The bogeyman of AI stocks has been summoned.

In late January, Chinese artificial intelligence company DeepSeek released an open source Large Language Model rivaling OpenAI’s ChatGPT, Google’s Gemini and Meta’s Llama.

The LLM, which was supposedly developed in only a few months with a budget under $6 million, is significantly more efficient than competitors and, consequently, 20 to 50 times cheaper to use than OpenAI’s o1 model.

The stock market’s reaction to the DeepSeek release was immediate, and, for a hot minute, there was blood in the streets on stocks even tangentially related to AI.

Tech darling Nvidia’s (NASDAQ: NVDA) shares plummeted nearly 18%, marking the largest single-day loss in its history and setting a new record for the biggest one-day loss for a single company in U.S. stock market history, erasing approximately $465 billion from Nvidia’s market cap.

The day’s other big losers included Vistra Corp (NYSE: VST), an electricity generation conglomerate with significant nuclear power holdings, and Arista Networks (NYSE: ANET), a purveyor of (among other things) cloud networking services for large AI data centers.

As if that wasn’t enough for the poor, beleaguered markets …

… after a small bounce back, additional volatility hit the market later that week as President Trump announced tariffs on trade with Mexico, Canada and China.

The tariff threat was later rolled back (for now) … but many retail investors are still reeling from the amount of uncertainty injected into the markets in a relatively short period.

So what’s the best way to take advantage of the trend?

3 Ways to Play a Crazy Market

If you’re looking to protect your portfolio while still capturing upside, you have a few options.

1. Defend

When markets get choppy, stable, dividend-paying stocks could help smooth out the ride.

Companies that sell essential products or services like food, beverages, and personal products tend to weather stock-market hurricanes with a reassuring stability.

Johnson & Johnson (NYSE: JNJ) is a classic example. With its mix of pharmaceuticals, medical devices, and consumer health products, JNJ has reliably provided investors with a port in the storm for decades.

Plus, with a 3% dividend yield and a low beta of 0.55, it provides reliable income and lower volatility — an excellent safe harbor in turbulent times.

Another “classic” example would be one of Warren Buffett’s favorite investments — Coca-Cola (NYSE: KO). This beverage behemoth has provided Buffett with stunning returns in the vicinity of 2,437% over the last few decades … while providing up to $700 million in dividends annually.

Neither stock dramatically outperforms the S&P until you zoom your chart out to 30+ years … but then again, the S&P doesn’t pay dividends.

If you are looking for longer-term, reasonably reliable gains while also receiving an income from dividends, playing “defense” could be a good strategy for your portfolio.

2. Parry

In fencing terms, a “parry” is a move that both defends and sets up for an attack … and that might be just the right move for a certain type of investor when the market’s going nuts.

This type of investor might consider using that volatility to their advantage by “buying the dip” when a high performing stock with solid fundamentals suddenly lurches downward.

In the DeepSeek panic noted above, several solid companies plunged more than 15% … but a few days later two of the three had rebounded as much as 20% from trough to peak.

Investors who kept their wits about them during the chaos of trading on January 28 had the opportunity to pick up some well performing, large cap stocks at a pretty decent discount and see an immediate ROI.

This is a more aggressive play, so be cautious as you are doing your due diligence on a potential investment; more than one investor has bled trying to catch a falling knife.

3. Attack

The most aggressive play — the high risk, high reward option — is to lean into the volatility and try to seek out an aggressive growth stock in the sector that’s primed to deliver outsized returns.

For example, President Trump’s outspoken desire to unleash American energy as a tool for American prosperity has the potential to dramatically affect the domestic oil and gas landscape.

His “Drill, baby, drill!” rhetoric hasn’t yet moved the needle for major producers like Chevron (NYSE: CVX), Occidental Petroleum (NASDAQ: OXY) or ExxonMobile (XOM) … but some smaller producers like Prairie Operating Co. (NASDAQ: PROP) have seen dramatic double-digit stock growth over the last month.

The growth isn’t the only thing dramatic about Prairie’s chart. The more observant readers will notice that the swings between company’s peaks and troughs are significantly larger than the bigger producers … but in that volatility lies the potential for what could be explosive growth.

Warning: Math Ahead

As of this writing, the stock is sitting around $8.60 with a $197.38 million market cap. The company released a 2025 EBITDA forecast between $100 million and $140 million and capex estimated at roughly $100 million for 2025. Additionally, the company has relatively low debt.

Based on a valuation formula called the Enterprise Multiple, some back-of-the-napkin math indicates that the company is currently trading at a 1.58x-2.21x multiple.

What does this mean?

It suggests that PROP is potentially undervalued compared to its peers — trading at a relatively low multiple compared to the broader oil and gas industry, which typically sees EV/EBITDA multiples between 4x and 8x.

If the company’s stock starts trading more in line with the industry average, the market cap could shoot up anywhere between $396 million to $1.096 billion.

That’s a huge range … and it’s not guaranteed that Prairie will ever hit those lofty heights.

But with Trump shouting from the rooftops that American energy is going to see a renaissance … this company could potentially be an aggressive investor’s vehicle to fairly significant returns.

The bottom line?

No matter how you choose to play market turmoil — defend, parry or attack — volatility isn’t necessarily something to fear …

… It’s something you could potentially profit from.

Make a plan, do your due diligence, then execute.

The FOMC is closed out 2024 this week.

While humbly bragging that inflation is well under control, they’ve set off in search of more “neutral” interest rate levels to ward off any slowdown in the economy.

Most media will tell you that they have spectacularly engineered the elusive “soft landing.” And that you don’t realize how good you’ve got it!

Others would beg to disagree..

They’ll point out Donald Trump won the White House in pretty amazing fashion based on the fact that Bidenomics and the economy it created both sucked.

Each camp comes to their conclusion based on the measuring stick they use.

And there’s more than one way to measure an inflation monster…

Welcome to “Sticky-ville”

As if there weren’t enough ways to demonstrate how badly the economy is treating you, the Atlanta Fed itself has devised another. It’s called the Sticky-Price CPI.

What is that?

The Atlanta Fed started tinkering with this measure nearly ten years ago. The idea behind it is that some items in the CPI basket change very rapidly in response to economic factors (they’re known as “flexible”) while other items change much more slowly (they’re “sticky”).

The big question on everybody’s mind was whether either of these groups was a better predictor of different drivers of inflation. In other words, was either one a better forecast tool.

After examining the data for a bit, they discovered that half of the categories change their prices every 4.3 months. So they used that as their cut off.

Items with prices that changed more frequently (like, say, tomatoes) were dubbed “flexible” while those that moved less frequently (like coin-operated laundries) fell into the “sticky” basket.

When you plot the two categories, they look pretty much like you’d expect:

But the trillion dollar question was still was either basket a better predictor?

To determine that, they dove into some high-level math. They used something called the root mean squared error (RSME) which is a statistical way to measure how accurate a prediction is.

They compared the RMSE of each basket to the RMSE of the forecast produced from the headline CPI at intervals of one month, three months, 12 months and 24 months out. (We’ll skip the boring math discussion.) What you need to know is that according to the Fed…

A relative RMSE less than 1.0 indicates that the alternative proxy for inflation expectations is more accurate than the headline CPI.

The results were undeniable.

The one month forecasts were all about equal. But, starting with three months out, the sticky and core sticky baskets proved to be better forecasters. And they became even better predictors the further out they went.

Forecasting Trouble

So what are they showing as the FOMC’s year came to a close?

The Atlanta Fed’s sticky-price consumer price index (CPI)—a weighted basket of items that change price relatively slowly—rose 2.4 percent (on an annualized basis) in November, following a 3.6 percent increase in October. On a year-over-year basis, the series is up 3.8 percent.

On a core basis (excluding food and energy), the sticky-price index rose 2.4 percent (annualized) in November, and its 12-month percent change was 3.9 percent.

The year-over-year numbers are double the Fed’s “mandate.”

While their “preferred” inflation gauge, the PCE index, is showing headline inflation around 2.3%, other measures like core CPI which hasn’t been below 3% since April 2021, suggest that things are still not under control.

And considering the Atlanta Fed’s sticky forecasting tool, it may not be for a while.

The Fed has officially embarked on its quest for the holy grail of monetary policy…

Having slain the inflation monster with restrictive rates of 5.5% (or so they say) they must now start easing off the brakes so the rest of the economy doesn’t sputter and die.

The problem is, as Chairman Powell has admitted over and over, they have no idea what “neutral” actually is. (But they assure us, they’ll know it when they see it.)

And despite not knowing where they’re headed, they launched their effort by slashing their target rate by 50 basis points. Pretty much as large as they could go without sparking some panic in the market.

The market, which had been in a solid uptrend since the low in October 2022, driven largely by mega-cap AI stocks, celebrated by continuing its rally.

This policy reversal by the Fed is something the market has been anticipating for some time. And now that the easing cycle is underway, it should continue to please those big players driving the market.

But it should also benefit another segment of the market that has been lagging. And that creates an opportunity for investors…

Rise of the Small Caps

Since the low in October 2022, small cap companies have lagged the bigger players in the market. Take a look at the chart below…

S&P 500 vs Russell 2000

You can see tightly related performance of both the S&P 500 (an index dominated by mega-cap companies) and the Russell 2000 (an index of small-cap companies) into the 2022 low.

Once mega-AI stocks began to drive the rally, the bigger better capitalized stocks took off. Smaller cap stocks, on the other hand, struggled to keep up lagging by over 20%.

That’s one sector that had been significantly impacted by the Fed’s tightening cycle. Now that’s very likely to change.

Why Small-Caps Love Lower Rates

Small cap companies are typically more sensitive to interest rates. One reason is that they tend to be more reliant on external financing to fund their operations and growth.

Huge companies like Alphabet, Amazon, Microsoft all have massive cash reserves they can fall back on to fund their strategic plans. Tens of billions have been spent by big tech from their war chests on AI development.

But many smaller companies, companies with market caps in the lower billion dollar range, don’t have that kind of financial ammo. They have to keep their eyes on operations. That means strategic borrowing is much more critical when it comes to things like financing growth and innovation.

Another reason is bottom line profitability.

Smaller-cap companies generally have smaller profit margins than their bigger capitalized cousins. And a higher cost of capital (what they pay to borrow) tends to take a significant bite out of their already-thin bottom line.

With the Fed moving to ease, lower financing costs will ultimately boost many small-cap companies’ bottom lines making them more profitable companies.

And of course, that leads to a third factor in bolstering the fortunes of the small-cap crowd — more profitable companies are more attractive to investors.

Lower interest rates, from an investor perspective, tends to generate what’s known as a “risk on” investment environment. One where funds and other institutional investors will leverage their portfolios by borrowing money to invest in companies they feel have potential for significant returns.

And companies that have the potential for significant returns? Well they’re generally the ones that are undervalued or have been lagging the broader market.

Right now, that’s the small cap sector.

Looking at the chart above, the small-cap sector as a whole has significant room to actually outperform larger-cap competitors.

Some small caps will do better than others. But right now may be the time for savvy investors to start scanning the small-cap universe for significant opportunities.

It accounts for 70% of the country’s GDP.

Consumer spending.

Makes sense. Healthy consumers are obviously necessary for a healthy economy.

But good health isn’t always apparent on the surface. Trouble can be quietly developing under the surface.

Like the heart disease candidate whose arteries are filling with plaque. They may look perfectly fine… until they’re lying on the ground clutching their chest.

Today’s economy is something like that.

Last October, the BEA announced that real GDP rose at an annualized rate of 2.8%.

That is an impressive number.

To take it at face value (much like the Fed has been insisting we do) you’d have to say that the economy, and consumers in particular, are doing just fine. So have another piece of cheesecake.

The reality underlying the situation, however, isn’t so good.

A Shift in Buying Preference

In a broadly healthy economy, a rising GDP should lift all boats. (Or most anyway.) You expect to see retailers posting great numbers across the board. Blood is pumping through those arteries.

But that’s not what has been happening. And it hasn’t been happening for some time…

All the way back in November 2022, the Wall Street Journal reported:

“Walmart gains more shoppers” sounds like good news. But article reported strains in the consumer sector:

The country’s largest retailer by revenue said Tuesday that households continue to face pressure from rising food prices, and lower-income shoppers are eating into savings.

Inflation was still roaring at the time and CPI for that month came in at 7.1%. And you’d expect that kind of news from lower-income shoppers. But what you might not expect…

During the most recent quarter, households earning $100,000 or more helped push Walmart grocery sales higher, executives said.

Sales data had indicated that higher-income consumers had begun to trade down searching for bargains. When inflation begins to reach the middle to upper income brackets, stress is beginning to build.

Still, with prices soaring over 7% annually, it’d be reasonable to argue that most households would be looking to save a buck or two.

But now with inflation “well on track back to 2%,” if you believe the Fed, things should be shifting back to normal. But they’re not.

In fact, they’re going in the opposite direction…

The Trade Down Continues

This November Walmart released its earnings. Not only did they beat revenue and earnings estimates, they raised their forward guidance.

In particular, management noted…

While average transaction growth slowed, customers are buying more at each visit, driving ticket sizes. A lot of that growth was driven by upper-income households making $100,000 a year or more as increasingly more affluent households trade down. That cohort made up roughly 75% of share gains for the quarter.

Two years later, the $100K and up cohort is still shopping at Walmart. And they’re doing it more and more.

This suggests clear strains in the economy. In a recent webinar, Goldman Sachs noted:

Our focus on the webinar centers around discussing high-end and low-end consumers trading down. This phenomenon occurs as macroeconomic headwinds mount, including elevated inflation and high interest rates due to backfiring ‘Bidenomics.’ More importantly, trading down occurs when incomes don’t keep up with inflation or when purchasing power decreases.

So the trade down phenomenon itself is suggesting trouble. But there’s more…

The bargain hunting isn’t carrying across the board.

Target, who released their earnings the same day as Walmart, missed everywhere with their stock dropping 21% on the news.

This suggests that the trade down to discount stores isn’t even widespread. (Even Dollar General collapsed on its latest earnings report.)

The bottom line: The trade down and concentration of retail customers suggests they’re taking a seriously defensive position as economic conditions become more and more uncertain.

Could be tough times ahead.

When asked what she would do to deal with inflation during her failed presidential campaign, Vice-President Kamala Harris repeatedly talked about battling the bogeyman of price gouging — the idea that retailers jack up prices to pad their profits

Now, never mind that many states have their own laws to deal with price gouging, her claim makes it seem like unscrupulous pricing practices have somehow been a root cause of the higher prices that everyone is struggling with.

Not so.

Let’s take a look at two areas where folks are most impacted by price fluctuations: the grocery store and the gas station…

According to the Grocery Store Guy, a site dedicated to tracking the industry, profit margins are definitely not the culprit…

Conventional grocery stores have a profit margin of about 2.2%, making them one of the least profitable industries in the U.S.

Gas stations on the other hand make the grocery industry look like Scrooge McDuck.

An analysis in Fortune Magazine pulled back the curtain of the industry to reveal…

Gas retailers receive a fraction of the price listed on the sign–their net profit per gallon is around $0.03-$0.07… This puts the net profit margin of a gas station at less than two percent.

Added up another way…

According to IBISWorld, gas stations make an average net margin of just 1.4% on their fuel.

So the idea of a fire hose of profits from retailers overpricing goods hardly matches with reality.

Of course, that doesn’t mean there isn’t some serious price gouging going on elsewhere…

If It’s Not the Grocery Store, Who is it?

If you really want to point a price gouging finger somewhere, you can look to none other than the Fed. Yep, your friendly neighborhood central bank has been in the business of gouging your prices for years.

But isn’t the Fed supposed to promote “price stability” you might ask?

Let’s consider that.

One of the Fed’s official “mandates” is to maintain a 2% annual rate of inflation. Why? Two reasons.

First, because by maintaining a stable rise in prices it sets an expectation in people’s mind. It reassures them that with the Fed in charge of monetary policy, prices won’t go soaring out of control. (Like they just did…)

The other factor is that 2% inflation is considered a margin of safety. What’s that mean? They insist that if the Fed were to attempt the Herculean task of maintaining a lower rate, they would risk creating a contractionary economic situation. Which would lead to recession and depression and all that stuff they can’t risk.

So 2% it is.

That’s their story. Problem is it’s all BS.

The 2% number is basically a random pick. (Watch as core CPI stays stuck above 3% you can bet the Fed will start floating “target range revision” talking points.)

But get past all the rationalizing of 2% inflation, you’ll realize that the Federal Reserve is actually in the business of creating inflation.

Why on earth would they want to do that?

Because in a financialized economy — one where fiat currency is more important than producing value — unchecked debt becomes the driving force to create “growth.” And at some point you have to deal with that.

You may have read that the federal black hole is now up to nearly $36 trillion. (What you may not have read is that there’s no longer a debt ceiling in place until 2025. We doubt it’ll even come back then.)

It’s reached 122% of GDP.

They have never nor will they ever pay that debt down. Here’s a chart of the government’s gross federal debt dating back to 1940…

The Federal Debt

Source: The Federal Reserve Bank of St. Louis

Even during the economic boom during the post-war years the actual debt never got paid down.

The way they keep it “under control” is by managing it as a percent of GDP — in other words, through inflation.

And while they’re doing that, they’re devaluing your money.

So, while your local grocery is scraping by, it’s the Fed that has actually been robbing you blind for years.

It was probably only interesting to financial geeks, but for the couple days going into last week’s FOMC meeting there was a real tug-of-war going on between “economists” and the market.

Since the beginning of the year, there had been expectations of interest rate cuts starting in March. Last December, the Fed itself was projecting nearly 100 basis points over 2024.

But then CPI got stuck at 3.5%. (Even the notoriously Fed-friendly PCE was rising 2.7% year-over-year.)

The party had to be postponed.

And after standing pat for a handful of meetings, convincing itself that they really had the inflation beast under control, the Fed finally saw its destiny in the jobs reports over July and August.

Back-to-back misses and downward revisions to nonfarm payroll numbers (which had been building all along) along with an uptick in the unemployment rate shifted their focus. (Or at least their talking points.)

At the Fed’s annual Jackson Hole Symposium, the three day get-together of central bankers and other elite types from around the world to discuss the fate of interest rates, Chairman Powell said the following:

Overall, the economy continues to grow at a solid pace. But the inflation and labor market data show an evolving situation. The upside risks to inflation have diminished. And the downside risks to employment have increased. As we highlighted in our last FOMC statement, we are attentive to the risks to both sides of our dual mandate.

The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.

There was no mistaking what he was saying. So by the time the September meeting rolled around, it was game on for the long awaited cuts. The question wasn’t “if” anymore, but “how much?”

On opening day of last week’s FOMC meeting, the market was all-in pricing in a 64% likelihood of a 50 basis point cut.

“Economists” on the other hand, (105 out of 114 surveyed) were insisting that the Fed would only go 25 bps.

And as the clock struck 2:00PM ET, the Fed dropped the bomb…

50 bps it was.

And after receiving what everyone thought would be the best news possible, the market went haywire and ended up lower on the day…

S&P 500 (5 min)

So What Does All This Mean?

First, it means “economists” aren’t that smart.

Second, it means the Fed is likely more worried about the economy than they’re letting on. The Fed’s rate cut logic goes something like this…

While they’re straining their shoulders to pat themselves on the back for taming inflation, they still insist the economy is doing just fine. So they need to move rates from “restrictive” to “neutral” now, before things do start to slow down and the economy falls into a recession. Thus engineering the mythical “soft landing.”

Let’s break that down…

According to Powell, things are humming right along as even with a Fed rate target of 5.25-5.50%.

On top of that, asset prices (stocks, housing, etc.) at all time highs.

And unemployment estimates are well within the 4% range, a range Powell himself insists is perfectly healthy.

So why cut 50 points now? Why not just 25?

According to JP: they’re trying to get out ahead of a potential economic slowdown by starting to move rates to “neutral” now. (I put neutral in quotes because even according to Powell almighty, the Fed has no idea what neutral is. Like pornography, they’ll know it when they see it!)

The reality is the Fed is completely incapable of predicting anything. I give you their “inflation is transitory” claim from three years ago as proof.

The Fed is easing because of meaning number three: they know the economy is in worse shape than their numbers let on.

They know (and now we do) that the BLS overstated jobs added by over 800,000 over the past year.

They know the unemployment number will only keep rising thanks to the millions of immigrants who’ve crossed the border over the past three years — a fact that Powell copped to in his Q&A.

They know that consumers (who represent over 60% of GDP) are getting crushed.

And they know the economy is hopelessly addicted to cheap money.

So 50 bps it was. (Anything bigger would have incited a panic.) And you can look for at least 50 more by the end of the year.

Longer term, the reality is cheaper money will always ~~inflate~~ benefit asset prices. Period.

That said, a 50 bp cut doesn’t equal “cheap” money.

The real question is how committed are they to trying to find “neutral.”

Because should inflation reheat with unemployment still on the rise, Powell and Co are going to find themselves in the unenviable position of floating up S#!% creek.

Exciting times ahead…