Holdings Letter: Energy for Inflation, Staying with AI
Long-term rates are rising, and the market is becoming more divided. Energy addresses inflation, AI follows the ongoing trend, and BTC and TRV are being added through scheduled purchases.
The most noticeable development this week was another jump in long-term interest rates. The 10-year U.S. Treasury yield is now 5.24%, compared with 4.79% a month ago and 4.1% a year ago—a rapid increase. Rising long-term rates suggest that markets are worried about further inflation and rate hikes, while the economy remains strong enough that investors are not rushing into Treasuries. But high interest rates make it harder for richly valued stocks to keep rallying, creating a headwind for equities.
Some companies have consequently seen their valuations fall. Since August, more than 54% of S&P 500 companies have fallen below their own long-term trends. The situation resembles March and April 2025, but for now it is high interest rates compressing valuations, rather than a substantive deterioration.
The S&P 500 and Nasdaq indexes are still rising, even as U.S. stocks diverge sharply. AI remains hot, but its current rally is driven more by earnings than by valuation expansion, which looks reasonably healthy. A small number of companies continue to carry the indexes higher.
Money and sentiment remain on the greedy side. This week, the HYG/IEF ratio is at its highest level over the past one to three years (percentile +1.0). HYG/IEF means high-yield bond prices divided by Treasury bond prices. A rising ratio indicates that investors are willing to buy high-yield bonds, companies can borrow easily, and risk tolerance is strong. The market is leaning toward greed.
Given these conditions, our portfolio responds to two macroeconomic states:
One is an overheated economy with high inflation, so we have exposure to energy and other real assets to follow that trend.
The other is the continuing AI trend. AI profits have improved, although the bubble remains large. Market confidence is still intact, and the trend has not reversed.
Our energy holding is XOM, ExxonMobil, currently the largest U.S. energy company by market capitalization. Its long history traces back to Standard Oil, founded by Rockefeller.
We currently have two ways to capture value in AI. One is SMH, a semiconductor ETF whose holdings include familiar AI-related companies such as Nvidia (NVDA), Taiwan Semiconductor (TSM), AMD, Broadcom (AVGO), and Micron (MU).
The other holding is Nvidia (NVDA). We hold it separately as an offensive position, since an index dilutes the gains of the largest companies. We also chose NVDA because this picks-and-shovels leader generates real revenue, which I see as a cushion that can soften a decline and leave room to react when the trend reverses.
Bitcoin (BTC) has also entered the recovery phase of its cycle, so I plan to complete my scheduled purchases over two months. Another position is TRV, Travelers. The current rising-rate environment benefits insurers, and this holding also helps stabilize the portfolio. I plan to complete my scheduled purchases over one month.
Space is limited this week. Next week, I will discuss the reasoning behind the remaining portfolio allocations in more detail.