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ONE BIG THING

Insiders knew that one day advanced AI models would escape the lab and wreak havoc 

There’s an open secret among AI developers: An incident like the one in which two OpenAI models escaped from a supposedly secure environment and hacked a rival AI company has been expected for a long time, and the best scientists and engineers in the world still don’t know how to prevent it, writes Helen Toner, a former OpenAI board member.

None of the current policies aimed at managing risks from frontier models would have mandated that the public—or even a government entity—be alerted. This lays bare an enormous blind spot in current policy approaches to managing risks for increasingly advanced AI systems. Allowing the government to review new model releases won’t fix the problem because that still ignores the most advanced, unreleased AI systems inside AI companies. As last week’s incident shows, these internally deployed AI systems can pose serious risks—even for third parties.

The solution: Draw inspiration from other industries where activity inside the industry is itself risky. Biological labs working with deadly pathogens, finance companies trading billions of dollars, and chemical plants handling toxic chemicals all face oversight of their internal operations, not just their external products.

• Related: Employees at the world’s biggest AI companies are calling for a slowdown in AI development - CNN

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Elon Musk said money doesn’t matter. Then he rolled out X Money and admitted he’s a ‘former trillionaire’ - Catherina Gioino

Jamie Dimon says his stockbroker father taught him to invest with a ‘brutally hard’ childhood game - Sarah Glodek

Trump broke his promise to lower—and eliminate—the national debt. A top investor thinks he’s the ‘worst-spending president in history’ - Marco Quiroz-Gutierrez

THE MARKETS

Semiconductor stocks continue brutal selloff after traders see 557% profit growth at SK Hynix and decide it isn’t good enough

To give you an idea of how brutal the rout against chipmaker stocks in Asia has been, consider that over the past month South Korea’s KOSPI index is down 32.54%. The index is dominated by two stocks, Samsung and SK Hynix, which both make chips. SK Hynix lost 9.61% today after reporting 557% growth in Q2 operating profit. That’s not a typo. Five-hundred and fifty-seven percent profit was not enough for traders, who were expecting more!

Korea is in full-blown crisis mode right now. The government’s finance minister apologized to the public for allowing the trade of single-stock leveraged ETFs, which have magnified the losses of speculators, many of whom were unsophisticated retail investors who perhaps did not understand the risks they were betting on. Officials met at 6 p.m. local time to discuss policy reforms.

“The country has turned into a casino,” People Power Party lawmaker Lee Jongwook said during a parliamentary hearing today. “These are products that should never have been allowed onto the market.”

Japan’s Nikkei 225, also a tech-heavy market, was down 1.49%. Globally, the iShares MSCI Global Semiconductors ETF is down 22% over the last month.

The price of oil rose three dollars to $86 per barrel of Brent crude this morning on news that Iran had sent 30 drones against U.S. positions and the U.S. had retaliated by striking Iranian proxy groups in Iraq. The peace talks are still going on, however.

• S&P 500 futures were up 0.23% this morning. The index ticked up 0.21% yesterday. 
• In Europe, the Stoxx 600 was down 0.25% in early trading, and the U.K.’s FTSE 100 was up 0.09% before lunch.
• Asia: South Korea’s KOSPI was down 5.98% today. Japan’s Nikkei 225 was down 1.49%. India’s Nifty 50 was up 1.19%. China’s CSI 300 was up 0.67%.
• Brent crude rose to $86 per barrel this morning from a low of $83 yesterday.
• Bitcoin was at $64K.

AI

Wall Street is starting to see hyperscaler capex as more of a problem than a solution

Here’s a simple explanation for why tech stocks have been so rattled recently. Analysts keep adjusting upward their estimates of what AI hyperscalers will spend on capex in the future, and that increased spend is driving down free cash flow estimates. Investors don’t like it when they see companies deliberately reducing their profits, hence all the selling.

This chart from Apollo Global Management’s Torsten Sløk illustrates the phenom:

The other problem, according to Wells Fargo’s Ohsung Kwon, is that “the market is concerned around the risk of eventual capex cuts if ROI isn't there,” he said in an email (emphasis added).

Given that both semiconductor chip companies and AI hyperscalers are essentially making the same bet—that AI will drive revenues and profits—you can see why investors might be nervous at any sign that those profits are being pushed further into the future.

THE FED

Does Fed chair Warsh have a massive surprise up his sleeve?

If the Fed raises U.S. interest rates today, it will be a huge shock. Some 70% of positions in Fed futures are betting that Chairman Kevin Warsh keeps the rate on hold at the 3.5% level. Since 1994, the Fed has never raised rates if more than 60% of speculators on CME Fedwatch believe the “hold” position is priced in. “A hike this week would be a) unprecedented, b) pull forward 2026 hikes from ~45bps to ~60bps, & c) establish Warsh's credibility on independence and inflation,” Mark Cabana et al at Bank of America said in an email yesterday. 

However, 70% is substantially below the 90%-plus level that we usually see on the day of a FOMC meeting. A hike could still happen, Cabana says: “Market won't rule out hike risk; neither will we.”

Deutsche Bank’s Jim Reid put it this way: “This is the most uncertain that the market has been on whether the Fed will change rates going into a meeting since December 2018.”

Lord of the Dings: Chief economist of UBS Global Wealth Management Paul Donovan has made no secret of the fact that he thinks Warsh’s policy of giving less guidance on the future direction of the Fed is a mistake. But he was particularly harsh on Warsh in his email to clients this morning, in which he compared Warsh to Gollum from Lord of the Rings:

“Fed Chair Warsh [is] refusing to offer markets a framework within which to consider policy,” Donovan said. “Does the Fed care about inflation expectations in a world of social media hysteria? What second-round inflation effects matter? … Warsh is channeling Gollum and crooning ‘my precious’ over the Fed’s framework, risking volatility and higher risk premiums in markets.”

STOCKS ON STEROIDS

Late-stage leverage has arrived, Pimco says

Traders are increasingly leveraged—meaning they have borrowed money to magnify both their potential gains and losses—and it’s a symptom of a market in a “late cycle,” according to Pimco’s Lotfi Karoui. “We’re observing a familiar feature of late-cycle markets.”

Don’t panic (yet), he says. “Securities margin balances—a direct measure of leverage employed by equity investors—have picked up meaningfully in recent years. As a share of total equity market capitalization, these balances remain below prior cyclical peaks, but the pace of increase over the past two years is notable.”

CHART OF THE DAY

Blame the midterms for the stock market being full of grouches

Q2 earnings results have been “exceptionally strong so far,” according to Deutsche Bank.  “Roughly a third of the way through reporting, nearly 90% of companies have beaten expectations, with aggregate earnings coming in around 10% above consensus,” the bank’s Jim Reid said in a note.

But the market doesn’t seem to be impressed. The S&P 500 remains below its all-time high. This chart shows that stocks often do this in a year where there are midterm elections, Reid says:

“The year before U.S. midterms has historically been a subdued one for the S&P 500, with equities often experiencing a summer dip ahead of the vote. However, a couple of months after the election the market tends to regain its mojo, and by nine months later it has never been lower in any of the 20 midterm cycles since WWII.”

NUMBER OF THE DAY: SEC HATERS

99.5%

The percentage of investors who are opposed to the SEC’s proposal that publicly traded companies be allowed to report earnings semi-annually instead of quarterly. This tracker has counted 110,991 submissions from the public on the issue, of which only 260 support the proposal.

THE FRONT PAGES TODAY

Mark Zuckerberg says US should not ban Chinese AI - FT

Why America’s super rich have embraced the appeal of British soccer teams - CNBC

Scoop: Second OpenAI agent incident tied to cybersecurity testing benchmark - Axios

A backlash against Anthropic is brewing in Silicon Valley - WSJ

Couple stalked by eBay settle for $56 million - NYT

NYC lawyer caught canoodling with his much-younger colleague in Central Park placed on leave: report - NY Post

ONE MORE THING

Shopify CEO endorses removing votes from anyone who doesn’t pay tax

Shopify CEO Tobias Lütke, whose company commands a market capitalization near $154 billion, told his social media followers this week that a tax-tiered voting system—one that would strip voting rights from anyone who pays no income tax—would be a “good system.”

The proposal would invert the founding American principle of “no taxation without representation” into something closer to “no representation without taxation.” Most Americans thought this debate was settled more than a century ago, Fortune’s Nick Lichtenberg reports. 

Under this proposed system, the disenfranchised bloc would be enormous. It would encompass all retirees living on Social Security and pension income, students, caregivers, disabled Americans, and millions of low-wage workers who owe no net federal income tax after deductions and credits. Meanwhile, a small population of high earners would receive up to five votes each—a fivefold multiplier on political power concentrated in the hands of people already holding disproportionate economic power. What could possibly go wrong?

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