Latest / Bull Market Conversations with Fexingo: Rallies, Momentum, and Riding Market Strength / How Bull Markets Create Their Own Defensive Sectors
Transcript
- Lucas: If someone told you three years ago that AI software stocks would be the new defensive plays in a bull market, you'd have laughed them out of the room. Growth stocks were the first thing you sold when the market got nervous. Luna: And now you're looking at Cloudflare, Datadog, CrowdStrike — names that used to be high-beta rockets — and they're acting like utilities in this June selloff. Lucas: Exactly. We've had a bit of a growth shakeout this week. The Russell 1000 Growth ETF, ticker symbol i w f, is down about 2.2 percent over the last five days. But look at the individual numbers: Cloudflare, ticker N-E-T, up 8.6 percent. Datadog, d d o g, up 8.3 percent. CrowdStrike, c r w d, up 3.8 percent. Luna: That's not just outperformance. That's a completely different correlation regime. When the growth index falls, these names are rallying. Lucas: Which raises the question: has the market decided that certain software companies are now structurally defensive? Not because they're boring, but because their revenue models have become bond-like. Luna: Let's unpack that. How does a subscription revenue model turn a high-growth stock into a defensive one? Lucas: It comes down to two things: revenue visibility and switching costs. Companies like Cloudflare and Datadog have net revenue retention above 120 percent. That means existing customers are spending more each year without any new sales effort. Their contracts are typically annual or multi-year, so the revenue stream is highly predictable. Luna: So investors are pricing those future cash flows almost like a bond coupon. Lower discount rate, higher valuation multiple, less sensitivity to economic shocks. Lucas: Right. And the switching costs are enormous. If you're a company that has built its entire data infrastructure on Cloudflare's edge network, you're not ripping that out in a downturn. It would break your business. So these companies have pricing power even when budgets get tight. Luna: But isn't this just a momentum trade? We saw the same narrative around SaaS stocks in 2021, and then 2022 happened. Lucas: Fair point. But the difference is that in 2021, these companies were trading at 30 times revenue with no profits. Today, Cloudflare has a price to sales ratio around 15, but it's generating positive free cash flow. Datadog is profitable on a GAAP basis. CrowdStrike has been free cash flow positive for years. Luna: So the fundamentals have caught up with the narrative. They're not just story stocks anymore. Lucas: Exactly. And there's an AI tailwind layered on top. These companies are critical infrastructure for AI workloads — Cloudflare for content delivery and security, Datadog for observability, CrowdStrike for endpoint security. AI adoption is creating a secular demand floor that traditional defensive sectors like consumer staples just don't have. Luna: Consumer staples companies are fighting for shelf space in a zero-growth grocery market. These software companies are selling into a market that's growing 20 percent a year. Lucas: That's the paradox. Old defensives — utilities, staples, healthcare — deliver steady but low single-digit earnings growth. New defensives deliver 20 percent revenue growth with high margins and recurring revenue. The market is starting to price that in. Luna: But if everyone piles into the same trade, doesn't that create its own risk? If these stocks are already pricing in years of perfection, one miss could be brutal. Lucas: Absolutely. Valuations still matter. Cloudflare at 15 times sales is not cheap by historical standards. If AI adoption slows or a company like Datadog guides lower, you could see a 30 percent drawdown. But the structural thesis doesn't require them to be cheap — it just requires them to be less volatile than the rest of the growth universe. Luna: So from a portfolio perspective, would you recommend overweighting these new defensives instead of traditional ones? Lucas: Not instead of — alongside. I think you want a barbell: traditional defensives for genuine recession protection, and these AI software defensives for drawdown protection within a growth portfolio. They serve different functions. Luna: That makes sense. And it ties into something we've talked about before — how bull markets create their own rules. The sectors that lead change as the cycle matures. Lucas: Right. And this is a perfect example. Ten years ago, if you wanted a defensive stock, you bought Procter and Gamble or Duke Energy. Today, you might buy CrowdStrike or Cloudflare. The definition of safety is evolving. Luna: And that evolution is partly driven by the fact that our money conversations have become more sophisticated. If these shows have helped you think about a portfolio decision differently, that's exactly why we keep doing them ad-free. Lucas: Yeah, we deliberately don't run ads on these episodes. No sponsors, no product pitches. Just the conversation. If you want to support that choice, the link is buy me a coffee dot com slash fexingo. Luna: It's a small way to keep this independent. And we really appreciate it. Back to the market — one thing I'm watching is whether this defensive rotation broadens out to other software verticals. Lucas: Good question. I think the key is the revenue model. Companies with high net revenue retention, long-duration contracts, and mission-critical use cases will get this defensive premium. That includes some names in cybersecurity, DevOps, and cloud infrastructure. But not every SaaS company qualifies. Luna: What about a company like Shopify? It's up 8.2 percent in the last five days, but its merchant base is small businesses — very cyclical. Lucas: Exactly. Shopify is a great company, but its revenue is tied to transaction volumes, which drop in a recession. So it shouldn't trade as a defensive. The market knows that. That's why Shopify's beta is still above 1.5, while Cloudflare's beta has dropped below 1.0. Luna: Interesting. So the market is already differentiating. It's not a blanket software trade. Lucas: No, and that's healthy. It means investors are doing the work. They're looking at contract duration, revenue concentration, end-market exposure. The companies that pass that test are being rewarded with lower volatility and higher multiples. Luna: And the ones that don't — they get sold off twice as hard in a downturn. Lucas: Right. Which brings us back to the big picture. This bull market is entering a phase where quality and visibility matter more than raw growth. The Fed is holding rates at 3.63 percent, and Minneapolis Fed President Neel Kashkari just said he still expects a rate hike this year. In that environment, you want companies whose earnings you can trust. Luna: And AI software companies with subscription models and high switching costs fit that bill better than most. Lucas: That's the thesis. Whether it holds for the next five years or just the next five months is the question. But right now, the market is voting with its dollars. Luna: And we'll keep watching to see if the vote holds. Lucas: Exactly. Next time, I want to look at SpaceX fast-tracking into the Nasdaq-100 — that's going to trigger massive ETF buying and it could reshape the index's sector composition. Luna: SpaceX in the Nasdaq-100. That's a whole new conversation. Lucas: It really is. The bull market keeps finding new stories.