2023.05.30 Weekly Notes

Fade the AI-bubble & DC resolution

For almost the whole month of May, I’ve been looking for equities to finally break its tight range to the downside and my PnL has taken a hit as a result of it. USD longs has helped to offset some losses in equities but was not enough to offset my stubborn attempts to keep reshorting NDX. I haven’t given up on the idea that the NDX breakout being the finale to what appeared to be distribution into a wedge top however, and I think it could still materialise when the focus shifts towards the data and Fed’s June meeting once the Fiscal Responsibility Act passes the Senate.

On NVDA last week, I had my suspicions that 1) there was a huge amount of 0dte call option interest into earnings which had 2) forced market maker’s gamma hedging algos to buy up the stock uncontested during illiquid trading hours. To note how extreme the NVDA post-earnings move was, courtesy of the ‘Macrodesiac Quant desk’ — the move was in the 99.9th percentile in the distribution of single day log-returns:

and ranked 6th among the top 10 biggest moves since 1999 where most in that set had occurred during the dotcom era:

Secondly, another gamma squeeze? This detailed look into the options activity that day from @jaredhstocks confirms what I’d suspected:

I don’t think there is any doubt that this is a Bubble, defined as:

a period when prices rise rapidly, outpacing the true worth, or intrinsic value, of an asset, market sector,, or an entire industry, such as real estate.

If anyone loves a good bubble its Jim Chanos where he took aim on the issue:

Short seller Jim Chanos rolls his eyes at AI hype as Nvidia signals it may sell new shares to eager…

Bank of America said Friday that the AI boom was likely a “baby bubble” that will be popped when the Fed tightens its monetary policy further in a bid to curb soaring prices.

“Don’t chase here… financial conditions are tightening again,” strategists said in a research note, pointing to previous stock market fads that ended as borrowing costs rose.

Markets trade on narratives and currently, AI mania and optimism towards a debt ceiling resolution has cause tech stocks to rally strongly despite the hawkish moves in US rates and Dollar which would otherwise be headwinds for the rallies. But I think it won’t be long til the narrative shifts back to the incoming data which is likely to have put more pressure on the Fed to hike another 25bps (core retail sales and PCE ex-housing surprised to the upside), and debt ceiling getting resolved and deferred another 2years since it would effectively relieve the FOMC of concerns about hiking into a potential government shutdown/default.

I think it would be much too bold if not a mistake for the Fed to opt for a pause in June and the Jobs reports this week could seal it’s fate.

NEWSFLOW

MARKETS

• Big Tech Rally Will Only Grow Further as Recession Worries Reign, Investors Say — Survey shows quality stocks to offer highest returns in 2023, Apple among stocks surging on profitable growth bets (BBG). Citi Strategists Lift US Stocks on AI Appeal, Resilient Growth — Boost tech stocks to overweight, US shares to neutral, Recession now seen only by fourth quarter or even later (BBG). Friday Is Now an Options Feeding Frenzy as Big Tech Meets Zero-Day Options — Trading volume in call options spikes around weekly expiry, Retail’s activity shows close relationship to stock returns (BBG). Traders Are Duped by Bear-Market Rally, Morgan Stanley’s Wilson Says — ‘Second half going to be choppier and downward,’ he cautions, Strategist says increased liquidity is driver of stock gains (BBG). Goldman Says Stocks Risk ‘Elevator Down’ With Quants Near Max Long — Pain trade is stocks up on debt deal, then correction: Rubner, Pullback is bad news for hedge funds just warming up to stocks (BBG).
• Nvidia races towards $1tn club as AI frenzy drives chip stocks higher (FT). Nvidia chief Jensen Huang says AI is creating a ‘new computing era’ (FT). Nvidia’s Blowout Forecast Sparks Huge Rally in All Things AI — Other chipmakers and AI-related software stocks are climbing, Investors were looking for evidence AI boom is boosting sales (BBG). Nvidia Isn’t The Only One Getting a Massive AI Boost — Memory chips are in a slump. Thankfully, artificial intelligence has a huge appetite that will benefit the likes of Samsung, SK Hynix and Micron (BBG). Qualcomm Says AI Will Demand More Power Than Just the Cloud — Phones and mobile PCs have to be able to handle AI tasks, Tech firms pitching themselves as beneficiaries of AI shift (BBG). South Korea’s Naver to target foreign governments with latest ChatGPT-like AI model (FT). Google CEO: Building AI responsibly is the only race that really matters (FT). Intel Risks Being Left Behind as Nvidia Ups AI Lead — Intel’s chips are seen as ill-suited for AI’s tech needs, While Nvidia stock has soared 158% in 2023, Intel is up 3.3% (BBG).
• Bearish Oil Bets Slide After Saudis Tell Speculators to ‘Watch Out’ — Net-long Brent holdings see biggest gain in almost two months, OPEC+ coalition meets June 3–4 to discuss production policy (BBG).

US

• Investors expect higher interest rates as inflation pressures mount — Markets switch from betting on economic slowdown to expecting tighter policy for longer. Federal Reserve’s preferred measure of inflation overshot expectations in April, data published on Friday showed, while US consumer spending rose last month and new orders for long-lasting goods unexpectedly increased (FT). Soaring Real Yields Suggest Fed’s Inflation Battle Isn’t Over — Elevated inflation keeps Fed hikes in play for June and July, TIPS index heading for a loss in May as real yields surge (BBG). Major central banks were expected to pause rate hikes soon. Now it’s not so clear cut — Stronger-than-expected U.S. jobs figures and GDP data have highlighted a key risk to the U.S. Federal Reserve potentially taking its foot off the monetary brake; Economic resilience and persistent labor market tightness could exert upward pressure on wages and inflation, which is in danger of becoming entrenched (CNBC). Fed’s Bullard suggests higher rates as ‘insurance’ against inflation — Views from hawkish St Louis president reflect policy divisions inside the central bank (FT). Former Fed Chair Ben Bernanke says there’s more work ahead to control inflation (CNBC). Fed Traders Fully Price In an Interest-Rate Hike Once Again — Two-year yield rise above 4.5%, up for 10 straight sessions — June and July swaps show at least a quarter-point hike priced (BBG).
• Debt Ceiling Deal impact on US Economy — Congress will vote on the “Fiscal Responsibility Act” tomorrow, and the Senate probably by Friday. Austerity measures offset by other details. The tl;dr is that most of these restraints and measures were probably coming anyway through normal budget sausage-making, and won’t have a huge fiscal or economic impact (FT). Traders turn optimistic on debt ceiling deal — and one strategist says it’s a ‘market opportunity’ — RenMac suggests investors could look at buying Treasury bonds to “lock in some of those higher yields” (CNBC).
• Yield-hungry investors push US money market assets to record $5.4tn — Treasury department is expected to have to borrow roughly $750bn in Treasury bills in the four months after a deal, according to JPMorgan estimates. A wave of issuance like that would suck up liquidity in markets, potentially increasing strains on banks and lifting funding costs. But, money market funds, with high volumes of cash to deploy, could step in (FT). UBS Warns of Rising Loan Risks and Junk Bond Spread Widening — spreads widening for high yield later this year, but says markets are heading into credit tightening rather than a credit crunch (BBG). US credit squeeze triggers rise in corporate bankruptcies — Chapter 11 filings by indebted companies jump in May, including five during a 24-hour span (FT).

EUROPE

• UK shop price inflation rises to record high, industry data shows — Food cost growth eases slightly as lower energy costs filter through supply chains (FT). Gilt yields soar towards mini-Budget levels after inflation disappoints — Despite fall to single figures, April’s consumer price inflation of 8.7% is significantly above BoE’s forecast (FT). UK Energy Bills to Drop as Easing Gas Costs Finally Register (BBG). Energy bills unlikely to hit pre-crisis levels for 2 years, Britain’s regulator warns (FT). Inflation is hitting society’s most vulnerable families hardest — This cost of living crisis is not a sudden emergency, but the latest chapter in a longer-term story of rising poverty (FT). Jeremy Hunt backs more UK interest rate rises despite recession risk — Only Argentina and South Sudan experienced bigger increases in core inflation last month (FT).
• Fall in German GDP increases threat of sustained recession in EU’s largest economy — First-quarter decline, on weak consumer and industrial activity, is second consecutive contraction in output (FT). Europe’s green transition impossible without China, says Dutch minister (FT). Spanish Inflation Slows More Than Expected, Nears 2-Year Low — Consumer prices rose 2.9% from year ago in May; est. 3.3% (BBG).
• Sweden Risks More Turbulence on Property Market Woes, Watchdog Warns (BBG). Swedish Krona Weakness May Pose Serious Problem, Riksbank’s Jansson Says (BBG).

ASIA

• China’s Manufacturing Sector Improved in May, Surveys Show — China Beige Book says factory activity gained in the month, Goldman says emerging market PMI shows stabilization (BBG). Chinese companies still keen on US but face higher hurdles — Many groups want to open factories in America but geopolitical and local issues often prevent investment (FT). World’s Largest Solar Manufacturer Is Fueling a Price War — Longi Green Energy Technology Co. cut wafer prices by as much as 31% on Monday (BBG).
• Chinese Stocks in the US Are Lagging S&P 500 By Most Since 2021 (BBG). Miserable May Is Dashing Hopes for a Rebound in Chinese Stocks — Pessimism abounds as a sluggish economic recovery, weakening yuan and tensions with the US leave investors with little reason to buy. Some China bulls are now starting to retreat in frustration, trimming portfolio allocations and rotating to other markets as the next leg of the reopening rally remains elusive (BBG). ‘Confidence is a big problem’: China’s economic recovery loses steam — Weak property sales, industrial output and consumption sap confidence in rapid bounceback from Covid (FT).
• Speculators Boost Yen Shorts to Most in a Year as Currency Slips — Leveraged funds raised yen shorts to biggest since June: CFTC, Currency slides to weakest since November this month (BBG). Yen at 140 Opens Door to More Weakness But Not Intervention This Time — “The situation is different from last year, especially as the deficit now is much smaller, with the recovery of inbound tourism and trade account limiting the yen’s downside,” said Koji Fukaya, a fellow at Market Risk Advisory. There aren’t enough factors to send the yen beyond 145 and close to the 150 area, he said (BBG). BOJ to Build Case for Big Move in Latter Half of 2024, BE Says — Ueda seen re-embracing OCR, scrapping YCC in main scenario, BOJ to widen yield band or shorten maturity in risk view (BBG). SocGen Says Yen to Gain 7% in Near-Term on June BOJ Policy Shift — Yen can approach 130 per dollar on yield-curve control tweak, Buy USD/JPY digital puts ahead of BOJ, SocGen’s Korber says (BBG). Call to ‘Buy Japan’ is premature, say Bank of America analysts — BofA expects the Japanese yen to weaken further to 143 against the U.S. dollar by the third quarter of this year (CNBC).
• Australia’s Building Approvals Slump to Lowest Level in 11 Years (BBG). Australia Sees ‘Enormous Market’ for Its Battery Metals in US — US is most promising market for critical minerals: minister, IRA favors imports from countries with US FTA, like Australia (BBG).

EQUITIES

MSCI World indices are rather unconvincing for sustained upside.

Developed and Emerging market indices also lacking technically bullish conviction, although holding recent support levels.

NDX and TAIEX (with TSMC being over 25% of total market cap) are are around important fib levels and since what usually leads up tends to lead down, it should be worth paying close attention to these markets/sectors.

COMMODITIES

Unlike equities, Commodity markets have been sensitive to the weak economic data we’ve been seeing so far this month particularly out of China and Europe, as well as the big move higher in US yields and Dollar.

RATES

As of 5/26 (Orange), 5/19 (Purple), 4/28 (Green)

UST’s broadly been selling off this month seeing a 50bps+ move across the curve from the lows in the first week of May.

Yields have continued to rise over the past week but the move higher in breakevens has begun to stall.

More pertinent to the risk rally is the move in real yields — 2yr is the highest its been as far back as this data feed goes, while the 5 and 10yr real yield is about 25bps shy of the Q3'22 high. The Dollar has been listening, but Equities haven’t being distracted by the AI narrative.

CURRENCIES

G8 eq-wtd performance last week:
- USD +1.55%
- CHF +0.77%
- EUR +0.67%
- GBP +0.66%
- CAD +0.49%
- JPY -0.67%
- AUD -0.77%
- NZD -2.59%

USD strongest following the continued widening in rate differentials so far mtd and higher beta AUD and NZD the weakest. As I don’t see data trends drastically changing against the USD’s favour, I would expect this trend to continue especially if risk assets falls back in line to the usual cross-asset correlations.

TRADING VIEWS/IDEAS

• Long US, more specifically the USD — US data and it’s consumers are proving more resilient than in Europe and Asia, and while rate cut expectations are continuously pushed back on higher-for-longer narrative regaining traction, I expect USD outperformance to continue.

• Short Europe — a theme where I have relatively high conviction in these tricky markets, Citi Economic Surprise index for the Eurozone continues to head lower while Stoxx Cyclicals (Purple) and EURUSD (Green) are holding up reasonably well. The widening rate differentials and strengthening USD should keep a lid on any rallies and I think we are well past the peak in the consensus long Europe theme.
• Short Gold (as well as NDX) — Gold (and NDX) faces a few headwinds — recession bets and rate cut expectations continue to get pushed back; higher real yields, stronger USD, and some debt ceiling optimism means appeal for the non-yielding safe-haven is unlikely to find appeal anytime soon.

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