Seven Stocks Are 41% of the S&P | John Davi on Building Portfolios Beyond the Mag 7 Bet

Oracle

Across the shows: 27 speakers in other episodes, 6 bullish and 24 bearish calls, past 30 days

• John Davi · Astoria Investment ManagementBearish

  Oracle could be the belly of the beast if AI spending funding strains show up.

  Davi says the market is signalling concern about whether the AI bet pays out, shown by credit spreads and hyperscaler CDS. Within that, he singles out Oracle as the most exposed, and says it could be the belly of the beast. He adds that there will be winners and losers in the AI trade, as there were in the late 1990s. He hedges the call with 'if I'm being honest', so it is a risk flag rather than a firm short.

  “But the market, you know, sort of, like, telling you, like, hey. We are concerned. Is this bet gonna pay out? And, you know, if you look at Oracle, I think that could be the belly of the beast, if I'm being honest.”at 45:47

US stock market outlook

• John Davi · Astoria Investment Management

  Astoria closed its equity overweight months ago, cutting risk after the easy money was made.

  Davi says Astoria is not bearish per se, but has scaled back its equity exposure from a portfolio risk management standpoint. Several months ago it closed its overweight position. He says the easy money has been made and that investors need to be idiosyncratic with their bets. Sentiment is high, inflows into leveraged products are heavy, and mega-cap cap-weighted index products are generally full on valuation, so the firm moved away from cap weight toward equal weight. He says the team knew it would never time the top, but reducing risk was prudent.

  “we're not bearish per se, but we have scaled back quite a bit from a portfolio risk management standpoint. So several months ago, you know, we closed our overweight position.”at 3:49

• John Davi · Astoria Investment Management

  Seven stocks at 41% of the S&P make the index a single AI bet, a risk investors should diversify away from.

  Seven stocks make up 41% of the S&P 500, so the index is tilted toward mega-cap hyperscalers. Consumer discretionary and staples are only about 13% of it and defensive sectors have shrunk, so the index no longer represents the broad market. Davi argues the whole investment world now looks like one AI bet, which is a problem. He says the S&P is masking concentrated risk, and that equal-weight and diversified approaches spread that risk and offer more opportunities. He stresses this is not a call for an AI bubble to pop; the aim is diversified portfolios, with investors trimming on the margins rather than dumping SPY or QQQ.

  “So seven stocks make up 41% of the S and P. ... this whole investment world seems like it's one AI bet, and I think that's, like, a problem.”at 11:39

• John Davi · Astoria Investment Management

  Passive index inflows create a self-fulfilling loop that bids up the same mega-cap stocks.

  Near-zero fees on ETFs make them an easy purchase, and investors have been taught to buy and hold. Trillions of dollars have gone into S&P index products, and the more money flows in, the more the highest-weighted stocks rise. Davi calls this a self-fulfilling prophecy. Index products have converged in cross-ownership and sector exposure, so flows bid up the same handful of stocks. The point is that flow-driven concentration creates an opportunity to tilt away from the index.

  “when you put hundreds and hundreds of billion and trillions into the S and P index product space, it's like this self fulfilling prophecy where the same stocks get bought. The higher the weight, the more they go.”at 12:23

• John Davi · Astoria Investment Management

  Policy backstops make a sustained 30-40% S&P drawdown unlikely; the Fed and government would step in.

  Davi says the Fed has protected left-tail risk since the Greenspan put, through the Yellen and Bernanke puts. Treasury steps in during crises, citing TARP, TALF, and the Fannie, Freddie and Bear Stearns backstops. He thinks a systemic shock, such as Oracle or an AI company blowing up, would likely be backstopped by the government. The Fed also has room to cut rates. Because of these tools, he does not expect a sustained drawdown of 30 to 40% that stays down for years. He notes that the Vanguard buy-the-dip mentality has trained investors to buy quick dips, and that taxpayers have made money on past bailouts.

  “So I don't think you'll have some sustained drawdown where the S and P falls 30, 40% and stays down because now we have these policies we dust off.”at 30:02

US inflation

• John Davi · Astoria Investment Management

  Inflation will stay high while the Iran-Iraq war remains in play.

  Davi says Astoria has been positioning for a structurally higher inflation regime since 2020 and 2021, and that this is now year six of the cycle. He links current inflation pressure to the geopolitical conflict. He argues that as long as the Iran-Iraq war stays in play, inflation is likely to stay high. That supports owning real assets rather than nominal ones.

  “As long as the Iran Iraq war remains in play, you know, it feels like inflation is gonna stay high.”at 10:41

• John Davi · Astoria Investment Management

  Today's setup resembles the 1970s oil-shock inflation era, not the late-1990s tech bubble.

  Davi argues the better historical analogy is the 1970s rather than the late 1990s. He cites an oil shock, wars, rampant inflation and a Fed aggressively hiking rates. He notes that at the start of the year markets expected rate cuts, but the Fed is now hiking, and the war has lasted longer than expected. He says the late 1990s were a bubble with no tangible earnings, which he does not think applies now.

  “You know, in the nineteen seventies, you had an oil shock. You had, you know, wars. You had rampant inflation. You had the Fed that was aggressively hiking rates. And, you know, that feels very similar to where we are now.”at 35:36

Banks

• John Davi · Astoria Investment Management

  Banks have had a tough run but are good value plays, and Astoria owns some bank stocks.

  Astoria's portfolios include some bank stocks as part of a value tilt. Davi acknowledges that banks have had a tough go lately, but argues that in general they are good value plays. This supports the broader point of tilting away from the mega-cap-heavy index toward cheaper areas.

  “We own, like, some banks' stocks. We think banks, it's having a tough go of late, but in general, I think banks are, you know, good value plays.”at 17:45

• John Davi · Astoria Investment Management

  Banks have a huge opportunity to use AI to raise productivity.

  Davi says there is a huge opportunity in banks and the healthcare system to use AI to increase productivity. This supports his preference for AI adopters over the enablers. He points to his own firm, where AI has already cut work time sharply, as an example of what this kind of productivity gain looks like.

  “I mean, there's a huge opportunity, I think, you know, within the banks and health care system to, like, use AI to increase productivity.”at 39:35

AI bubble & tech valuations

• John Davi · Astoria Investment Management

  Underweighting tech has been the biggest mistake; recent tech valuations are not bubble-like.

  Over the last 25 years, the biggest mistake a portfolio manager could make was being underweight tech. Tech was overvalued during the Internet bubble, but valuations in the most recent cycle, over the last 10 to 15 years, have been only about one to one-and-a-half standard deviations high and not bubble-like. Tech is still the largest contributor to S&P earnings growth and where a lot of investment is. Davi is still cautious on megacap concentration. He would neutralise stock bets within tech rather than fade the sector, and he thinks some of the mega-caps have become expensive, though their multiples have derated healthily this year.

  “the number one mistake you would have made as a portfolio manager over the last two and a half decades is to be underweight tech. ... the valuations in this last cycle ... they haven't been, like, bubble like.”at 21:43

• John Davi · Astoria Investment Management

  The Magnificent Seven are not a bubble; their moats, margins and tangible businesses justify the valuations.

  Davi says the word bubble is overused. He defines a bubble as buying an asset with no real understanding or intrinsic value, with no valuable business behind it. He would put some cryptocurrencies in that bucket, but not US equities or the Magnificent Seven. He cites their incredible businesses, moats, strong margins and tangible operations. He concedes they may be making too much of a bet on AI, and says hyperscalers have drained their free cash flow, but argues the investment landscape has changed without the companies becoming bubble stocks.

  “I don't think you should use the word bubble for them because, again, they have incredible businesses, incredible moats, strong margins, and, you know, these are, like, good tangible companies.”at 37:29

US Treasuries & yields

• John Davi · Astoria Investment Management

  A 5% ten-year yield is not excessive, since rates are rising on growth and sit near historical norms.

  Davi argues rates are rising because of growth, and the spread between nominal economic growth and the ten-year yield is what matters. A chart from Morgan Stanley supports the point that rates are not extreme relative to growth. He says the ten-year fell to about 80 basis points after the financial crisis and Europe and Japan had negative rates, so current levels are a normalisation. He adds that the long-run average is even above today's level. Higher rates are also good for savers, who can earn around 4 to 4.25% in money markets. He says the economy and market can absorb a 50 to 75 basis point hiking cycle followed by a pause, because the Fed has only partly reversed last year's cuts.

  “I would say that, like, rates are rising because you have growth. Right? So there's still a spread between, like, economic growth over the ten year.”at 3:21

Market sentiment, positioning & volatility

• John Davi · Astoria Investment Management

  Retail euphoria is sky high, with ETF inflows already past $1.5 trillion versus $7.8 trillion in a good year.

  Davi has been in the ETF space for 25 years. In a good year, the industry gets about $7.8 trillion of inflows, and it had already crossed $1.5 trillion a month or two before the recording. He says euphoria is sky high in terms of retail participation, and that this is what bull markets look like. Astoria scaled back risk because of this, though it knew it could not time the top.

  “There's a lot of euphoria out there... On a good year, you would get $7,800,000,000,000 of inflows. We've already crossed 1,500,000,000,000 about a month or two ago.”at 5:19

US consumer

• John Davi · Astoria Investment Management

  Higher rates are pinching small businesses and lower-income consumers hard, even as megacaps absorb them.

  The US economy is dominated by the hyperscalers and mega-cap stocks, which Davi says can withstand higher interest rates. Small businesses and lower-income consumers, though, are getting pinched hard by higher rates. He sees a dichotomy: the aggregate economy looks healthy because of mega-caps, while the households and businesses that depend on borrowing feel the squeeze.

  “the mag seven stocks to their credit, they can withstand higher interest rates. Right? But the small businesses, ... the lower, income consumers, I mean, I think for sure, they're getting pinched hard by higher rates.”at 6:56

US rates & the Fed

• John Davi · Astoria Investment Management

  The Fed probably needs to hike more, since inflation still outpaces the yields savers earn.

  Davi says inflation is still higher than rates, so lower-end consumers who earn 4 to 4.5% on bank deposits are still losing purchasing power to inflation. That is the trouble, which he says is why the Fed probably has to hike rates more. He thinks the market can digest 50 to 75 basis points of further hikes and then a pause, since the Fed cut a couple of times last year and this roughly reverses that.

  “We would still argue that inflation's higher... he's still losing to the rate inflation. So that's still the trouble, which is why the Fed probably has to hike rate more.”at 8:46

Commodities (broad)

• John Davi · Astoria Investment Management

  Commodities are the best-performing asset class this year; investors should hold real assets against sticky inflation.

  Davi uses the 2000s as a precedent. After the Internet bubble burst, the S&P fell 40% and the Nasdaq fell 80%, and over the following decade emerging markets and commodities rose more than 100%. He says commodities are currently the best-performing asset class year to date. He argues that investors should own real assets, such as infrastructure, industrials, energy equities and commodities, and move some nominal assets into them to hedge inflation. Astoria has been overweight real assets for more than five years and plans to keep that position.

  “you could see commodities are the best performing asset class year to date. So I think it speaks to a point that... you sort of wanna own real assets”at 10:25

International equities

• John Davi · Astoria Investment Management

  International stocks offer offsetting factor exposure, higher dividends and buybacks versus the low-yielding S&P.

  Astoria owns a lot of international stocks because it sees them as offsetting the factor exposures in US large caps. International stocks pay dividends and buy back shares. The S&P 500 dividend yield is only about 1%, so the US index offers much less income. Owning international equities diversifies a portfolio that would otherwise be dominated by the mega-cap US tech names in the index.

  “we do own a lot of international just because we think that international has, offsetting factor exposures. International stocks pay dividends. ... S and P dividend yield is, you know, very low. It's, like, 1%.”at 17:23

AI infrastructure & data centers

• John Davi · Astoria Investment Management

  Mega-cap AI capex has eroded hyperscalers' balance sheets, so the Mag 7 now carry more risk than before.

  The Mag 7 used to be bought as high-quality stocks with strong free cash flow, dividends and low debt. Two years ago they went all in on AI, drained free cash flow, began issuing debt, and one company issued equity. That changed the investment case. Davi says there is more risk in the Mag 7 now than ever. The open question is whether revenue and earnings growth will outpace capex spending. He thinks investors will know within a year or two whether the AI build-out has paid off.

  “the Mag seven as an investment case has dramatically changed. ... They started issuing debt. One company issued equity offering. ... There definitely is more risk in the Mag seven now than ever.”at 24:44

Bitcoin & crypto markets

• John Davi · Astoria Investment Management

  Select cryptocurrencies are bubble-like because most have very little utility or intrinsic value.

  Davi defines a bubble as buying an asset with no understanding or intrinsic value and no good valuable business behind it. He puts select cryptocurrencies in that bucket because most have very little utility. He contrasts this with US equities and the Magnificent Seven, which he says have real businesses and should not be called bubbles.

  “I'd put select cryptocurrencies in that bucket where there's very little utility in most, you know, cryptos”at 37:19

Earnings & corporate profits

• John Davi · Astoria Investment Management

  Earnings growth is extremely strong, so expectations are high and the bar is set high for upcoming results.

  Davi notes the long run of very large earnings growth, with quarters of plus 20 to 30 percent. Historically, earnings growth at this level has usually followed a recession, but this growth is not coming after one. That makes the bar high. He is heading into a big earnings week and will watch how US equities respond.

  “when you have this level of earnings growth, it's usually after some type of recession. Right? But we're seeing these, like, plus 20, 30% earnings growth quarters, ... not after a recession. So I think that, you know, the bar is set high”at 38:30

Enterprise AI adoption & AI software

• John Davi · Astoria Investment Management

  Investors should favour AI adopters over AI enablers; his firm is underweight Mag 7 for mid-caps, financials and healthcare.

  Davi prefers companies that use AI to improve processes and scale their business, which he calls adopters, over the enablers that build the infrastructure. This is why his portfolios are underweight the Magnificent Seven and US large cap and tilted toward mid caps, financials and healthcare. As evidence, he describes his own firm, where staff are mandated to use AI. He says a Claude project turned a 30-page macro deck into podcast talking points in about five minutes, versus three to four hours by hand. Filling out a 35-page due diligence questionnaire took him four hours manually, while an AI draft took about 30 to 45 minutes to finish. He says AI gets you 90% of the way, but you still need to verify the rest.

  “we would prefer more of, like, let's say, like, the adopters, like, that actually use an AI to sort of improve their, you know, processes and, you know, kind of scale their business. So I'd say invest in, like, you know, the adopters as opposed to, like, the enablers”at 39:05

Healthcare system & insurers

• John Davi · Astoria Investment Management

  The healthcare system has a huge opportunity to use AI to increase productivity.

  Davi names the healthcare system alongside banks as having a huge opportunity to use AI to raise productivity. This is part of his argument for investing in AI adopters outside the largest tech companies. He does not give specifics for healthcare beyond the general productivity point.

  “I mean, there's a huge opportunity, I think, you know, within the banks and health care system to, like, use AI to increase productivity.”at 39:35

Credit markets

• John Davi · Astoria Investment Management

  Widening credit spreads and hyperscaler CDS are the warning signs that the market doubts the AI spending payoff.

  Davi says he would watch credit and funding markets as the first signs of cracks in the AI trade. He cites hyperscaler CDS and the gap between triple-C and double-B spreads, which is around 11 to 12 points and has gone vertical. He reads this as the market asking whether the AI bet will pay out. He would then check whether the stress is about credit or just funding.

  “We're looking at credit markets... the CDSs of the hyperscalers. We're looking at, like, triple c's versus double b's. I mean, spreads are blowing out... a spread's, like, 11, 12. It's kinda gone vertical and parabolic.”at 45:21