Pro Perspectives 5/24/23

 

 
 

 

 

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May 24, 2023

We talked about the “AI effect” on the stock market yesterday.  And with the booming stock performance in the tech giants this year, where AI powers are heavily concentrated, there were building expectations that the earnings report by Nvidia this afternoon might undershoot.

That was not the case.  In fact, it was the opposite.  This Nvidia report might be the big wake-up call on the massive technological transformation underway (and in just the early stages).

After the bell, Nvidia reported a huge earnings and revenue beat.  With an even bigger upgrade in guidance.

They grew revenues at 19% since last quarter (Q1). 

And they think they will grow revenues for Q2 by 33% —  driven by “a steep increase in demand” related to generative AI and large language models. 

Again, that’s quarter-over-quarter growth. 

A key question in the earnings call: Can they continue that kind of growth? 

The answer:  “We have visibility (on demand) that is probably extended out a few quarters … Yes.  We are expecting a substantial increase in second half compared to first half.”

And, importantly, they say they have secured “substantially higher supply for the second half of the year,” to meet surging demand.

For perspective:  Nvidia is the leader in producing graphic processing units (GPUs) which enable the move from “general purpose computing” (powered by CPUs) to “accelerated computing” (powered by GPUs).

On the earnings call, they say the world’s $1 trillion worth of global data center infrastructure is based on CPUs — and there is aggressive demand to “re-tool” (across industries) to accelerated computing.

Keep in mind, before today’s report, Nvidia was the seventh most valuable company in the world ($770 billion market cap).  With this explosion in growth, Nvidia may be challenging Microsoft and Apple as the biggest company in the world very soon (joining the multi-trillion dollar market cap club).

As I said yesterday …

Just as the 1920s were defined by innovation (the automobile and widespread access to electricity), we have the formula here for another “roaring 20s.”

 

Pro Perspectives 5/23/23

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May 23, 2023
 
Stocks put in a technical reversal signal today.  It happened first in the dollar-denominated Nikkei (which was up 20% on the year, at the highs overnight).  And then in the Nasdaq (up 24% ytd at the highs).  The S&P also finished with a bearish outside day.
 
Small caps were bucking the trend on the day, up 1.3%, but reversed in the afternoon to close down on the day. 
 
What's going on?  
 
The noise about the debt ceiling continues.  The speculation about a June pause by the Fed continues. 
 
But this looks more like profit taking on the artificial intelligence trade going into tomorrow's Nvidia earnings. 
 
Nvidia is considered to be the leading provider of technology that powers AI, including ChatGPT.  The stock has more than doubled since the beginning of the year, making it the sixth most valuable company in the world.  Seven of the top ten are involved in AI (which, by market cap, is about a third of the S&P 500).
 
I suspect the markets are hoping for an earnings miss tomorrow, from Nvidia, for the opportunity to buy it cheaper.
 
More on AI …  
 
I've been using it since it launched in November, ChatGPT, and more recently Google's AI.  
 
My view:  The automobile is to mobility, as AI is to productivity.
 
A productivity boom is coming, and it is well needed.
 
Productivity growth is the key to improving living standards.  As ChatGPT says, "sustained productivity growth of around 2% per year has historically been associated with positive economic outcomes and improvements in living standards." 
 
We averaged just 1% for the decade prior to the pandemic, and negative 0.7% since the fourth quarter of 2020.
 
Just as the 1920s were defined by innovation (the automobile and widespread access to electricity), we have the formula here for another "roaring 20s." 

Pro Perspectives 5/22/23

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May 22, 2023
 
Last week we looked at charts on Japanese and German stocks.  And we looked at the U.S. benchmark (S&P 500).  All continue to trade around technical breakout levels (you can revisit that Thursday note, here).
 
This is the Vanguard Total World ETF.  This too, after retracing to pre-covid levels, is at a similar inflection point.   
Interestingly, the chart on Chinese stocks looks like the inverse. 
As we know China is still recovering from the zero-covid policies (finally abandoned in December of last year).  But exports are well above pre-pandemic levels.  The economy is growing at near 5% (above estimates), which is fast relative to the rest of the world, but still in recession-like territory for China. And the PBOC is allowing the yuan to weaken, nearing the levels of the 2019 (trade war) lows — which is intentionally stimulative to exports. 
 
Add to the above, in the past two weeks, in a "reopening quarter" the big four tech constituents of this Chinese ETF (FXI) all beat earnings estimates.
 
Valuation:  The P/E of FXI is 11 (ttm).  The P/E of the S&P 500 is 21 (ttm).
 
All of this said, coming out of the Great Financial Crisis/ Great Recession, Wall Street told us the era of developed world dominance had come to an end, and that the future of investing was in China.  By 2010, it was obvious that China couldn't thrive while the Western world economies were suffering.
 
Here we are again, coming out of a global crisis, but this time Western world economies are dealing with booming, rather than busting, nominal growth. This should be a time for a booming bounce-back in Chinese growth — unless the Western world decides to push back on China's economic and geopolitical ascension (and related, power).
 
It may be the last chance. 
 
And based on the G7 leaders meeting that took place through this past weekend, it may be happening.
 
The G7 communique mentioned China 20 times.  That's the most since 2014 (when the communique expressed concerns about human rights, trade practices and military expansion).  This is the first time since 2019 (in the depth of the Trump trade war), that the G7 leaders said they would work toward "diversifying" supply chains, to reduce reliance on China.  They addressed Taiwan, human rights, China's ability to influence Russia, and the importance of "playing by international rules."
 
What did China think about this?  China's state-controlled media called the G7 meeting, an "anti-China workshop."
 
Now, keep in mind, China intentionally, and aggressively, ramped it's influence building in Western world economies over the past 15-year (post-GFC, particularly in Europe).  And with that, the approach on dealing with China has appeared influenced.  Mike Pompeo called China enemy number one.  In contrast, Biden has called China a "tough competitor."  This, as Xi has continued to explicitly state his goal of world domination.
 
So, with this G7 statement, maybe the G7 leaders are finally prepared to hold China to account on what they call "economic coercion" (a term, before this past weekend, which has never been used before in a G7 communique, related to China).   
 
And with that, maybe FXI (the Chinese stock ETF) is rightly  communicating the geopolitical risk (i.e. vulnerable to breaking down).

Pro Perspectives 5/18/23

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May 18, 2023
 
Yesterday, we talked about the significant movement in the debt ceiling negotiations.  We went from no movement in the prior week, to this statement from Biden yesterday:  “we have to move on.” 
 
With that, the risk premium in markets is being unwound.  That means stocks are up.  
 
We’ve been looking at this chart on the S&P …
At the end of the first quarter, we had a break of the big descending trendline that describes the bear market of last year (the yellow line).  And we’ve been watching this 4200 level (specifically 4208, the high of the year).  This looks like a breakout today.  We traded up to 4215.
 
This, as the market has been heavily short, or underweight equities, as per the CFTC’s Commitment of Traders report, and Bank of America’s Asset Manager survey, respectively.  As we’ve discussed, a market that is leaning the wrong way tends to exacerbate a breakout like this, as they are forced to chase the market higher in order to reposition.
 
If we look around, globally, there’s support for the breakout scenario in stocks. 
 
German stocks made a 16-month high today.  And as you can see in the chart, this is knocking on the door of new record highs.  
And Japanese stocks have been marching higher by the day, just half a percent away from the highest levels since July of 1990. 

Pro Perspectives 5/17/23

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May 17, 2023
 
We had some surprisingly good commentary on the debt ceiling negotiations today.  
 
It started with this statement from Biden this morning, signaling a deal by Sunday.  He also said, importantly, “to be clear, this negotiation is about the outline of what the budget will look like, it’s is not about whether or not we will pay our debts.”  
 
McCarthy followed a half our later and said “a deal by Sunday is doable.”
 
Stocks did this …     
That said, we need the government to get out of the way, and let the liquidity that is already in the system do its job – to ensure a sustainable recovery from the 2020 economic damage. 
 
But what about rates?  We've never seen rates go from zero to 5% in a year's time. 
 
True.  But we've also never seen ten-years worth of money supply growth dumped onto the economy over a two-year period (the pandemic response).  
 
The tidal wave of new money should trump the adoption of what is (at 5%) an historically normal interest rate.
 
This money supply explosion should have resulted in inflation.  And it did.  But it also should have resulted in boom-time economic activity. 
 
Coming out of the pandemic recession, the economy should be in the midst of multi-year double-digit nominal growth (before the effects of inflation), and well above trend in real growth (after stripping out the effects of inflation).  Instead growth has been petering out.   
 
The good news:  The pandemic emergency policies and all of the subsidies and moratoriums that came with it, are over (or coming to an end).  This should normalize the labor supply (which has been in a shortage).  And we need higher wages (a reset in wages to offset the reset in prices) — to restore the standard of living.
 
That being the case, we could be looking at a boom in economic growth, just as people have been looking for recession.
 
On a related note, I want to revisit some of my analysis of the long-term path of the stock market.
This chart shows us what it would take to put us back on path of 8% annualized growth in the S&P 500.  

The blue line represents what the S&P 500 would have looked like, had it continued to grow at its long-run annualized rate of 8%, from the 2007 pre-Great Financial Crisis peak.  

The orange line is the actual path of stocks (which includes the deep financial crisis decline and the subsequent recovery). 

Through the years of looking at this chart above, there has been plenty of chatter along the way about the performance and status of the stock market — plenty of bubble and overvaluation talk.  But the reality is, we were knocked off of the path of the long-term trajectory of stocks (the orange line).  And that path of a long-term 8% annualized appreciation has never been regained (the blue line). 

What can we attribute this gap to?

 
Post-recession economic recoveries in stocks are typically driven by an aggressive bounce-back in growth, to return the economy to "trend growth."
 
We didn't get it in the post-great recession era.  Growth was dangerously shallow and slow.  Deflationary pressures persisted.
 

However, the pandemic fiscal response, unlike the great recession fiscal response, put cash in the hands of consumers.  And you can see what the short-lived boom-period did to close that gap in the chart (the orange line converging to the blue line). 

Pro Perspectives 5/16/23

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May 16, 2023
 
The financial media bangs the drum daily about things that could go wrong.  Risks.  Threats.  Bad news.  Recessions signals.  
 
While the list is a bit longer than usual, it's important to know that we've had a lot of bad news, risks and threats for the better part of the past fifteen year.
 
And stocks have a pretty good record of climbing a "wall of worry."
 
Remember, a little more than a decade ago, we had a sovereign debt crisis in Europe (exposed by the global financial crisis) that should have unraveled the European monetary union (the euro).  It was game over for the second most widely-held reserve currency in the world. 
 
It didn't happen because the world stepped in to save it, with a coordinated policy response from major global central banks (the ECB, the Fed, BOE and the BOJ).  And China played a large role.  They came in as buyers of euros, and of (insolvent) European sovereign debt and European state-owned assets (namely Greek islands).
 
With that in mind, what the media doesn't spend much time talking about are the global consequences of a potential technical default of U.S. debt.  The trouble would be far bigger outside of the U.S.
 
With that, the G7 Finance Ministers met over the weekend to prep for a scheduled G7 leaders meeting this coming weekend.  Remember, this is a group that has a very consistent history (of the past fifteen years) of coordinating and collaborating to ensure global financial market and economic stability.  In fact, they used those words (coordinate and collaborate) 18 times in their recent post-meeting communique. 
 
The history of U.S. debt ceiling adjustments (including suspensions) and the more recent history of coordination and shared interests of major global governments (and central banks), should make it a safe bet that there is a contingency plan for the Treasury to meet U.S. debt obligations, if the two political parties can't find agreement by June 1. 
 
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Pro Perspectives 5/15/23

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May 15, 2023
 
A second meeting between the President and Speaker of the House, on the debt ceiling, is scheduled for tomorrow.
 
Thus far, McCarthy says "nowhere near" getting a deal done.
 
For the moment, the markets continue to assign a low probability of a negative outcome from the debt ceiling negotiations. 
 
The 10-year yield is at 3.5%, closer to the lows of the 90 basis point range of the year.  And stocks are trading closer to the high of the year's range.  And the VIX, looks like no fear …
The VIX tracks the implied volatility of S&P 500 index options.  This reflects the level of certainty that market makers have, or don't have, about the future.
 
To put it simply, if you are an options market maker, and you think the risk of a sharp market decline is rising, then you will charge more to sell downside protection (ex: puts on the S&P) to another market participant — just as an insurance company would charge a client more for a homeowner’s policy in an area more likely to see hurricanes.
 
An "uncertainty premium" would translate into the violent spikes in the VIX that you can see on the chart.
 
And as you can see, spikes are not too uncommon, especially in this post-pandemic environment. 
 
For now, the VIX appears to be signaling some relative calm.  
 
But this, low level in the VIX (lack of demand), might be the product of a market that is already very short, and very bearish (twenty-year extreme short positions from the leveraged futures traders, and global fund managers most bearish stocks, relative to bonds, since 2009).
 
So, the market position suggests expectations of more downside.  And that actually creates vulnerability to a sharp move higher. Why?  With some good news, the shorts (and those that are underweight equities) will be scurrying to reposition (long), which can exacerbate the move.
 
We're already seeing significant strength in big tech stocks (and the Nasdaq).  And a technical breakout level in the S&P 500 is nearby — this (white) line in the S&P 500 would be new nine-month highs … 
This, as the Fed tightening cycle should be over.  And stocks tend to do well at the end of tightening cycles. 
 

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Pro Perspectives 5/12/23

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May 12, 2023
 
Let’s talk a bit more about the building debt ceiling drama, and the comparisons to 2011.
 
Obama entered office with an aligned Congress, and a war-chest of fiscal stimulus.  But beyond the $800 billion stimulus package (within the $1.4 trillion deficit of 2009), he ran a $1.2 trillion deficit in 2010, and proposed a $1.6 trillion deficit in 2011 (over three times the pre-financial crisis budget deficit of 2008).
 
Keep in mind, the economic contraction of the Great Recession, the maximum drawdown in economic output, based on the Fed’s quarterly readings, was “only” $500 billion.  To put it simply, the emergency fiscal stimulus, and subsequent deficit spending deluge was FAR in excess of the damage.
 
If we include the 2011 deficit proposal, that’s $2.8 trillion in spending (in excess of the pre-crisis, 2008, budget deficit), — to resolve a $500 billion loss in economic output. 
 
Sadly, it wasn’t growth producing (it was agenda fulfilling).  The economy grew at below trend rate, with the weakest recovery since World War 2.  
 
This is, in part, why Congress divided by late 2010.  In 2011, the House Republican’s pushed back on the madness and ultimately got a reduction in spending, in exchange for a last minute debt ceiling increase.  
 
In that case, then Secretary of Treasury, Tim Geithner put a hard stop date on a debt ceiling raise of July 8th.  The stalemate continued on July 7th — and Geithner moved it to August 2nd.  They did a deal on August 2nd. 
 
Fast forward to today:  Biden walked into office with an economy that had already fully recovered the pandemic-induced loss of economic output.  It was a $2.1 trillion loss of GDP.  And it was plugged by the $2.2 trillion Cares Act.  GDP was nearly back to peak levels by the end of Q4, 2020.    
However, if we include the 2023 budget proposal, we’re getting $5.7 trillion in deficit spending over three years.  That’s $2.7 trillion in excess of the pre-crisis deficit spending level of 2019 (as a reference point/benchmark). 
 
So, we have $2.7 trillion in excess spending, to resolve a economic output hole was already plugged. 
 
It’s driving inflation.  But it’s producing, relatively, weak growth AFTER the effects of inflation.  No bang for the buck, just debt, with a rising debt service cost. 
 
Why?  Because it’s not intended to be growth targeted.  It’s spending on the Biden administration’s social and economic transformation agenda.
 
This is precisely why I said earlier this week, this debt ceiling standoff (between parties) is as much about policy-path (maybe moreso), as it is about debt levels. 
 
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Pro Perspectives 5/11/23

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May 11, 2023
 
As we discussed yesterday, nothing has had more influence on stocks over the past sixteen months than inflation, and the fears over a draconian Fed response to it. 
 
On that note, we looked at the trajectory of U.S. CPI earlier this week.  By June, prices will be measured against a higher base (of the year prior), and that should deliver us a year-over-year inflation number in the mid 3s (percent), if not in the high 2% area.
 
This trajectory of U.S. inflation aligns with the producer prices, reported from China overnight.  As you can see in the chart below, the rate-of-change in producer prices has crashed into deflationary territory. 
This is the equivalent of "skating to where the puck is going."  The price of the products we will be buying in the months ahead, will be determined (in large part) by the inputs into Chinese production. 
 
This Chinese PPI was at 26-year highs when the Fed was telling us back in 2021 that there was no inflation.  It led on the way up (for global price pressures).  And it is leading on the way down. 
 
This also aligns with the record contraction in money supply. 
What is typically associated with a contraction in the supply of money and credit (both are happening)?  Deflation.  
 
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Pro Perspectives 5/10/23

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May 9, 2023
 
We had the April inflation report this morning.  The year-over-year price change came in just under 5%.
 
As you can see, this is the slowest rate-of-change in the headline inflation number since April of 2021. 
Most interesting, this number is going to fall off a cliff by June. 
 
Because of this …
The April number reported today was against the low base shown in this chart above.  By June, that base will rise dramatically.  Even if inflation runs at a hot rate of 1/2 percent per month, from now through June, the year-over-year June inflation number would be 3.4%.
 
If inflation were to be flat over the next two months, the year-over-year June inflation would be in the mid-2s (percent) — converging on the Fed’s target! 
 
This is precisely why the interest rate market was pricing out any chance of a June hike today.  And why the market is now looking for 75 basis points in cuts by year-end.
 
This scenario would align with the message the 2-year yield is sending …
As you can also see, the 2-year was trading at a technical inflection point today, going into this number — and resolved with a big move lower.
 
Let’s take a look at where this leaves the spread between the Fed Funds rate and the 2-year yield (i.e. the difference between where the Fed has set short-term rates, and the market’s judgement on where rates should be) …
The market is 118 basis points lower. 
 
The tightening cycle should be done.  With that, nothing has had more influence on stocks over the past sixteen months than inflation, and the fears over a draconian Fed response to it.
 
And with the end of tightening, we are left with this chart.
As we've discussed in my notes, stocks have broken above this big descending trendline that represents the bear market of last year – also above the 200-day moving average.  The next big technical level to watch is 4200.  That's only 1% away.  
 
Meanwhile, we're just coming to the end of Q1 earnings season, which was expected to be the worst quarter of the year for corporate America, with a recovery in earnings growth expected to come in the second half. 
 
But the Q1 reports have been full of positive surprises.  As of last Friday, 85% of companies had reported, with above average earnings beats (79%).  And the earnings contraction, at that point, was just 2.2%, versus expectations coming into the earnings season of 6.7%.
 
And this also comes as the institutional investment community is positioned in a very bearish stance (twenty-year extreme short positions from the leveraged futures traders, and global fund managers most bearish stocks, relative to bonds, since 2009).  As we've discussed, these are contrarian indicators.
 
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