Tag Archives: #magnificent7

Clearly the Rage

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While AI is clearly the rage
Where Mag 7 try to engage
Consider the fact
That during this act
They’re fighting each other backstage

Just a little aside regarding the situation in equity markets, which in the US really means the Magnificent 7 these days.  One of the key features of their cumulative success was that these companies had no significant overlap regarding their business models.  Online shopping, iphones, EV’s, search, GPUs, streaming services and a social network clearly intersected to some extent, but the main focus of all these companies was spread out in different directions.  Yes, Amazon prime competes with Netflix, as does Apple TV, and yes, Amazon Web Services, Microsoft Azure and Google Cloud are all in the same business, but there is a huge amount in that particular segment that is still unfulfilled, so competition but not cutthroat.

But AI is a different kettle of fish.  All of them are actively investing in their own AI programs and working to integrate them into their current services and products.  And we are already seeing announcements of new GPU’s to directly compete with Nvidia and bring that supply chain in-house for the other users.  The point is, there is going to be a lot more investment, if not overinvestment, in this space with, arguably, quite a while before whatever AI does starts to really help the bottom line.  In other words, do not be surprised to see margins start to decline in these companies which is unlikely to help drive their share prices higher.  As well, with investment focused on this new area, we need to expect to see a reduction in share repurchases, removing one of the key bids to the market.

All I’m saying is that even in a soft or no landing scenario, it strikes me that the Magnificent 7 may be running out of room to continue their amazing run of share price gains.  And if they start to stumble, just the very nature of the equity indices, where their capital weightings are so large combined, > 30%, I suspect the indices themselves may find themselves under a lot of pressure, regardless of whether the Fed cuts rates or not.  And if the Fed cuts rates because the economy is slipping into recession, or has already gotten there, that cannot be good for margins either.  While timing is everything in life, this is something that needs to be on everyone’s radar, because it will change the risk narrative, and that matters for all markets.  Just sayin’.

While last week was mercif’ly free
Of Fedspeak, the FOMC
This week will explain
Again and again
Why higher for longer’s the key

As the market returns to full strength, at least from a staffing perspective, post the Thanksgiving holiday, things are opening fairly quietly.  A quick recap of the data since I last wrote shows that the mix of good and bad continues to leave prospects uncertain going forward.  This has allowed both the soft/no landing camp and the recession camp to point to specific things and claim they are on the right track.  So, Durable goods were pretty lousy in October and Michigan Sentiment also fell sharply, but Initial Claims fell as well, indicating that the labor market remains robust overall.  In other words, uncertainty continues to reign.  

One of the interesting things is that different markets appear to be pricing very different outcomes.  For instance, commodity markets, or at least energy markets, are clearly in the recession camp as oil prices remain under pressure, falling another 1.5% this morning as the market awaits the outcome of Thursday’s delayed OPEC+ meeting.  Talk is that there could be another 1 million bbl/day production cut to help support prices, but nothing is yet certain.  At the same time, both copper and aluminum remain under pressure, sliding a bit further last week and this morning while gold (+0.5%) is back firmly above $2000/oz, hardly a sign of a positive future.

However, as dour as the commodity markets feel, equity markets remain quite resilient overall.  Although this morning, we are seeing modest declines around the world, with European bourses lower by -0.2% or -0.3%, and US futures are currently (8:00) down by -0.15%, the month of November has been a big winner almost everywhere.  Gains, ranging from 5% – 11% are the order of the month as equity investors have gone all-in on the idea of a soft landing and that the major central banks are going to be slowly reducing interest rates to ensure economic growth continues.

In truth, bond markets are of a similar mind as equities with 10-year yields lower by between 25bps and 40bps during November throughout the G10 (Japan excepted but even there lower by 10bps).  Clearly, all this can be traced back to the QRA released back on November 1st when Treasury Secretary Yellen let it be known that there would not be as much coupon issuance as had been anticipated, and that more of the Federal government’s borrowing would take place in the T-Bill market.  That was the starting gun for the bond market rally and the ensuing stock market rally. 

So, which of these two views is correct?  That, of course, is the $64 trillion question, and one with no clear answer yet.  As I have written numerous times, and as we saw last week, the data continues to be mixed, with both positive and negative signs.  While the Fed, and virtually every other G10 central bank continues to harp on the idea that they will not be cutting rates anytime soon, markets are pricing in rate cuts starting in early Q2 of 2024.

Ultimately, there will be a winner of this battle, but the game is still afoot.  FWIW, while I have long been concerned that the imbalances in the economy were going to lead to a more significant correction in equity prices, there is another side to the story that is worth exploring, and that is the concept of fiscal dominance.  

According to the St Louis Fed, a good definition of fiscal dominance is: “…the possibility that accumulating government debt and deficits can produce increases in inflation that dominate central bank intentions to keep inflation low.”  The corollary here is that the Fed is losing its power over one of its key mandates, stable prices, because the Federal government’s fiscal impulse is so great as to overwhelm the Fed’s actions.  

With 2024 a presidential election year, and with the TGA currently at $725 billion plus negotiations for more spending on Ukraine, Israel and the southern border, there will be no shortage of additional Federal moneys flowing into the economy.  Add to this the fact that the surge in T-Bill issuance will move savings from a “dead zone” in the standing RRP facility, which is still at $935 billion, to more active money, able to be used in the real economy, and it is easy to see how economic activity is going to be supported throughout 2024.  Whatever your views on the appropriateness of these policies, the reality on the ground is that the current administration will do everything in its power to be re-elected and that includes spending as much money as possible.  Remember, too, that there is no operable debt ceiling, so they can issue as much debt as they want to fund whatever they can get legislated.  

If the Fed has lost control of the narrative, and it does appear to be slipping through their fingers, then we will need to start to focus elsewhere to find market drivers. Of course, if the Fed is losing its grip, do not think for a moment they will go meekly into the sunset.  Instead, I could see several more rate hikes as they continue to try to fight for price stability amid an economy flush with cash.  In other words, this story is nowhere near finished.

At this point, let’s take a look at this week’s data, which will bring updated GDP and PCE readings amongst other things.

TodayNew Home Sales723K
 Dallas Fed Manufacturing-17
TuesdayCase Shiller Home Prices4.0%
 Consumer Confidence101.0
WednesdayQ3 GDP5.0%
 Goods Trade Balance-$85.7B
ThursdayInitial Claims220K
 Continuing Claims1872K
 Personal Income0.2%
 Personal Spending0.2%
 Core PCE0.2% (3.5% Y/Y)
 Chicago PMI45.4
FridayISM Manufacturing47.6

Source: Tradingeconomics.com

Despite Friday being the first of December, payrolls are not released until next week due to the holiday last week.  Plus, in addition to the data above, we hear from seven different Fed speakers over ten venues including Chairman Powell Friday morning.  That will be the last Fed speaker until the next FOMC meeting, so it will be keenly watched.  However, I would wager a great deal it will continue to harp on progress made but higher for longer to prevent any resurgence in inflation.

As to the dollar, right now, it is softening as market participants focus on the idea of Fed cuts and simultaneously reduce large, long USD positions.  For now, I feel like lower is the way forward, but if we start to see increased hawkishness again because there is no landing, merely continued growth, look for the dollar to return to its winning ways.

Good luck

Adf

Growth Dynamo

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The data continues to show
Economies still want to grow
Here in the US
The Retail success
Came ere China's growth dynamo

The upshot is all of the talk
That bonds are where people should flock
Turns out to be wrong
Then those who went long
Are likely to soon be in shock

Wow!  That’s all you can say about the data from yesterday where Retail Sales were hot and beat on every measure (headline 0.7%, ex-autos 0.6%, control group 0.6%) while IP (0.3%) and Capacity Utilization (79.7%) also indicated that economic activity remains quite robust in the US.  On the data front, this was followed by last night’s Chinese data dump where every one of their monthly indicators; GDP (4.9%), IP (4.5%), Retail Sales (5.5%), Fixed Asset Investment (3.1%), Capacity Utilization (75.6%) and Unemployment (5.0%), was better than expected.

Perhaps the idea that a recession is right around the corner needs to be reconsidered.  And remember, I have been in that camp as well, but the data is the data and needs to inform our opinions.  The immediate reaction to yesterday’s US data was a sharp decline in both stocks and bonds, while oil rallied, gold edged higher and the dollar tread water.  Of this movement, I was most surprised at the dollar’s lack of dynamism given the rate situation.  Unremarkably, given the ongoing belief in the Fed pivot, by the end of the day, US equities were tantamount to unchanged.  But the bond market remains under severe pressure with yields having risen another 12bps in the 10-year and having now reversed the entire safe haven move on the back of the Israeli-Hamas war situation.  

I continue to believe that yields have much further to rise and stronger data will only add to the case.  My view had been based on the combination of stickier inflation than the punditry describes along with massive amounts of new issuance requiring a lower price (higher yield) to clear markets.  But if we are going to continue to see strong economic growth, then there is an added catalyst for yields to rise.

One of the problems about which we hear constantly these days is the fact that there are no more natural buyers of US Treasury debt, at least not at current yield levels.  Many point to the decline in ownership by both Japan and China, the two largest foreign holders of Treasuries, and claim they are both selling their holdings.  However, I have a quibble with that thesis and would contend that perhaps, they are merely suffering the same mark-to-market losses that the banks are.  For instance, according to the US Treasury Department, holdings by these two nations from July 2022 through July 2023 declined by -9.6% (Japan) and -12.5% (China) respectively as can be seen in the chart below.  (data source US Treasury)

But ask yourself what has happened to interest rates over the past year?  They have risen dramatically (10yr yields +85bps) and that means the price of bonds has declined.  As a proxy, in the past 12 months, TLT (the long bond ETF) has declined by more than 13% in price.  So, if you have the exact same amount of bonds and their prices declined by 13%, it is not hard to understand how when you measure the value of your portfolio it has shrunk by upwards of 13%.  I have no idea what the maturity ladders for Japan and China look like, and it is likely they own a mix of short and long-dated bonds, but it is not at all clear to me they have actually been selling Treasuries.  Likely, they are simply holding tight, and I would not be surprised, given the dramatic rise in yields here, if they roll maturities into new bonds.  All I’m saying here is that the narrative about everybody fleeing bonds may not be correct.  In fact, regarding the TLT, which is a pretty good proxy for bond demand of the retail investor, there is a case to be made that demand is quite high.  My understanding is that calls on the TLT are amongst the most active contracts in the options market, and people don’t buy calls if they are bearish!

With that in mind, though, the underlying point is US yields continue to rise and that is going to be the driver for all markets.  In global bond markets, the US unambiguously leads the way and we have seen European sovereigns show similar movement to the US with large moves higher in yields yesterday, on the order of 10bps – 15bps depending on the nation, and consolidation today with virtually no movement, the same as Treasuries.  Last night, JGB yields managed to rally 3bps as well, another indication that as goes the US, so goes the world.

But the more interesting thing to me is the ability of the equity market to hold onto its gains.  The fact that US markets rallied back nearly one full percent from the immediate post-data lows was quite impressive.  Consider that the leadership of the US stock market has been the so-called magnificent 7 tech stocks (Apple, Microsoft, Google, Amazon, Nvidia, Meta (nee Facebook), and Tesla) most of which are essentially long duration assets with their extreme values based on a belief that they will continue to grow at incredible rates.  But with yields rising, the present value of those anticipated earnings continues to decline which should generally be a negative for their price.  So far, they have held up reasonably well, but cracks are definitely starting to show.  I suspect that at some point in the not-too-distant future if yields continue on their current trajectory, that equity market comeuppance will arrive and these stocks will feel the brunt of it.  But not yet apparently.  Interestingly, despite the positive Chinese data, equities in Hong Kong and the mainland both declined about -0.5%.  And looking at Europe, weakness is the theme with all the major bourses lower by -0.5%.  As to US futures, -0.25% covers the situation at this hour (8:00).

Meanwhile, the escalation in Israel and concerns about a wider Mideast war have joined with the stronger economic data, especially from China, to push oil prices higher again this morning, up 1.8%.  And that war theme has gold rocking as well, up 1.3% to new highs for the move with both copper and aluminum rising on the better economic data.  High nominal growth and high inflation (so low real growth) is going to be a powerful support for commodity prices.

Finally, turning to the dollar, this is where I lose my train of thought.  Given the higher yields and seeming increased worries about a wider Mideast war, I would have expected the dollar to continue to rally.  But that has not been the case.  Instead, it has been stable, stuck in a tight range against most of its major and emerging market counterparts.  Perhaps this market is waiting to hear from Chairman Powell tomorrow before traders take a view, but I need to keep looking for a reason to sell the dollar as the evidence to buy it seems strong, higher yields and safety.

Today’s data brings Housing Starts (exp 1.38M) and Building Permits (1.45M) as well as the EIA oil inventory data.  We also hear from a bunch more Fed speakers; Waller, Williams, Bowman Harker and Cook, so it will be interesting to see if there are more definitive views on a pause, especially after the recent hot data.  I have not changed my view that the dollar has further to rise, but its recent relative weakness is a potential warning that something else is driving things.  I will continue to investigate, but for now, higher still seems the better bet.

Good luck

Adf