AI’s $500 Billion Hole
Executive Summary
July 8, 2024
• Big Picture: More of the same last week as mega-cap tech ripped higher each day at the market open, while the rest of the market lagged. The breadth divergences are at record extremes along with mega-cap tech concentration (which further implies record extremes in mega-cap tech outperformance). This week we will get the latest CPI report, which might finally give direction to the rest of the market. Will we see the laggards begin to rally or has their recent performance foreshadowed a breakdown?
• Composite Equity Relative Sentiment: Composite equity relative sentiment (CERS) held steady at 62% last week—a bullish reading. Since 1994, the market has annualized 21% with a Sharpe ratio greater than 1 when CERS has been between 60% and 80%.
• Investor-Class Equity Positioning: Due to the midweek holiday, the Commitments of Traders Report has been delayed until Monday. The previous report showed institutions had been selling equities again after a multi-week spate of buying.
• U.S. Equity Strategic Outlook: The 10-year annualized expected U.S. equity return fell to 0.5% last week (down from 0.7% the week prior)—380 basis points below the 10-year Treasury yield. Consequently, U.S. equities are not even remotely attractive from a long-term buy-and-hold perspective.
• Dollar Positioning: The most recent CoT report showed that while dollar relative sentiment was still bearish, it was just barely so. Thus, Monday’s report will let us know whether dollar relative sentiment will turn bullish this week. If so, that could have negative repercussions for risk assets (and may indicate the equity rally is nearing an end.)
• Gold Positioning: The most recent CoT report showed that institutions had taken a strongly bearish relative position (versus retail traders) in both gold and silver. As a result, the positioning environment for precious metals is likely to remain unfavorable for the next several weeks.
Market Commentary
Market Recap
We continue to be astounded by both the narrowness and vigor of the equity rally from the April lows.
Mega-cap tech continued its absolute dominance last week, with the Nasdaq 100 rising 3.6%. In concert, the S&P 500 was dragged higher to the tune of 1.9%. Both developed and emerging markets also rose nicely, with Japan up 2.5% and China notching a 1.7% gain.
Sector-wise, technology and consumer discretionary—bastions of mega-cap tech—led the way, while energy, materials, and industrials had modest losses.
Accordingly, both the Russell 2000 and the equal-weighted S&P continued to languish, with the former down 1% and the latter down 0.4%. These broader indices have been moving sideways or lower now for seven weeks.
The 4.60% weekly outperformance of the Nasdaq 100 vs. the Russell 2000 was the first time in over 24 years that one has outperformed the other by that much with the VIX at 12.
Further, the intraday (i.e., open-to-close) outperformance of the Nasdaq 100 vs. the Russell 2000 was greater than 100 basis points for four consecutive sessions—an event that had occurred only four times before in the prior 6063 trading days.
At times last week it looked like the Nasdaq and Russell had a correlation of -1. That is, it wasn’t a case of both indices rising, but one rising more. No, when one rose, the other fell, and vice versa.
Interestingly, while neither Asia nor Europe thought there was any reason to buy the Nasdaq 100 overnight on any day last week, as soon as the U.S. sessions opened, investors began to pounce as though they would never again be allowed to own the Mag7 if they didn’t buy right then and there. Look at this
step-function chart of the Nasdaq 100 last week.
This verticality was courtesy of the usual suspects: TSLA (27.1%), AAPL (7.5%), META (7.1%), GOOGL (4.6%), MSFT (4.6%), AMZN (3.5%), and NVDA (1.9%).
As an aside, we find it fascinating that trillion dollar companies, presumably scrutinized by the greatest number of investors— thus making them the most efficient markets—nevertheless move by hundreds of billions of dollars a day, every day, on no material news or headlines.
With respect to narrowness, the Nasdaq 100 has been making new highs for much of the past month while the number of new lows on the Nasdaq has been outstripping the number of new highs virtually every day.
Breadth has been so bad that despite the dollar (-1%) and interest rates both falling last week and crude oil rising (2%), energy stocks still managed to finish down 1%.
Likewise, silver, copper, and gold were all notably higher (7%, 6%, and 2.6%, respectively), yet materials stocks were down 0.5%. There appears to be no investor appetite for anything outside
of mega-cap tech. On the economic front, several PMI reports came out last week along with the non-farm payroll report. The former were generally weaker than expected—and economic surprises indices continue to hit multi-year lows—while the latter was “stronger” than expected. (But, of course, next month it will be revised lower as has nearly every jobs report the last three years.)
Next Week
Next week will be a live one.
Fed Chairman Powell will testify in front of Congress on Tuesday and Wednesday; CPI comes out on Thursday, and PPI on Friday. Treasury Secretary Yellen will also speak Tuesday; Wednesday brings a 10-year bond auction; and we’ll get a gaggle of Fed speakers throughout the week. The CPI report might be the catalyst that causes the broader market, which has been moving sideways for many weeks, to pick a direction.
Excluding mega-cap tech, recent broad market action (plus the behavior of the dollar, rates, and gold), has been indicative of a growth slowdown. A cooler than expected inflation report would likely lead to a
higher implied probability of the Fed cutting rates sooner—a positive for stocks. But such a report might also be viewed as a confirmation of a slowdown—a negative. As a result, how the market behaves post-CPI could be quite informative.
Investor Positioning
Composite equity relative sentiment (CERS) remains bullish at 62%. We will get a fresh Commitments of Traders (CoT) Report on Monday, but it’s unlikely it will have any near-term effect on CERS.
Monday’s CoT Report will also give us an update on dollar, gold, and long-duration bond positioning.
As of last week:
Dollar relative sentiment was bearish but on the precipice of turning bullish (if the Smart Money continued to buy).
Gold relative sentiment was the worst it had been in some time and strongly bearish—it would likely take several weeks of buying to turn it bullish again.
Long-duration bond relative sentiment turned bearish this week and that condition looks set to last for quite some time.