996):

Burger and fries: Predicted $16 (accurate for a sit-down restaurant today).
Vacation: Predicted $12,500 (likely an underestimate for today's costs).
Basic car: Predicted $65,000 (remarkably accurate, matching the average purchase price in the US today). The hosts ponder future prices, estimating a burger and fries could cost $37-$100 in 30 years.

OpenAI and ChatGPT Challenges

OpenAI CEO Sam Altman has declared a "code red" to improve ChatGPT's quality, delaying other products. The focus is on enhancing personalization, speed, reliability, and the ability to answer a wider range of questions, driven by competition from Google's Gemini.

User Frustration: Users report issues with ChatGPT not remembering past interactions, "freelancing" with responses, and requiring constant re-teaching, leading to frustration despite the technology's "magic."
Monetization Pressure: OpenAI's compute bill runs into billions per quarter, with HSBC projecting over $100 billion in cumulative losses by 2029. This financial pressure is leading the company to "trade purity for revenue," with leaked reports showing a "fully formed ad system" in ChatGPT's Android beta.
Market Impact: If OpenAI were public, it would likely be experiencing a significant drawdown (30-40%) due to these challenges and the need to introduce ads, which could alienate paying users.
Competition: Gemini's user base grew from 480 million to 650 million in a month, indicating strong competition that OpenAI cannot afford to ignore.

Make the Case: Energy Stocks

Michael Batnik makes a case for investing in energy stocks, noting their significant underperformance as a sector (up 97% over 10 years vs. S&P up 280%).

Why Buy the Energy Index (e.g., XLE, IEO):

Low Dispersion, High Correlation: Energy stocks exhibit low average dispersion (little opportunity for individual stock picking) and the highest average correlation among sectors. This means they tend to move together, primarily driven by the price of oil, making an index approach more suitable.
Hedge Against Oil Spikes: Energy stocks serve as a "true hedge" against an oil price spike emergency, providing diversification for an equity portfolio.

Specific Stock Examples:

Baker Hughes (BKR): Despite underperforming, BKR is at a 52-week high, attempting to break through $50. Declining rig counts (tracked by BKR since 1944) are seen as a bullish indicator for future earnings when the trend reverses.
Marathon (MPC): A refiner, trading on the "crack spread" (difference between crude oil and gasoline prices), described as "the best stock on the market."
Phillips 66 (PSX): Another refiner, poised to break through $140.
Exxon (XOM): Not yet ready for a breakout but forming an "ascending triangle" pattern, suggesting a decision point closer to the upper end of its range.

Mystery Chart: Bitcoin vs. Triple Q's (QQQ)

A mystery chart reveals the performance of two closely related assets: Bitcoin and the Nasdaq 100 ETF (QQQ).

Divergence: For the past year, Bitcoin and QQQ were highly correlated, but they have recently diverged, with QQQ recovering faster while Bitcoin's performance has worsened.
Correlation Decline: The actual correlation between Bitcoin and QQQ is at its lowest since the end of 2023, requiring a look back to the pandemic era for a period of less correlation.
MicroStrategy (MSTR) and Vanguard: The discussion touches on MicroStrategy (MSTR) as a proxy for Bitcoin exposure. Vanguard's recent decision to allow brokerage clients to buy crypto products is seen as bullish for Bitcoin itself, but potentially negative for MSTR, as it removes the need for a proxy. This move by Vanguard is interpreted as an effort to attract the "next wave of customers" rather than catering to its existing client base, which historically prioritizes cash-flow-generating assets.

Conclusion

The episode covers a wide range of market topics, from systematic research on "broken compounders" offering cautionary tales for dip-buyers, to the resilience of tech giants like Apple, the shifting leadership in the broader market, and the challenges faced by emerging AI leaders like OpenAI. It also delves into specific investment cases for Adobe and the energy sector, and highlights the evolving relationship between traditional tech and cryptocurrencies. The overarching theme emphasizes the importance of data-driven decision-making over instinct and adapting to the dynamic nature of market cycles and technological disruptions.