Monthly Archives: June 2022

Michigan Survey Shows Consumer Concerns

Over the past few months, we have witnessed a decided deterioration in consumer spending. For instance, first-quarter sales from many large retailers showed little to no growth. Economic data like Q1 GDP and the recent retail sales report further confirm that personal consumption is slowing. Last Friday, the University of Michigan Consumer Sentiment Survey followed suit as it was much weaker than expected. In particular, as shown below, the University of Michigan’s current economic conditions survey fell sharply and is not far from record lows. Current conditions are 62.5. That compares to a prior reading of 69.6. Furthermore, the expectation was for the index to increase to 72.2. According to the University of Michigan, the average since 1951 has been 95.31.

With the boost in pandemic-related savings largely depleted, credit usage soaring, and irregular post-pandemic consumption behaviors finally normalizing, consumers no longer have the means or desire to overspend. While one’s financial situation plays a vital role in spending, sentiment is also a function of politics and inflation. The rate of inflation has come down, but the price of goods is still rising—and, importantly, they remain well above what consumers are used to. Regarding politics, other surveys have shown significant differences between what Republicans and Democrats think on economic issues. Because the election is nearing, some of those surveyed by the University of Michigan may be swayed by their politics.

university of michigan consumer sentiment

What To Watch Today

Earnings

Earnings Calendar

Economy

Market Trading Update

As noted on Friday, market breadth remains weak even as the market continues to push higher. Furthermore, investors are now primarily going “all in” on Technology and selling everything else. This kind of behavior has historically ended poorly, but irrational behavior can last much longer than logic predicts.

The economic data shows signs of weakness, which will likely feed into the Fed’s outlook for rate cuts over the next few months. While the market remains oblivious to the diversion between economic realities and Wall Street exuberance, such will eventually reconnect. However, for now, as we enter a new trading week, there is little standing in the way of the bulls momentarily. The market remains on a buy signal, and while short-term overbought, corrections should be contained by the 20-DMA. For investors, adding risk exposure on dips remains a logical strategy. However, that will eventually change.

Market Trading Update

The Week Ahead

Retail sales kick off the economic calendar on Tuesday. As we led this commentary, will it show that consumers are retrenching? The current estimate is for a gain of 0.3% versus 0.0% last month. Building permits and housing starts will likely show that new construction of homes and multifamily properties is slowing rapidly. The graph below shows that housing starts have been trending lower for two years and are back to the peak of the pre-pandemic era. Building permits are now slightly below the 2019 highs.

With the FOMC meeting past, Fed members will be on the speaking circuit. It will be interesting to hear their views on recent data and if they are reconsidering the potential for a rate cut in July.

Many companies will enter buyback blackout windows as we are about a month away from Q2 earnings reports.

housing starts

Macron’s Gamble Is Blowing Up Alongside French Markets

After Marine Le Pen and other right-wing parties pulled off stunning and decisive victories in the European Union elections a week ago, French President Emmanuel Macron made a bold political gamble. He dissolved France’s National Assembly and held snap elections. With the first round of voting occurring in only three weeks, he didn’t think there was enough time for his opponents to form alliances. Hence, they would struggle to win enough votes to advance to the July 7th runoff election. His plan, if successful, helps him secure the backing of a large block of voters in the National Assembly. It appears his plan is backfiring.

The most recent polls show Le Pen could garner about 270 seats in the 577-seat National Assembly. That would make Le Pen’s party, the National Rally, the biggest party in the lower chamber. Furthermore, it gives Le Pen a decent chance to become the next President in 2027 when Macron’s term ends and term limits preclude him from running again. Markets are uneasy with Le Pen’s victory. While Macron vows to hold on to his seat, markets are betting that his powers will be much more limited.

The first graph below, courtesy of SimpleVisor, shares information on EWQ, the U.S. ETF representing the primary French stock index, the CAC 40. It has fallen by about 8% in the last week while the S&P 500 continues to rally. The second graph shows that the yield on French bonds recently rose about 30bps versus German bonds. Lastly, as a result of right-wing gains in France and Germany, volatility in many European stock markets is increasing.

french cac40 EWQ simplevisor

german vs french bond yield spreads
euro vs us volatility france

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Sentimentrader Highlights Bad Market Breadth

Bad market breadth seems to be a hallmark of the rally off of the 2022 lows. Simply, very few stocks are leading markets higher, while many stocks languish. Consider that the equal-weighted S&P 500 index (RSP) is up 3.70% since the start of the year. Over the same period, the market-weighted S&P 500 (SPY) is up over 14%. Just Nvidia has contributed more to the market-weighted S&P 500 than the entire RSP gain for the year. With that in mind, consider the graph below from Sentimentrader. It shows the S&P 500 is hitting new highs, but three important breadth indicators are troublesome.

Per Sentimentrader:

  • More NYSE issues are hitting 52-week lows than highs
  • More NYSE issues are declining than advancing
  • and More NYSE volume is flowing into losers than winners

This confluence of negative indicators with the market at new highs is rare. Per Sentimentrader’s graph, it has occurred four times, including today, since 1965. In 1995, the market surged despite the warning. It was again triggered multiple times in 1999, which was followed by a significant decline. Similarly, the signal in late 2021 was followed by a moderate drawdown in 2022. The new Sentimentrader signal could be a false alarm like in 1995. However, it might be a more immediate warning that the market is heading lower. Given the market breadth and large deviations from key moving averages, we are paying close attention to our technical indicators and will act if necessary. For more information on Sentimentrader’s services, please click HERE.

sentimentrader bad breadth

What To Watch Today

Earnings

  • No notable earnings reports

Economy

Earnings Calendar

Market Trading Update

In yesterday’s market update, we touched on the negative divergences in the market and the poor breadth of the advance. Due to that lack of breadth, combined with a more overbought condition, we noted that the upside may be somewhat limited in the near term until a correction or consolidation occurs. Yesterday, despite a much cooler PPI report, stocks sold off mid-day, although they recovered somewhat into the afternoon. Furthermore, as shown in the heat map below, winners were sparse, with Nvidia and Tesla doing most of the work on the market capitalization-weighted index.

Furthermore, the weaker-than-expected inflation reports and strong bond auctions sent bonds higher. Bond prices have cleared all the major moving averages, are on a buy signal, and successfully retested the breakout of the downtrend from the beginning of the year.

From a technical perspective, bonds appear to have gained some traction on several fronts, and a retracement to the highs from the beginning of the year seems reasonable. While rates are set up for a decent trade, we have not reached the point where the fundamentals support a substantial move higher. For that, it will likely take weaker economic growth into the 2nd half of this year, a further decline in inflation, and the Fed cutting rates.

We will get there. It will most likely be later this year or early next year.

Helping Powell Appreciate Poor Consumer Sentiment

At the FOMC press conference on Wednesday, Jerome Powell stated:

“I don’t think anyone…has a definitive answer why people are not as happy about the economy as they might be.”

He went on to say that the unemployment rate is near record lows. Essentially, he presumes that because most people have jobs, they should be happy with the economy. Apparently, Jerome Powell doesn’t go shopping. The graph below shows the CPI price index for white bread and the annual percentage price change for white bread. In Jerome Powell’s economist mindset, he will tell you that the price of white bread per pound has risen 1.03% over the last year. In his mind, that is a reason for optimism, as white bread inflation is below his 2% inflation objective.

On the other hand, the consumer sees that white bread now costs $1.97 a pound, much higher than the $1.37 a pound before the pandemic. The data in the graph is the same, but the way of looking at it is starkly different. This explains why people have a very different opinion of the economy than Powell expects they should have.

cpi white bread powell

Furthermore

The Rise of Technology

The chart below shows how the mix of sectors within the S&P 500 and the economy as a whole has changed drastically since 1980. When comparing today to 1980, the most notable change is the decline of manufacturing and the increase in innovation. Appreciating this massive shift in the economic structure of the market and the economy helps us understand why valuations have increased over the last forty years. Innovation stocks, predominately residing in the technology sector, tend to be in high-growth situations. As such, they trade with high valuations as investors, and the companies will grow at above-market rates. Manufacturing tends to grow more in line with the economy. Therefore, many of these companies have lower valuations. More innovation and less manufacturing equals higher valuations.

s&p 500 sectors innovation technology manufacturing

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Grant: Rates Are Going Much Higher. Is He Right?

Recently, James Grant, editor of the Interest Rate Observer, was asked about his outlook for interest rates. He sees interest rates moving in a cyclical pattern, potentially rising for another multi-decade period. Grant bases his view on historical observations rather than a mystical belief in cycles. He states that finance has shown a cyclical nature, moving from extremes of euphoria to revulsion in various asset classes. Therefore, he proposes that persistent inflation, increased military spending, and significant fiscal deficits could drive rates higher. The Fed’s target of a 2% inflation rate and the electorate’s preference for policies that lead to inflation also contribute to this trend.

Let me state that I have a tremendous amount of respect for Grant and his work. However, I can’t entirely agree with his view. I will focus today’s discussion on the outlook for interest rates based on the two bolded sentences above.

The chart below shows the long-term view of short and long-bond interest rates, inflation, and GDP. As Grant notes, there is a cycle to interest rates previously.

Interest rates rose during three previous periods in history.

  1. During the economic/inflationary spike in the early 1860s
  2. The “Golden Age” from 1900-1929 saw inflation rise as economic growth resulted from the Industrial Revolution.
  3. The most recent period was the prolonged manufacturing cycle in the 1950s and 1960s. That cycle followed the end of WWII when the U.S. was the global manufacturing epicenter.

Remembering History

However, while interest rates fell during the Depression, economic growth and inflationary pressures remained robust. Such was due to the very lopsided nature of the economy at that time. Like the current economic cycle, the wealthy prospered while the middle class suffered. Therefore, money did not flow through the system, leading to a decline in monetary velocity.

The 1950s and 60s are the most important.

Following World War II, America became the “last man standing.” France, England, Russia, Germany, Poland, Japan, and others were devastated, with little ability to produce for themselves. America found its most substantial economic growth as the “boys of war” returned home to start rebuilding a war-ravaged globe.

But that was just the start of it.

In the late ’50s, America stepped into the abyss as humankind took its first steps into space. The space race, which lasted nearly two decades, led to leaps in innovation and technology that paved the way for America’s future.

These advances, combined with the industrial and manufacturing backdrop, fostered high levels of economic growth, increased savings rates, and capital investment, which supported higher interest rates.

Furthermore, the Government ran NO deficit, and household debt to net worth was about 60%. So, while inflation increased and interest rates rose in tandem, the average household could sustain its living standard. 

So, why is this bit of history so important to the outlook of interest rates,

What Drives Interest Rates

Grant suggests that interest rates will rise because they have been low for so long. That is akin to saying that since the Atlanta Falcons have not won a Super Bowl in the last 58 years, they should now win it every year for the next 58 years. What drives the Atlanta Falcons to win a Super Bowl are the ingredients to lead to a great team, not just the fact that they have never won one. The same goes for interest rates.

Interest rates are a function of the general trend of economic growth and inflation. More robust growth and inflation rates allow lenders to charge higher borrowing costs within the economy. Such is also why bonds can’t be overvalued. To wit:

“Unlike stocks, bonds have a finite value. The principal and final interest payments are returned to the lender at maturity. Therefore, bond buyers know the price they pay today for the return they will get tomorrow. Unlike an equity buyer taking on investment risk, a bond buyer loans money to another entity for a specific period. Therefore, the interest rate takes into account several substantial risks:”

  • Default risk
  • Rate risk
  • Inflation risk
  • Opportunity risk
  • Economic growth risk

Since the future return of any bond, on the date of purchase, is calculable to the 1/100th of a cent, a bond buyer will not pay a price that yields a negative return in the future. (This assumes a holding period until maturity. One might purchase a negative yield on a trading basis if expectations are benchmark rates will decline further.) “

The chart below shows the correlation between economic growth, inflation, and interest rates. Unsurprisingly, interest rates rise when economic growth increases, leading to more demand for credit. Inflation rises with economic activity as the supply/demand imbalance increases prices. That is basic economics.

The chart above shows a lot going on, so let’s create a composite index of wages (which provides consumer purchasing power, aka demand), economic growth (the result of production and consumption), and inflation (the byproduct of increased demand from rising economic activity). We then compare that composite index to interest rates. Unsurprisingly, there is a high correlation between economic activity, inflation, and interest rates as rates respond to the drivers of inflation.

Grant further suggests that interest rates will be higher due to increased debt and deficits. Unfortunately, there is no evidence supporting that hypothesis.

The Deficit Fallacy

As shown below, the 10-year economic growth average correlates with interest rates. When economic growth rises, lenders can charge higher interest rates.

What should immediately jump out at you is that the 10-year average economic growth rate was around 8%, except for the Great Depression era, from 1900 through 1980. However, there has been a marked decline in economic growth since then. (The current spike in interest rates is a function of the artificial stimulus injected into the economy, which is now reversing.)

Increases in the national debt squandered on non-productive investments and rising debt service results in a negative return on investment. Therefore, the larger the debt balance, the more economically destructive it is by diverting increasing amounts of dollars from productive assets to debt service.

Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. What should be evident is that increases in debt and deficits continue to divert more tax dollars away from productive investments into the service of debt and social welfare. The result is lower, not higher, economic growth, inflation, and, ultimately, interest rates.

When put into perspective, one can understand the more significant problem plaguing economic growth. A long look at history clearly shows the negative impact of debt on economic growth.

Furthermore, changes in structural employment, demographics, and deflationary pressures derived from changes in productivity will magnify these problems.

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Inflation Wasn’t Just The 1970s

While many focus on the inflation surge during the late 1970s, as noted above, the entire period from the 1950s through 1980 was marked by rising interest rates and inflation due to a more robust economic growth cycle.

Like today, the Fed was hiking rates to quell inflationary pressures from exogenous factors. In the late 70s, the oil crisis led to inflationary pressures as oil prices fed through a manufacturing-intensive economy. Today, inflation resulted from monetary interventions that created demand against a supply-constrained economy.

Such is a critical point.

During “That 70s Show,” the economy was primarily manufacturing-based, providing a high multiplier effect on economic growth. Today, the mix has reversed, with services making up the bulk of economic activity. While services are essential, they have an extremely low multiplier effect on economic activity.

One primary reason is that services require lower wage growth than manufacturing. Inflation rose in the 1970s due to a steady trend of increasing wages, which created more economic demand. Outside of the artificial spike in demand from government stimulus in 2020, the longer-term trend of wage growth, and ultimately inflation, is lower as wage growth remains suppressed.

Wages come from the type of employment. Full-time employment provides higher salaries to support economic growth. Unfortunately, full-time employment as a percentage of the working-age population has declined since the turn of the century. Such is due to increased productivity levels through technology, offshoring, and immigration. The byproduct of fewer full-time employees is lower consumption and lower rates of economic growth.

Today’s economic environment vastly differs from the economic boom years of the 1970s. Rising debt levels, increased deficits, productivity, and wage suppression erode economic growth, not support it. Therefore, while Grant makes the case for higher interest rates for “much, much longer,” the economic evidence does not support that thesis.

Conclusion

However, even if Grant is correct and increasing debt levels and deficits do cause higher rates, central banks will take actions to artificially lower rates.

At 4% on 10-year Treasury bonds, borrowing costs remain relatively low from a historical perspective. However, we still see signs of economic deterioration and negative consumer impacts even at that rate. When the economy’s leverage ratio is nearly 5:1, 5% to 6% rates are an entirely different matter.

  • Interest payments on the Government debt increase, requiring further deficit spending.
  • The housing market will decline. People buy payments, not houses, and rising rates mean higher payments.
  • Higher interest rates will increase borrowing costs, which leads to lower profit margins for corporations. 
  • There is a negative impact on the massive derivatives market, leading to another potential credit crisis as interest rate spread derivatives go bust.
  • As rates increase, so do the variable interest payments on credit cards. Such will lead to a contraction in disposable income and rising defaults. 
  • Rising rates negatively impact banks, as higher rates impair the banks’ collateral, leading to bank failures.

I could go on, but you get the idea.

Therefore, as debt and deficits increase, Central Banks are forced to suppress interest rates to keep borrowing costs down and sustain weak economic growth rates.

The problem with Grant’s assumption that rates MUST go higher is three-fold:

  1. All interest rates are relative. The assumption that rates in the U.S. are about to spike higher is likely wrong. Higher yields on U.S. debt attract flows of capital from countries with low to negative yields, pushing rates lower in the U.S. Given the current push by Central Banks globally to suppress interest rates to keep nascent economic growth going, an eventual zero-yield on U.S. debt is not unrealistic.
  2. The budget deficit balloon. Given Washington’s lack of fiscal policy controls and promises of continued largesse, the budget deficit is set to swell above $2 Trillion in coming years. This will require more government bond issuance to fund future expenditures, which will be magnified during the next recessionary spat as tax revenue falls.
  3. Central Banks will continue to buy bonds to maintain the current status quo but will become more aggressive buyers during the next recession. The Fed’s next QE program to offset the next economic downturn will likely be $4 trillion or more, pushing the 10-year yield toward zero.

If you need a road map of how this ends with lower rates, look at Japan.

Historical evidence suggests that interest rates will be lower, not higher, unless the Government embarks on a massive infrastructure development program. Such would potentially revitalize the American economy and lead to higher rates, stronger wages, and a prosperous society.

However, outside of that, the path of interest rates in the future remains lower.

The CPI Report Supports Rate Cuts Later This Year

The Fed got good news yesterday, with the headline CPI coming in at 0% for the month. More importantly, core CPI rose by +.16% versus expectations of +.30%. That brings the year-over-year core CPI rate to 3.4%, a tenth below expectations. Excluding shelter costs, accounting for 40% of CPI, core CPI, also called “super core,” was down for the month. This is the first decline since September 2021. This is important because CPI shelter costs should decrease in the coming months. Thus, “super core” could push further into deflationary territory. The graph below shows that CPI rents, a large component of shelter costs, lag changes in current rental costs. For almost a year, actual rent cost changes have hovered near zero percent. Inflation will likely approach the Fed’s 2% target when the CPI shelter costs catch up with actual data.

In our opinion, it’s a matter of when, not if, shelter prices normalize. Therefore, it’s likely that when the CPI shelter normalizes, the Fed will be more comfortable with inflation trends, allowing it to cut the Fed Funds rate. The December Fed Funds contract jumped by 12 bps on the CPI number, thus implying that investors added an additional 50% chance of a rate cut by year-end. With the market reaction, Fed Funds futures now imply two rate cuts by year-end. As we share below, the Fed projects only one rate cut by year-end.


What To Watch Today

Earnings

Economy

Market Trading Update

As noted yesterday, the market has been waiting on the inflation data and the Fed meeting. With inflation coming in cooler than expected and the Fed still on track to cut rates, the market closed higher yesterday. Bonds also rallied sharply, and rates fell.

The bullish underpinnings have weakened while the market continues to set new highs. Breadth has narrowed, and the negative divergence of the advance-decline line to the market has previously warned of a potential overshoot by overly zealous investors.

Speaking of negative divergences, the market has also been rising against a decline in the relative strength index and the MACD. As shown, these negative divergences often suggest that the market’s internals are weaker than the index may suggest.

For now, the 20-DMA continues to act as initial support, but the growing divergence between the market and the 50-DMA is reaching levels that have previously preceded a short-term correction. That deviation, combined with the negative divergences, suggests that investors be a little more cautious with risk exposure in the near term. While nothing suggests that a correction of magnitude is in the offing, a pullback to the 20- and 50-DMA is quite likely in the near term.

Trade accordingly.

The FOMC Meeting Recap

The market was not expecting much in the way of surprises from the FOMC minutes, and the Fed lived up to expectations. However, the quarterly economic projections of the Fed members were a little more hawkish than expected. As we circle below, they increased their core PCE inflation forecast from 2.6% to 2.8% for year-end. Accordingly, they reduced the number of Fed Funds rate cuts to one from three last March.

While their projections seem hawkish, a slight tweak in the statement’s language suggests a dovish tilt. The May minutes say, “In recent months, there has been a lack of further progress toward the Committee’s 2% inflation objective.” The latest minutes state, “In recent months, there has been modest further progress toward the Committee’s 2% inflation objective.

fed fomc economic projections

The following comments are from Jerome Powell’s press conference following the release of the minutes and economic projections:

  • The Fed is prepared to respond if unemployment rises quicker than expected or prices fall faster than expected.
  • Two or three more CPI readings like yesterday’s could lead to a September cut.
  • Powell stressed numerous times that their decisions are data-dependent, and they do not confidently hold their projections. “Do we have high confidence in forecasts? No, we don’t.” He also mentioned they made their projections prior to knowing the data within the CPI report.
  • Powell acknowledged the argument that the strength in job creation (non-farm payrolls) “may be a bit overstated.”
  • post-pandemic normalization of the labor market has now run its course.”
  • Rates are less likely to go down to pre-pandemic levels.” But, “we do not know that.”

Market Cap Distortion On Display

On Tuesday, the S&P 500 rose by 0.25% on the back of Apple’s 7% gain, while the equal weight S&P 500 index (RSP) fell by -0.45%. This familiar story of a few stocks driving the market has been happening for over six months. Statistically, as we show below courtesy of Tier1 Alpha, the 3-month rolling correlation between the market cap-weighted and equal-weighted S&P 500 is at a three-decade low.

The second graph shows the price of the two indexes (SPY/RSP). As shown, it has risen by about 30%. In other words, an equal investment in all 500 S&P stocks would have underperformed the index by 30%. How long can such outperformance continue? With 28% of the S&P market cap concentrated in five stocks (MSFT 7.05%, NVDA 6.68%, AAPL 6.21%, GOOG 4.22%, and AMZN 3.79%), the more direct question is how long can those five stocks or a subset of them continue to grossly beat the markets?

s&p 500 and Equal weight rsp correlation, market cap distortion
spy vs rsp

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Energy Prices Drive The Fed Despite What They Say

The Fed often stresses that it prefers core inflation measures, which exclude food and energy prices. They do this for a few reasons. First, food and energy tend to be more volatile than most other goods. Accordingly, they can distort the broader price trends. Second, food and energy prices are affected by many variables, many of which the Fed is unable to manage. Lastly, the Fed believes core inflation is a better predictive measure of inflation.  

So, while the Fed prefers to ignore food and energy prices, they also heavily rely on energy prices, albeit indirectly. Jerome Powell and other Fed members have emphasized that inflation expectations are very important to follow as they influence inflation. The problem with the Fed’s logic is that energy prices greatly sway inflation expectations. The graph on the left shows crude oil and 1-year inflation expectations. As shown, they track each other closely. We share the same data in a scatter plot to the right to highlight the relationship further. The R-squared (.57) is statistically significant.

Bottom line: energy is used to manufacture, produce, and ship a wide range of goods. While the Fed may want to ignore energy prices, they are too important to the economy, the prices of other goods, and our inflation expectations to dismiss.

energy and inflation expectations

What To Watch Today

Earnings

Economy

Market Trading Update

In yesterday’s commentary, we discussed the decline in oil prices and how, from a trading perspective, this sets up a decent opportunity for an energy trade. Adding to that thesis were two other points for why we added to our position in Diamondback Energy (FANG) in our equity portfolio yesterday.

The first is that speculative trading accounts sharply reduced their bets on oil. The recent sharp liquidation of those contracts provides the fuel for a reversal trade.

Secondly, over the last 10 weeks, energy has been corrected from being overbought to being oversold on a relative and absolute performance basis.

While this does not mean that energy stocks are about to explode higher, the data does suggest that a tradable opportunity is present over the next few months. Such is particularly true as we enter peak driving and hurricane season, where potential demand and drilling disruptions could increase prices.

New Fed Dot Plots Today

Part of today’s FOMC announcement will include the revised economic projections, aka dot plots. The table below shows the projections from March. Revisions to the unemployment rate and GDP will shed light on how their views may have changed over the past three months due to some weaker-than-expected economic data. Projections for Core PCE were increased by 0.2% at the March meeting. If they lower it back down, it will infer confidence that inflation is falling again after having stalled.

Lastly, and certainly most important for investors, is the Fed’s outlook on the Fed Funds rate. In March, they thought they could reduce Fed Funds by .75% by year-end. The Fed Funds market implies equal odds of 25 or 50 bps in cuts by year-end. We suspect the Fed will gravitate toward the market’s view. The Fed will probably want to avoid adjusting rates at the September meeting because it’s an election year. Furthermore, July may be too early for a cut unless inflation declines more than expected. If we assume they skip the next two meetings, that only leaves two more meetings before the year’s end.

fed dot plot economic projections

The Bogus Gas Price Narrative

Given our opening paragraphs about the connection between energy prices and inflation expectations and how the Fed may proceed with monetary policy, it’s worth debunking a narrative. As much as you keep hearing, gas prices are not spiking. Yes, they have been up over 10% for the year to date. However, gas prices tend to follow a seasonal pattern, increasing into the summer driving season and then giving up those price increases in the year’s second half.

The graph below charts the average weekly year-to-date change in gas prices from 2005 to 2023 and compares it to the change in gas prices this year. As shown, gas prices rose more than the average in the first fifteen weeks of 2024. However, that reversed sharply. The current year-to-date change is now about 10% less than is typical for this time of the year. Gasoline prices are volatile, so we should be careful not to read too much into this graph. But, the narrative that high gas prices are a reason to suspect inflation is rising is false.

year to date gas price changes

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Golf and Investing: Mastering Long and Short Games For Success

Let’s play a hole of golf to appreciate how two distinct aspects of golf provide valuable lessons for investors.

You tee off with a driver on a 450-yard par four hole. Your drive is perfect. Not only does the ball land in the middle of the fairway, but you only have 200 yards remaining to the pin. Next, you pull out an iron, hit a beautiful shot, and the ball bounces onto the putting green. With only 40 feet between the ball and the pin and over 95% of the hole behind you, you think a birdie is possible, and in the worst case, you can get a par.

Your birdie putt misses by 10 feet. You come up just short on the next putt, and your confidence turns to angst. Finally, the third putt rattles into the cup, scoring a disappointing bogey.

Your long and straight 250-yard drive counts precisely as the 3-foot short putt you missed for par. Similarly, an investment idea backed by a well-thought-out macro thesis is only as good as adequately navigating the many short-term factors that can threaten investment performance.  

Investing’s Long Game

The long game involves forming expectations of economic growth and how revenues and earnings for sectors and industries may change with the economy as it cycles through your big-picture thesis. More simply, the long game is investing based on a macroeconomic outlook.

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Macroeconomic Analysis

Macroeconomic analysis studies the behavior and performance of a country’s economy and its interaction with the global economy. It focuses on broad aggregate variables, including existing economic trends, business cycles, productivity, demographics, geopolitics, governments/central banks, credit, and technological change. 

An increasingly important part of macroeconomic analysis is assessing how fiscal and monetary policies might affect economic growth and price trends.

As we have recently witnessed, fiscal spending can have a massive impact on economic activity and inflation. However, as we may find out, it can also be a drag on economic activity in future years. Similarly, a central bank’s monetary policy, including how it manages interest rates and asset holdings, often dictates liquidity and financial conditions, significantly influencing asset markets and the economy.

International trade and finance, including geopolitics, can play noteworthy roles in macroeconomic analysis. This incorporates trade balances and exchange rates, which are predicated on interest rates and inflation. Other factors include competitiveness, foreign relationships, and foreign investor cash flows.

While longer-term views on the factors we note are critically important, we must also appreciate shorter periods in which our long-term thesis may seem out of favor. Importantly, we must assess whether aberrations to longer trends are short-term or new trends being established.

Similar to golf, an excellent long investing game is crucial to understanding the economic path that directly feeds corporate earnings and consumer and government spending behaviors. Think of the long game as a road map, and your goal is to get from point A to point B. Therefore, assessing the most efficient route is your paramount task.

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Investing’s Short Game

As we now discuss, an investor’s short game is equally important. These are the inevitable traffic jams, accidents, and weather conditions that will force you to stray from the long game.

Investing’s short game includes market conditions, narratives, personal biases, behavioral traits, liquidity, and other factors that briefly influence asset prices away from longer-term trends.

Even if you have an outstanding macroeconomic outlook, ignoring the short game, like being a lousy putter in golf, virtually ensures a bogey or worse on your investment performance.  

Biases and Behaviors

We have written numerous articles on our inherent biases and behavioral traits. For example, our latest on the topic, Behavioral Traits That Are Killing Your Portfolio Returns, reviews five traits that often hurt investors’ performance. We share a summary below, along with a bit of advice.

Confirmation Bias: favoring information that affirms your beliefs. Therefore, read investment advice that goes against your views and may be uncomfortable. It will strengthen your convictions or help you appreciate where your thesis may prove wrong.

Gamblers Fallacy: believing that future outcomes will follow prior outcomes. Today’s hot assets are often laggards tomorrow. While tracking and investing in today’s popular stocks is worthy, keep an open mind that some other stock or asset will likely be tomorrow’s winner.

Herd Bias: doing what everyone else is doing. The thought process is rooted in the belief that if “everyone else” is doing something, I must do it to be accepted. As we wrote in Behavioral Traits:

Investors generate the most profits in the long term by moving against the “herd.” Unfortunately, most individuals have difficulty knowing when to “bet” against the stampede.

Trading with the “herd” can be profitable at times. However, we must understand the inherent flaws in group logic and always appreciate the contrarian opinion.

The table below provides a few more examples.

bias and behaviors

Technical Analysis

Technical analysis is one of the best clubs in our short-game bag. While it can be inconsistent, as with every other forecasting model, it is the best tool for quantifying investors’ collective behaviors. Historical price and volume data provide a critical context for various price levels likely to motivate buyers and sellers.

Technical analysis helps detect trend changes. Like reading a putt, technical analysis can help us grasp the risks and rewards a market offers. Furthermore, it can provide price levels with which to buy or sell. In turn, limits allow us to separate our trading actions from our behavioral traits.

Liquidity Drivers/Fed

Financial market liquidity is impossible to quantify, even though investors throw the word around like it’s a known commodity. Liquidity refers to the funds available for investors to invest. When liquidity is plentiful, investors tend to take more risk. Conversely, when liquidity is lacking, investors are often risk-averse.

While liquidity is often considered part and parcel with actual investible dollars available, it’s more a function of investors’ cumulative actions. For instance, the Fed supplied the market with ample liquidity in late 2008, but a meaningful fear of significant bank failures crippled many investors. Sellers were plentiful, and buyers were hard to find. Liquidity was poor. The result was a sharp drawdown in equity prices with high volatility.

The Fed supplies monetary liquidity to the banking system through interest rate policy and its balance sheet. Furthermore, as their role seemingly becomes more dominant with time, their actions become more impactful to markets. Consequently, as we see today, the stock market rallies as prospects of the Fed providing more liquidity via lower interest rates.

Domestic and Global Events

War, weather events, terrorism, political instability, and other local or global events can move markets. Quite often, event-driven trends are short-lived. During event-related volatile periods, investors should try to remain cool and calm. It’s easy to sell into a fear-laced narrative. It’s much harder to buy in such an environment. To quote Warren Buffett:

Be fearful when others are greedy and be greedy only when others are fearful.

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Summary

A well-thought-out long-game thesis can stay intact for long periods with slight adjustments when needed. Like a long and straight drive in golf, when your macroeconomic thesis proves correct, a good portion of your investing job is done.

But, like golf, letting your irrational behaviors control your investment acumen, not appreciating that markets are sometimes foolish, or misdiagnosing what the Fed is doing can devastate shorter- and longer-term results.

Do not forget the two-foot putt counts the same as a daunting drive off the tee box.

Degen Traders Are Taking Storm Of The Markets

Degen traders, short for degenerates, are taking storm of the markets. The Wall Street Journal recently published Meet The Degen Traders Fueling The Latest Meme-Stock Mania. The article introduces its readers to a new type of investor creating incredible volatility in a handful of stocks and cryptocurrencies. Per the article: “Degens are gamblers, not traders or investors. Fundamentals are not a concern for Degens. Instead, they seek excitement.

Degens largely day trade. Furthermore, they have become adept at trading same-day expiration options (0DTE – see Tweet of the Day). We believe 0DTE trades are akin to playing roulette or flipping a coin. Similarly, penny stocks are in vogue with the Degen crowd. The seeming leader of the Degen movement is Keith Gill, aka Roaring Kitty. Through tweets and Reddit posts, Roaring Kitty has single-handedly caused stocks to more than double in minutes. His latest foray is in GameStop shares. As the SimpleVisor graphic below shows, its stock (green) has seen massive volatility. In comparison, the S&P 500 (gray) looks like a flat line.

The ending quote from the article summarizes the story well: “It ends up shaping your way of seeing things. You’re not looking at things as financial instruments anymore,” she said. “You’re just absorbed into this micro-culture.” Our take: unlike most investors, Degens’ are not evaluating stocks based on the potential future earnings of the corporation. Instead, they view it like sports gambling. While Degens can warp the value of stocks for short periods, we believe fundamental investors will take advantage of such opportunities to short said stocks and bring them back toward their fair value.

gme gamestop

What To Watch Today

Earnings

Economy

Market Trading Update

As discussed yesterday, the markets are in a holding pattern ahead of this week’s CPI inflation report and the June FOMC meeting. However, today, the market will focus on the latest OPEC report to assess the next moves in the oil market. After the post-pandemic run-up, the Ukraine war, and unrest in the Middle East, Wall Street was expecting oil prices to soar above $150/bbl. However, as is almost always the case, those exuberant estimates rarely come to fruition.

Since April 2022, oil prices have steadily declined and are flirting with support around $70/bbl. That level is high enough to encourage producers to drill but not enough to impede the economy grossly.

Unsurprisingly, given the input cost of oil to energy companies, there is a high correlation between the Energy Sector ETF (XLE) and oil prices.

From a trading perspective, we remain long our energy holdings, after having taken profits in them early this year, and are looking for a reversal in oil prices to signal the next entry point. With Hurricane season fast approaching, we may get another short-term trading opportunity in the next couple of months.

Market Breadth Is Poor As Nvdia Drives The S&P 500

Nvidia, up 35% last month, has become the second-largest stock in the S&P 500, overtaking Apple last week. As such, its contribution to the index grows. This week’s SimpleVisor sector analysis shows that while the S&P 500 rose 1% last week and 2.5% over the previous month, the underlying sectors are not keeping up. The absolute scores also confirm this. Other than XLC (.54), SPY is more overbought than every other sector. Simply, Nvidia and a small handful of other stocks are leading the markets.

The energy sector remains the weakest on an absolute and relative basis. The second graphic below highlights the sector’s top ten holdings and their relative scores versus each other and the XLE sector ETF. We circle Williams (WMB) as it is overbought versus every other energy stock and the sector ETF. The third graph shows the price ratio of WMB to XLE is very extended and has just triggered a sell signal on our proprietary model. Mind you, the sell signal is on the price ratio. This implies that XLE will outperform WMB over the coming weeks, but not necessarily that WMB shares will fall.

simplevisor sector analysis
wmb energy sector
wmb vs xle

Japan Takes Another Economic Step Backwards

The good news for Japan is that its GDP has been revised higher. However, the revision brought it from -2% to -1.8%. Interestingly, the negative growth occurs when its central bank (BOJ) is removing stimulus. The BOJ just raised its benchmark rate for the first time since 2007 and is discussing curbing its bond purchases. This comes at a time when the ECB and Bank of Canada cut rates for the first time since the pandemic. Further, the Fed is reducing the amount of monthly QT, and it is widely expected the Fed’s next move will be a rate reduction.

The yen has traded poorly, as its interest rates are much lower than most developed economies. The graph below shows the yen sits at its lowest level in at least 30 years. If the Bank of Japan does indeed reduce bond purchases and allows rates to move higher, the Fed cuts rates later this year, and other banks follow with similar rate cuts, the yen may finally catch a bid. For now, betting on the yen is like trying to catch a falling knife. However, if the BOJ can revive growth and its interest rates become more in line with those of other nations, the yen may be a good investment at some point in the next six months to a year.

jpy rates bank of japan

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It’s Not 2000. But There Are Similarities.

More than a few individuals were active in the markets in 1999-2000, but many participants today were not. I remember looking at charts and writing about the craziness in markets as the fears of “Y2K” and the boom of “internet” filled media headlines. It was quite the dichotomy. On one hand, it was feared that the turn of the century would “break the computer age,” as computers could not handle the date change to 2000. However, at the same moment, the internet would turbocharge the world with massive productivity increases.

Back then, the S&P 500, particularly the Nasdaq, rallied harder each day than the last. Market breadth looked pretty weak, as the big names were soaring, forcing indexers and ETFs to buy them to keep their weightings. The reinforcing positive feedback cycle fueled markets higher day after day.

I remember those days clearly. It was the “gold rush” of the 21st century for investors.

Interestingly, much like then, we are witnessing investors chase anything related to “artificial Intelligence.” Just as the internet had companies adding a “dot.com” address to their corporate name in 1999, today, we are seeing an increasing number of companies announce an “AI” strategy in their corporate outlooks.

“Execs can’t stop talking about AI. The number of companies that have mentioned AI on earnings calls has rocketed since the launch of ChatGPT. The number of times AI has been mentioned on earnings calls has seen a similar rise.” – Accenture Technology Vision 2024 Report

The difference versus today was that companies would advance regardless of actual revenue, earnings, or valuations. It only mattered if they were on the cutting edge of the internet revolution. Today, the companies racing higher on artificial intelligence have actual revenues and income.

But does that difference remove the risk of another disappointing outcome?

A Forced Feeding Frenzy

As noted above, in 1999, as the “Dot.com” bubble swelled, ETF providers and index tracking managers were forced to buy increasing quantities of the largest stocks to remain balanced with the index. As we have discussed previously, given the proliferation of ETFs and investors’ increasing amount of money flows into passive ETFs, there is a forced feeding frenzy in the largest stocks. To wit:

“The top-10 stocks in the S&P 500 index comprise more than 1/3rd of the index. In other words, a 1% gain in the top-10 stocks is the same as a 1% gain in the bottom 90%.

As investors buy shares of a passive ETF, the shares of all the underlying companies must get purchased. Given the massive inflows into ETFs over the last year and subsequent inflows into the top-10 stocks, the mirage of market stability is not surprising.

Unsurprisingly, the forced feeding of dollars into the largest weighted stocks makes market performance appear more robust than it is. As of June 1st, only 30% of stocks were outperforming the index as a whole.

That lack of breadth is far more apparent when comparing the market-capitalization-weighted index to the equal-weighted index.

However, the concentration of flows into the largest market-cap-weighted companies continues to increase the market capitalization of those top stocks to levels well above that of the “Dot.com” bubble.

The forced feeding of the largest companies in the index, while reminiscent of 2000, does not mean there will be an immediate reversal. If this is indeed a bubble in the market, it can last far longer than logic would suggest.

Just as it was in 2000, what eventually causes the market reversal is when reality fails to live up to expectations. Currently, the sales growth expectations are an exponential growth trend higher.

While it is certainly possible that those expectations will be met, there is also a considerable risk that something will happen.

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Trees Don’t Grow To The Sky

Just as in 2000, the valuations investors paid for companies like Cisco Systems (CSCO), which was the Nvidia (NVDA) of the Dot.com craze, plunged back to reality. The same could be true for Artificial Intelligence in the future. As noted recently by the WSJ:

“AI has had an astounding run since OpenAI unveiled ChatGPT to the world in late 2022, and Nvidia has been the biggest winner as everyone races to buy its microchips. To see what could go wrong, note that this isn’t the usual speculative mania (though there was a mini-AI bubble last year). Nvidia’s profits are rising about as fast as its share price, so if there is a bubble, it’s a bubble in demand for chips, not a pure stock bubble. To the extent there is a mispricing, it’s more like the banks in 2007—when profits were unsustainably high—than it is to the profitless dot-coms of the 2000 bubble.”

It is a good analysis of the four (4) things that could go wrong with AI:

  1. Demand falls because AI is overhyped. (Much like we saw with the Dot.com companies.)
  2. Competition reduces prices.
  3. Suppliers ask for a more significant share of the revenue.
  4. What if the scale doesn’t matter?

As Rober McNamee, a Silicon Valley investing legend, stated:

“There are corporations and journalists that have completely bought into this [the AI hype.] Before investors buy into this we should just ask: How are you going to get paid? How are you going to get a return on something that is effectively a half million dollars each time you do a training set… in a 5% environment.”

As is always the case, the current boom of “artificial intelligence” stocks is just another in a series of “investment themes” over the market’s long term.

“But if we learned nothing else during the SPACs, the crypto, the meme stocks, and whatever else fueled the market’s last run – you know, the one when stocks were the only place to put your money because rates were so low – it’s that when this stuff reverses, it’s always brutal.”Herb Greenberg

And, as we noted previously:

“These booms provided great opportunities as the innovations offered great investment opportunities to capitalize on the advances. Each phase led to stellar market returns that lasted a decade or more as investors chased emerging opportunities.” 

We are again experiencing another of these speculative “booms,” as anything related to artificial intelligence grips investors’ imaginations. What remains the same is that analysts and investors once again believe that “trees can grow to the sky.” 

Trees don’t grow to the sky is a German proverb that suggests that there are natural limits to growth and improvement.
The proverb is associated with investing and banking where it is used to describe the dangers of maturing companies with a high growth rate. In some cases, a company that has an exponential growth rate will achieve a high valuation based on the unrealistic expectation that growth will continue at the same pace as the company becomes larger. For example, if a company has $10 billion in revenue and a 200% growth rate it’s easy to think that it will achieve 100s of billions in revenue within a few short years.

Generally speaking, the larger a company becomes the more difficult it becomes to achieve a high growth rate. For example, a firm that has a 1% market share might easily achieve 2%. However, when a firm has an 80% market share, doubling sales requires growing the market or entering new markets where it isn’t as strong. Firms also tend to become less
efficient and innovative as they grow due to diseconomies of scale.

Modeling how quickly a growth rate will slow as a firm becomes larger is amongst the most difficult elements of equity valuation.”Simplicable

The internet craze in 1999 sucked in retail and professionals alike. Then, Jim Cramer published his famous list of “winners” for the decade in March 2000.

Jim Cramer's Dot.com Winners For The Next Decade

Such is unsurprising, as endless possibilities existed of how the internet would change our lives, the workplace, and futures. While the internet did indeed change our world, the reality of valuations and earnings growth eventually collided with the fantasy.

No, today is not like 2000, but there are similarities. Is this time different, or will trees again fail to reach the sky? Unfortunately, we won’t know for certain until we can look back through the lens of history.

A Great Jobs Report With Ugly Underpinings

The BLS jobs report showed the economy added 272k jobs, well above expectations of 175k, and the 152k jobs reported by ADP. Also pointing to a strong labor market, average hourly earnings were 0.1% above expectations at +0.4%. While the jobs data seems strong, there is a lot of other data within the report, leading us to question its veracity. For starters, the unemployment rose from 3.9% to 4.0%. While the economy did add jobs per the establishment survey, the unemployment rate calculation uses the household survey. That shows the number of employed people fell by 408k. Further, the participation rate dropped from 62.7% to 62.5%. The graph below shows that over the last six months, the headline-garnering establishment survey has added 2.3 million more jobs than the household survey. Such dwarfs any divergence since the pandemic.

The quality of jobs also has a lot to be desired. The number of full-time jobs fell by 625k while part-time jobs rose by 286k. Such is the biggest drop in full-time employment since last December. Furthermore, the number of people with multiple jobs is now 8.4 million, which is just below a record high. The report also highlights why economic survey results, including Democrats, show dismay at Biden’s economic performance. In just May alone, 414k legal and illegal immigrants gained a job. Meanwhile, 663k native-born Americans lost their jobs. Since the pandemic, native-born workers have lost around 2 million jobs.

The bond market’s initial reaction was very negative due to the strong headline job growth and hourly earnings beat. However, we think that over the next few days, as the market digests the complete set of jobs data, it may feel otherwise. Remember that the coming CPI, FOMC meetings, and Treasury bond auctions also weigh on bonds.

jobs establishment survey vs household suvery

What To Watch Today

Earnings

  • There are no notable earnings reports today.

Economy

  • There are no notable economic reports today.

Market Trading Update

Last week, we noted that the market remains range-bound within the recent consolidation. To wit:

“Crucially, the market has now registered a ‘sell signal,’ which will limit any rallies in the near term. Therefore, investors should continue to use bounces to reduce exposure and rebalance portfolios as needed. The upside to the market is likely constrained to recent highs.

While the market set marginal new all-time highs this past week, the upside likely remains somewhat limited in the near term, given the more overbought conditions. On Friday, the market flipped back onto a MACD “buy signal,” suggesting that the rally remains firmly intact, with the 20-DMA continuing to act as the primary support. Furthermore, volatility remains very suppressed, suggesting that traders are not worried about a significant decline anytime soon. However, with that said, the FOMC meeting and inflation reports are next week, which will have an outsized impact on the broader market. Therefore, continue to manage risk accordingly.

While the market did sell off early on Friday with the strong headline report, the underlying data strongly suggests that employment is much weaker than headlines suggest. For the Federal Reserve and the upcoming FOMC meeting next week, the 4% unemployment rate will likely keep them focused on the risk to the economy and on track to cut rates this year.

Such should continue to a bid under the market for now.

The Week Ahead

This will be a very busy week with lots of information for investors to digest. Wednesday, in particular, could be volatile, with CPI being released at 8:30 am ET, followed by the FOMC at 2:00 pm ET. The market expects CPI to be 0.3% on a monthly basis. Little is expected of the Fed, although it will be interesting to see if they shift their view on the economy to a slightly weaker outlook based on recent data. Jerome Powell may share his thoughts on Friday’s employment report. Given that the Philadelphia Fed expects a significant downward revision of employment figures, he may offer that the jobs market is not as strong as the headlines portray. We look forward to hearing his thoughts on the recent rate cuts by the ECB and Bank of Canada.

Also, this week, the 10-year UST auction will be held on Tuesday, and the 30-year auction will be held on Thursday. Like CPI, PPI on Thursday is expected to rise +0.3%.

Housing Struggles

Not surprisingly, with almost two years of mortgage rates north of 7%, the existing home market has been struggling. Buyers are few and far between as high prices and mortgage rates make home-buying difficult. Further, for many homeowners with sub-4 % mortgages, selling a home and buying a new home with much higher mortgage rates is not appealing. Sales for new homes have performed much better than those for existing homes as homebuilders have been offering customers reduced-rate mortgages. The graphs below show us that both the new and existing markets are essentially shut down.

The first graph shows pending home sales. They are homes under contract but have yet to go to settlement. Last month, they declined 7.7% compared to the prior month. Furthermore, they are down 7.4% versus one year ago. Most stunning, the index is at the same level as in April of 2020, when COVID essentially closed the real estate market. Home sales track very closely with pending home sales.

The second graph shows that the supply of new homes is rising and approaching the 2008 highs. The lower graph measures the supply slightly differently.

The final graph is important as it shows that the balance between supply and demand for homes may be shifting. Before recently, home prices have remained relatively stable despite high mortgage rates. This is largely a function of the small number of sellers in the market. However, as the third graph shows, price cuts to entice borrowers are becoming more popular. In fact, the percentage of listings with a price cut is back to pre-pandemic levels.

pending home sales
new home inventory rising
price cuts housing market

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The Texas Stock Exchange

Yes, you read that right: Texas will host a stock exchange. BlackRock and Citadel are lead investors in a new national stock exchange that plans on calling Texas its headquarters. The Texas Stock Exchange will file for registration with the SEC later this year and hopes to be operational in 2026. The exchange will be 100% electronic, meaning there will not be an iconic trading floor like the New York Stock Exchange (NYSE) or the commodity and futures exchanges in Chicago.

Many upstart exchanges have recently failed. Furthermore, older regional exchanges, like Boston and Philadelphia, which were bought out by the NYSE, no longer exist. However, the odds of success are better for the Texas Stock Exchange due to its backing by Citadel and BlackRock. Blackrock is the world’s largest money management firm, and, therefore, it can shift business toward the new exchange. Citadel is one of the largest electronic trading firms. Ergo, it can also force some of its trades to the new exchange. While the Texas Stock Exchange has financially strong supporters, the Exchange has stiff competition. The graphic below, courtesy of the Visual Capitalist, shows that the NYSE and NASDAQ are the largest stock exchanges in America and the world.

worlds top stock exchanges

What To Watch Today

Earnings

  • No notable earnings releases.

Economy

Market Trading Update

In yesterday’s commentary, we discussed how the mega-cap stocks continue to drive the market. This has left a widening gap between the S&P market-cap weighted index, the equal-weight index, and mid-cap and small-cap stocks.

This bifurcation of performance should not be overly surprising. The reason is that 100% of the entire market’s earnings growth comes from the top-7 stocks in the index. In other words, those improving earnings of the S&P index are non-existent if you strip out the “Magnificent 7.”

The problem with this, of course, is that it leaves very little room for error in Wall Street expectations. Eventually, when the economy slows, earnings will slow even for those magnificent companies, and the market will need to reprice accordingly.

Trade accordingly.

The ECB Cuts Rates

We shared news of the Bank of Canada cutting its interest rates two days ago. Yesterday, the European Central Bank (ECB) cut its interest rates for the first time since it began tightening rates two years ago. It lowered interest rates by 25 basis points on its three key monetary facilities as follows: Deposit (to +3.75%), Marginal Lending (to +4.50%), and Main Refi (to +4.25%).

ECB President Lagarde said they would now wait and see what other central bankers do. Clearly, this is a reference to the Fed. The U.S. economy has been much more robust than most other economies. Therefore, there is less need for the Fed to cut rates. The problem facing the ECB and other central banks that cut rates is the potential for dollar strength, which would increase inflationary pressures.

World central banks often coordinate their efforts. Assuming the next couple of rounds of employment and inflation data are weak, the Fed could ease rates as soon as the July 31st meeting, although the market only implies a 16% chance they will do so at that meeting.

ecb rates

Lower For Longest

The chart below from Charlie Bilello shows the current yield curve inversion is the longest in at least 60 years. This means monetary policy has been restrictive for a long time. What the graph doesn’t tell you is whether it’s restrictive enough. The massive stimulus from the pandemic caused a surge in economic activity and inflation. Restrictive policy is needed to help balance the economy. Even with the yield curve inversion, which limits profits on bank lending and thus disincentivizes lending, the economy has done well. However, with the stimulus having primarily left the system, restrictive policy will weigh on the economy. Once the Fed starts to cut rates, which could come as early as July, the yield curve will start to uninvert, and Fed policies will become less restrictive.

us treasury yield curve fed

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Commodities And The Boom-Bust Cycle

It is always interesting when commodity prices rise. The market produces various narratives to suggest why prices will keep growing indefinitely. Such applies to all commodities, from oil to orange juice or cocoa beans. For example, Michael Hartnett of BofA recently noted:

The 40-year period from 1980 to 2020 was the era of disinflation: thanks to fiscal discipline, globalization, and peace, markets saw ‘deflation assets’ (government and corporate bonds, S&P, growth stocks) outperform ‘inflation assets’ (cash, commodities, TIPS, EAFE, banks, value). As shown below, ‘deflation’ annualized 10% vs. 8% for ‘inflation’ over the 40-year period.

But the regime change of the past 4 years has roles reversed, and now ‘magnificent’ inflation assets are annualizing 11% returns vs 7% for deflation assets.”

Mind you, this is not the first time that markets have gone “cuckoo for commodities.” The most recent episode in 2007 was “Peak Oil.” However, crucially, this time is never different. As shown below, commodities regularly have surges in performance and are the best-performing asset class in a given year or two. Then, that performance reverses sharply to the worst-performing asset class.

That performance “boom and bust” has remained since the 1970s. The chart below shows the Commodities Index’s performance over the last 50 years. On a buy-and-hold basis, investors received a 40% total return on their investment. This is because, along the way, there were fantastic rallies in commodities followed by huge busts.

Such brings us to the big question? Why do commodities regularly boom and bust?

Why Do Commodities Boom And Bust

The problem with the idea of a structural shift to commodities in the future and why it hasn’t happened in the past is due to the drivers of commodity prices.

Here is a simplistic example.

  • During a commodity cycle, the initial phase of a commodity price increase is due to rising demand exceeding existing supply. This is often seen in orange juice, where a drought or infestation wipes out a season’s crops. Suddenly, the existing demand for orange juice massively outweighs the supply of oranges.
  • As orange juice prices rise, Wall Street speculators start bidding up the price of orange juice futures contracts. As orange juice prices increase, more speculators buy futures contracts driving the price of orange juice higher.
  • Farmers scrap plans to produce lemons and increase the orange supply in response to higher orange juice prices. As more oranges are produced, the supply of oranges begins to outstrip the demand for orange juice, leading to an inventory glut of oranges. The excess supply of oranges requires producers to sell them at a cheaper price; otherwise, they will rot in the warehouses.
  • Wall Street speculators begin to sell their futures contracts as prices decline, pushing the price lower. As prices fall, more speculators dump their contracts and sell short orange futures contracts, causing prices to fall further.
  • With the price of oranges crashing, farmers stop planting orange trees and start growing lemons again.
  • The cycle then repeats.

Furthermore, high commodity prices threaten themselves. As always, “high prices are a cure for high prices.” If orange juice prices become too expensive, consumers will consume less, leading to declining demand and supply buildup. The following chart of commodities compared to nominal GDP shows the same. Whenever there was a sharp rise in commodity prices, it slowed economic growth rates. Such is unsurprising since consumption drives ~70% of GDP.

There is also a high correlation between commodities and inflation. It should be self-evident that when commodity prices rise, the cost of goods and services also rises due to higher input costs. However, the price increase is constrained as consumers are unable to purchase those goods and services. As noted, the consequence of higher prices is less demand. Less demand leads to lower prices or disinflation.

Such is why hard asset trades repeatedly end badly despite the more ebullient media coverage.

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Hard Asset Trades Tend To End Badly

Commodities, and hard assets in general, can be an exhilarating and profitable ride on the way up. However, as shown in the long-term chart above, that trade tends to end badly. Commodities have repeatedly led market downturns and recessions.

Will this time be different? Such is unlikely to be the case for two reasons.

As discussed, high prices (inflation) are the cure for high prices as it reduces demand. As shown above, as the consumer retrenches, demand will fall, leading to lower inflation in the future.

Secondly, as the country moves toward a more socialistic profile, economic growth will remain constrained to 2% or less, with deflation remaining a consistent long-term threat. Dr. Lacy Hunt suggests the same.

Contrary to conventional wisdom, disinflation is more likely than accelerating inflation. Since prices deflated in the second quarter of 2020, the annual inflation rate will move transitorily higher. Once these base effects are exhausted, cyclical, structural, and monetary considerations suggest that the inflation rate will moderate lower by year-end and undershoot the Fed Reserve’s target of 2%. The inflationary psychosis that has gripped the bond market will fade away in the face of such persistent disinflation.

As he concludes:

The two main structural impediments to traditional U.S. and global economic growth are massive debt overhang and deteriorating demographics both having worsened as a consequence of 2020.

The last point is crucial. As liquidity drains from the system, the debt overhang weighs on consumption as incomes are diverted from productive activity to debt service. As such, the demand for commodities will weaken.

While the commodity trade is certainly “in bloom” with the surge in liquidity, be careful of its eventual reversal.

For investors, deflation remains a “trap in the making” for hard assets.

There is nothing wrong with owning commodities; just don’t forget to take profits.

Zero Down Mortgages Are Back

Here we go again. At the peak of the mortgage bubble, leading to the Great Financial Crisis (GFC), lenders were offering zero down mortgages. As you may remember, that ended poorly. Accordingly, we presumed that the mistake would not be repeated. We are proven wrong. Per CNN, United Wholesale Mortgage (UWM) is offering mortgage borrowers a traditional 30-year mortgage for 97% of the purchase price and a 3% interest-free loan for the remaining 3%. The 3% interest-free loan does not accrue interest, but the loan must be paid back if you sell the home or refinance the mortgage. In other words, a borrower does not come to the settlement table with cash and thus has zero home equity on day one. Compare that to data from ATTOM below, which shows that the median down payment across the United States is 15%.

UWM claims their robust underwriting process will help ensure this is a profitable business for them. Per the article:

“People who make these claims are uneducated about the current state of the industry,” Alex Elezaj, UWM’s chief strategy officer, told CNN. “In today’s environment, UWM is responsible for underwriting the loan, which gives us confidence that these are high quality loans.”

They may have excellent underwriting, but zero-down mortgages are a recipe for problems. Without sufficient equity in a house, zero down borrowers will have trouble refinancing into a new mortgage when mortgage rates fall. Further, if home prices decline, the lender has no equity to cushion a default. As we saw in 2008, some borrowers will mail in the keys to the bank and make the loss the bank’s problem. It will be interesting to see if zero down mortgages are a one-off offering from UWM or a product their competitors will soon offer.

zero down mortgages average down payments

What To Watch Today

Earnings

Economy

Market Trading Update

Yesterday’s commentary noted that the market continues to hold support along the bullishly trending moving averages. However, the internal breadth of the market remains a non-confirmation of the current bullish views. The market rallied strongly yesterday, with many familiar names leading the charge, with Semiconductors at the head of the pack. Such remains a familiar rally theme over the last several months, where a brief rotation into defensive stocks quickly returns to the “Magnificent 7.”

Market Heat Map

While it seems unlikely, Danny and I discussed what a potential market reversal would look like on yesterday’s Real Investment Show. I got a few emails asking if I could reproduce the chart I quickly threw together during the broadcast. I used a simple 50- and 200-month moving average during the show. However, the following chart uses a 24, 48, and 96-month moving average, which are better trend lines for the market. The 48-month moving average was the trend line support for the “Dot.com” crash. That moving average was taken out during the “Financial Crisis,” which bottomed at the 96-month moving average. Since the onset of the liquidity-driven, zero-interest rate cycle in 2009, the 24-month moving average has supported the bull market.

Using a Fibonacci retracement sequence, a correction back to the 96-month moving average would be a roughly 50% decline from current levels and would equate to the previous two bear market cycles. However, such a decline would require a 61.8% retracement of the market from current levels, suggesting a really deep economic recession/credit cycle has unfolded. The most likely corrective levels for a more normal economic recession will be a retest of the 24- or 48-month moving averages with a maximum drawdown of a 38.2% retracement, which would align with the 2022 corrective lows.

This is strictly a hypothetical exercise but does provide some reasonable risk/reward analysis for the future.

ADP and ISM Services

The ADP reported the economy added 152k jobs last month, below the 175k expected jobs. The quote below from ADP’s Chief Economist, Nela Richardson, summarizes the report well.

Job gains and pay growth are slowing going into the second half of the year. The labor market is solid, but we’re monitoring notable pockets of weakness tied to both producers and consumers.

The graph below charts the monthly change in ADP employment (orange). The dotted line represents the 2012-2019 average. As shown, job growth has been below the pre-pandemic average for nearly a year. The green and red bars highlight the six-month moving average of the difference between BLS job growth and ADP. Thus far, in 2024, the average difference is nearly 100k jobs. The average was only 16k between 2012 and 2019. Based solely on this data, it appears the BLS jobs data is due for a “catch-down” with ADP.

adp vs bls employment data

On the heels of an unexpectedly weak ISM manufacturing survey, the ISM services sector survey was stronger than expected at 53.8, well above estimates of 50.8 and last month’s 49.4. Given that the service sector represents over three-quarters of the U.S. economy, this survey indicates continued economic growth. The employment sub-component was 47.1, below expectations and 50. Such points to a contraction in service sector jobs. The price index was 58.1, a relatively high number but below the previous reading of 59.2 and expectations of 60.0. The graph below shows that ISM services have fluctuated between 50 and 55 for the last year and a half. Before the pandemic, the range was 55 to 60

ISM services

The Bank Of Canada Cuts Rates

On Wednesday, the Bank of Canada (BOC) cut its overnight borrowing rate from 5.25% to 5.00%. Similar to the Fed, the BOC is making interest rate decisions one meeting at a time. However, they expect further cuts if inflation continues to ease.

The graph below shows that central bank rates between the U.S. and Canada are often very similar. Hence, might this be a precursor to the Fed cutting rates?

Canada borrowing rate vs fed funds

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Why is Crude Oil Tumbling?

Crude oil prices have fallen by 10% over the last five days and nearly 20% since early April. As we will share, a few factors are negatively impacting the price of crude oil. First, OPEC surprised the markets this past weekend. They agreed to extend most of its production cuts to next year but are phasing out voluntary cuts. The deal appears to be an underhanded way of increasing production. Further pushing crude oil lower is a growing likelihood of a cease-fire agreement in Gaza. Importantly, an agreement could include broader peace agreements extending through the Middle East. Lastly, the recent slowing of economic activity in the U.S. and continued poor economic growth in China are weakening the demand for crude oil. Along those lines, the EIA recently shared that U.S. demand for diesel fell to its lowest seasonal level in over 25 years. Per Reuters:

Products supplied of distillate, EIA’s measure of demand, fell over 6% from February to 3.67 million barrels per day (bpd) in March, lowest for the month since 1998.

The long-term crude oil graph below, using a log scale y-axis, shows that the price of crude oil has formed a wedge pattern over the last two years. Typically, the price breaks out of wedge patterns with a sharp move higher or lower. A break lower would be troublesome, as the blue dotted support line has been dependable support for nearly ten years, except for the early days of the pandemic. Further, a break lower could result in the 50-week moving average crossing below the 200-week moving average. The price of crude oil sits on its 200-week moving average, which has been good support for the last year. On the bullish side, the trend has been upward for eight years, and a break above the dotted blue resistance line could propel crude oil prices back closer to $100.

crude oil prices

What To Watch Today

Earnings

Economy

Market Trading Update

As we have noted over the last few days, there is nothing seemingly “wrong” with the market that would require investors to take a more defensive posture. However, with that said, since we tend to be more “risk averse” by nature, we do pay attention to internal signals that could suggest that risk is rising.

One thing that we do pay attention to is market breadth. When the stock market rises, it should be accompanied by a rising number of stocks trading above their respective 50- and 200-DMAs. The opposite is true during declining markets. However, there are times when breadth does not confirm the market’s current bullish or bearish trend. These “negative divergences” are often worth paying attention to as they suggest that underlying weaknesses or strengths in the market may exist.

While the market has rallied fairly sharply from the April lows, the number of stocks trading above their respective 50 and 200-DMA is mostly unchanged. There are periods when the market has rallied despite weak participation, but more often than not, this is a sign worth paying attention to. If the current market rally will continue higher over the next few months, we need to see broader participation in the market to support that rise. Otherwise, if that breadth continues to narrow, any upside is likely going to be very limited.

As Bob Farrell once wrote:

Rule #7. “Markets are strongest when they are broad, and weakest when they narrow to a handful of blue-chip names”

Small Caps And Bonds Are Well-correlated

The graph below shows that bond prices and the Russell 2000 small-cap index have been well-correlated since bond yields started rising in 2022. Small-cap stock earnings tend to be more sensitive to debt costs and have less access to the capital markets to meet their borrowing needs. Furthermore, banks have been running conservative lending policies, disproportionately affecting smaller companies more than larger ones. If the recent downtick in yields due to weakening economic activity holds, we might expect the small-cap sector to lead the market. Mind you, it is too early, and there is insufficient data to make such an economic claim at this point.

small cap and bonds well correlated

JOLTs

In the latest JOLTs report, the number of job openings fell below 8.1 million to its lowest level since February 2021. Expectations were for 8.4 million. The graph below further indicates that the jobs market is normalizing. It shows the ratio of job openings to the number of unemployed is back to its pre-pandemic peak. The quits rate and hires rate are also back to pre-pandemic levels. We suspect that expectations for Friday’s employment figures will decline slightly on the JOLTs data.

ratio of job openings to unemployed

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Investments For The Coming Power Grid Expansion- Part 3

We continue with our discussion of investment ideas that could benefit from upgrading and expanding the power grid to accommodate surging demand from AI data centers and EVs.

This third and final part of this series focuses on alternative energy sources, utility companies, and other companies related to the power grid infrastructure.

If you haven’t read Parts ONE or TWO we recommend reading them before continuing.

Alternative/Renewable Energy Sources

In 2022, the Department of Energy calculated that renewable energy from solar, wind, hydro, geothermal, and biomass accounted for a fifth of all electricity generation. By 2028, the IEA thinks the percentage will double to 42%. Solar and wind power are expected to be the primary alternative energy sources.

renewable energy

Investments in solar, wind, and other alternative energy sources, along with natural gas, coal, and nuclear, will be increasingly vital to power our utility plants. Furthermore, suppose the US and other nations continue to strive for net zero emissions by 2050 and other environmental goals. The demand for existing and new alternative energy sources will surge in that case.   

net zero emissions
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Renewable energy has benefits and flaws compared to natural gas. The significant advantage of renewable energy is it produces minimal greenhouse gas emissions, as shown below. Second, and equally important, according to the IEA World Energy Outlook, solar and wind energy are the cheapest renewable energy sources and cost much less than carbon-based ones.

safest and cleanest energy sources

However, they have considerable flaws that need to be overcome. Consider the following from Green Solutions.

Relies heavily on weather conditions. When adverse weather conditions occur, renewable energy technologies like solar cells may not be as effective. For example, during periods of rain, PV panels cannot generate electricity, necessitating a shift back to traditional power sources.

Lower efficiency. Regrettably, renewable technologies generally exhibit lower efficiency compared to traditional energy conversion devices. For example, commercially available solar panels have an efficiency of about 15% to 20%. In contrast, traditional technologies utilizing coal or natural gas can achieve efficiency levels of up to 40% and 60%, respectively.

High upfront cost. The manufacturing and installation processes for renewable energy devices, such as PV panels, can be relatively expensive. Only for installation, solar panels cost about $17,430 to $23,870 on average.

Limited geographical region. The availability of high-quality land is limited, leading developers to urgently search for new sites. For example, in Germany, regulatory, environmental, and technical limitations significantly reduce the potentially suitable for onshore wind farms to just 2%.

Shortages of key raw materials. This includes essential metals like nickel, copper, and rare earth metals, such as neodymium and praseodymium, which are vital for the creation of magnets used in wind turbine generators.

Renewable Stocks Are Not Following the Narrative

With time, we believe renewable energy will become much more efficient and hopefully be in a better position to help meet the surging needs of the nation’s utility plants. Investors do not seem as hopeful. 

The recent narrative pushing investors to power grid-related investments has skipped past renewable stocks. The graph below shows two popular alternative energy ETFs, Invesco’s Solar ETF (TAN) and iShares Global Clean Energy ETF (ICLN). Both ETFs are well off their 2008 highs and recent peaks in late 2020. 

alternative energy etfs

Alternative energy stocks and diversified ETFs may be excellent investments for longer-term investors as renewable energy will be relied upon heavily. Furthermore, their stocks have not benefited from the power grid expansion narrative.

Batteries Technology Is Vital To Renewable Energy

Solar and wind energy are not dependable due to weather conditions. For example, the following quote from OilPrice.com:

But while solar power has made the U.S. power-generating system greener, it has also made it more volatile, especially in the top solar market, California. 

There, peak solar power generation coincides with the lowest residential electricity demand during the midday. When power demand begins to surge after 6 p.m., solar output begins to fade.  

In California, for example, “on sunny spring days when there is not as much demand, electricity prices go negative and solar generation must be ‘curtailed’ or essentially, thrown away,” says the Institute for Energy Research (IER).

Accordingly, utilities need more efficient batteries to store excess renewable energy for use during peak demand periods and when the weather isn’t conducive for electricity generation. Without more efficient batteries, undependable alternative energy sources cannot be relied upon as much as the environmental goals demand.

Companies involved in energy storage, especially those at the forefront of producing more efficient batteries, may have significant upside. But, with unproven technology come substantial risks for investors. For instance, many new types of battery technology are in development.

  • Solid-state batteries
  • Lithium-sulfur batteries
  • Cobalt-free lithium-ion batteries
  • Sodium-ion batteries
  • Iron-air batteries
  • Zinc-based batteries
  • Graphene batteries

Battery Diversification May Be Critical

Even if you know which type of battery will be the winner, so to speak, you also have the arduous task of figuring out which company will be a primary producer of the battery. Unless you believe you have good insight into battery technology and the key players in the industry, we think a diversified battery ETF may provide the best investment results. Further, the large battery ETFs are also diversified, with investments in lithium and other metal producers. Unfortunately, ETFs in this space are limited.

Global X Lithium & Battery Tech (LIT) is far and away the largest, with nearly $1.5 billion AUM. While it invests in companies with new battery technology, it also “invests in the full lithium cycle, from mining and refining the metal, through battery production.” Its top three holdings are lithium producers.

Amplify Lithium and Battery Technology (BATT) is the second largest ETF with a mere $89 million in AUM. Like LIT, they invest in lithium producers like BHP and Albemarle.

If you want to make investments in individual companies, Tesla (battery technologies), LG Chem, and Samsung SDI are well-positioned in the industry.

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Lithium Miners

Assuming lithium remains a crucial component in electricity storage batteries, its miners should do well, especially given the recent decline in lithium prices and the related stocks.

North Carolina-based Albemarle (ALB) is the world’s top lithium producer and the largest producer by market cap. It is the only lithium producer of size based in the US. Like the rest of the alternative energy sector, its stock has traded poorly recently. However, with a forward P/E of 16, there is value if its revenues continue upward at their recent pace.

albermarle lithium revenues

We caution you that lithium deposits are being actively explored. Assuming success, the lithium supply may limit the price appreciation of lithium. As an example from The Hill- Researchers make massive lithium discovery in Pennsylvania.

Utility and Grid Operators

Utilities will generate more power, thus increasing their revenue. However, they must invest significant capital to modernize, expand, and reduce greenhouse emissions.

AI data center locations are partially chosen based on their ability to source cheap electricity. Thus, utility companies in the Southeast and Midwest, with access to cheaper natural gas and more reliable alternative energy generation, will be the most cost-effective locations for data centers. The map below shows that Virginia hosts the greatest number of data centers, followed by California and Texas.

ai data centers

Dominion Energy (D) in Virginia and Entergy (ETR) in Texas are the two utility companies that may be the biggest beneficiaries of the growth of AI data centers. Both stocks have relatively low forward P/E’s of approximately 14 and dividend yields of 4.25% for D and 5.50% for ETR. It will be crucial to follow their margins to see how effectively they offset the expansion costs with rising revenue.

Constellation Energy (CEG) and NextEra Energy (NEE) are also worth tracking as they invest heavily in renewable energy infrastructure and will benefit from increased demand. We would add Duke (DUK) and Southern Company (SO) to the list of companies to follow.

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Additional Investment Ideas

We now present an assortment of industries and firms that can benefit.

Technology and AI Firms

Companies specializing in AI software for energy efficiency and management will find opportunities in this evolving landscape. Some of the more prominent names in this sector include IBM, Google, Microsoft, Oracle, and GE Vernova.

Physical Plant Expansion

Companies that supply utility plants with generators, transformers, circuit breakers, and switchboards, among many other parts, will undoubtedly benefit from power grid expansion.

GE Vernova, Eaton, Quanta Services, Emerson Electric, and Siemens

Water/Cooling

The average data center uses 300,000 gallons of water a day to cool its equipment. That is the equivalent of the water used by 100,000 homes. Therefore, companies that can develop cheap cooling solutions for data centers will be in high demand.

Vertiv Holdings (VRT) is a leader in this segment. Its shares have risen tenfold since it went public in 2019 and now trades at a P/E of 100. It’s a high-risk, high-reward stock, not for the faint of heart.

Infrastructure ETFs

There are many other businesses set to profit from the coming infrastructure boom.

Those looking for a diversified investment approach in the power grid may want to explore thematic ETFs.

For example, the First Trust Clean Edge Smart Grid Infrastructure Fund (GRID) holds 103 positions. Beyond diversification and portfolio manager expertise, the fund can buy stocks in foreign markets, which many US investors do not have access to or are uncomfortable with.

iShares (IFRA) is a similar fund with a different basket of stocks and approach toward investing in the industry.

The bottom line is we are confident the expansion and modernization of the power grid will be highly profitable for some companies. However, many companies involved, especially smaller companies with limited product offerings, offer massive rewards but substantial risks. Diversification will prove to be essential for investors.   

Summary

The more we researched the power grid expansion, the more industries, and companies we exposed that could benefit from it. While this article stops here, we will continue investigating the topic and share any exciting findings in the future. The number of rabbit holes is seemingly endless. We encourage you to explore the topic and share any findings you may uncover with us.

Like the birth of the internet, some companies like AOL, Yahoo, and Sun Microsystem, which were the supposed internet leaders, fell by the wayside. Other companies, some already large, others virtually unknown, become leaders. The key to investing in this expansion is to remain vigilant for new companies and technologies that can blossom. Do not assume that the companies in charge today will be so tomorrow. Keep your head on a swivel.

For those unable to invest the time and effort to understand industry trends and identify companies likely to profit, a fund(s) with professionals highly focused on the industry may prove an excellent way to take advantage of the potential infrastructure boom.

Roaring Kitty Goes All In On GameStop

GameStop shares traded nearly 100% higher in pre-market trading before Monday’s official 9:30 ET opening. The reason is a Tweet and Reddit post from Roaring Kitty. On Twitter, he shared the picture below of an Uno playing card. Further, on Reddit, Roaring Kitty posted for the first time in three years. It sounds unbelievable because it is. His Reddit message was a disclosure of his GameStop holdings. Assuming he is not lying to prop up shares of GameStop, he now owns 5 million shares of GameStop and 120,000 June 21st call options with a strike of $20. 120,000 options is the equivalent of 120 million shares, or about a third of all outstanding shares. Because the shares have risen so much, the dealers who wrote those calls will have to buy GameStop stock to hedge their positions. Accordingly, dealers are likely to pressure the stock even higher.

If you recall, Roaring Kitty posted an esoteric graphic on Twitter, which was assumed by investors that it was time again to buy GameStop. Accordingly, the stock rose from 17 to 50 in two days. Three days later, it gave up those gains. GameStop executives have been taking advantage of the situation by issuing shares of the stock at inflated prices. On May 24th, they raised almost one billion dollars in much-needed funding. This instance will likely be similar. The stock will surge and ultimately fall. Some, like Roaring Kitty, will likely make boatloads of money. Others who are late to the game could lose significantly. The question in our mind is when, not if, the SEC will get involved.

gamestop roaring kitty unocard

What To Watch Today

Earnings

Economy

Market Trading Update

As discussed yesterday:

“The 20-DMA crossed above the 50-DMA. On Friday, that support level held, with the market bouncing off of it, keeping the current consolidation in process. If the 20-DMA fails, the 50-DMA is the next logical support level. Below that will be the 100-DMA held during the April sell-off.”

Yesterday, the market tested the 20-DMA again on an intraday basis and then rallied into the close. Over the last two trading days, there has been consistent buying at the end of the day, suggesting that institutions are accumulating stocks. Such tends to be a bullish signal short-term and suggests that while the upside may be somewhat limited momentarily, the downside risk is contained as well. There has been an interesting rotation of money between sectors, with technology lagging and other defensive areas gaining some traction. For now, there is little need to be overly cautious with portfolios. However, it is worth keeping a close eye on the 20- and 50-DMA for any signs of market erosion in the near term.

Discretionary Stocks Weaken With The Consumer

Last week, we noted that personal consumption appears to be slowing. Earnings from many large goods (LINK) and food (LINK) retail outlets are showing poor growth and, in many cases, below the growth rate existing before the pandemic. Government retail sales and consumer spending data further confirm some weaknesses. The SimpleVisor relative and absolute analysis affirm that investors are concerned.

The discretionary sector (XLY) is now tied with the transportation sector (XTN) as the most oversold on a relative basis. The second graphic shows the ratio of XLY/SPY, which has been oversold for most of this year. This is unsurprising given XLY has given up over 11% to the S&P 500 this year.

simplevisor sector analysis
discretionary etf xly vs spy

The Atlanta and New York Fed Point To Slowing Growth

The first graph below shows that the Atlanta Fed’s GDP Now estimate of second-quarter economic growth continues to decline. It peaked at 4.1% and now sits at 1.8%. (Note they have not updated the graph) Such growth is better aligned with Wall Street economists. Similarly, the New York Fed’s Nowcast GDP model forecasts a 1.76% growth rate. This is down about .25% over the last week. The third graphic shows the impact of the last week’s data on the Nowcast GDP estimate.

new york fed nowcast

new york fed nowcast data impact

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Deviations From Long-Term Growth Trends Back To Extremes

In 2022, we discussed the market’s deviations from long-term growth trends. That discussion centered on Jeremy Grantham’s commentary about market bubbles. To wit:

All 2-sigma equity bubbles in developed countries have broken back to trend. But before they did, a handful went on to become superbubbles of 3-sigma or greater: in the U.S. in 1929 and 2000 and in Japan in 1989. There were also superbubbles in housing in the U.S. in 2006 and Japan in 1989. All five of these superbubbles corrected all the way back to trend with much greater and longer pain than average.

Today in the U.S. we are in the fourth superbubble of the last hundred years.”

Are we currently in a market bubble? Maybe. Honestly, I have no idea. The problem is that market bubbles are only evident and acknowledged after they pop. This is because, during the inflation phase of the market bubble, investors rationalize why “this time is different.” 

As we noted then, there are three components of market bubbles:

  1. Price
  2. Valuations
  3. Investor Psychology

When investors bid up asset prices that exceed underlying earnings growth rates, market bubbles were previously present. Since economic activity generates revenues and earnings, valuations can not indefinitely exceed the underlying fundamental realities.

Interestingly, the correction in 2022 started the reversion process of that deviation. However, investor speculation has since pushed that deviation near its previous peak.

As is always the case, valuations are a function of price and earnings; therefore, deviations in price from the long-term exponential growth trend have marked prior peaks. Unsurprisingly, when price momentum increases rapidly, investors rationalize why overpaying for earnings is justified this time. Unfortunately, as shown, such has rarely worked out well.

As the chart shows, and the definition of a market bubble states, “assets typically trade at a price that significantly exceeds the asset’s intrinsic value. Instead, the price does not align with the fundamentals of the asset. “

Crucially, as previously discussed, excess valuations and price deviations from long-term norms are solely a function of investor psychology.

“Valuation metrics are just that – a measure of current valuation. More importantly, when valuation metrics are excessive, it is a better measure of ‘investor psychology’ and the manifestation of the ‘greater fool theory.’ As shown, there is a high correlation between our composite consumer confidence index and trailing 1-year S&P 500 valuations.”

What valuations do provide is a reasonable estimate of long-term investment returns. It is logical that if you overpay for a stream of future cash flows today, your future return will be low.

So, why are we rehashing this topic?

An Optimistic Bunch

While sufficient data suggests that economic growth rates are weakening, investors are again chasing assets with near reckless abandon. For example, investor allocations to equities are rising sharply as chasing asset market returns displaces logic and underlying fundamentals.

The American Association Of Individual Investors (AAII) allocation measures suggest the same, with investors increasing exposure to equities and reducing cash.

Furthermore, extremely low levels of volatility suggest a high level of complacency among investors. Historically, low levels of market volatility tend to reverse suddenly.

Suppose we create a composite index of investor sentiment and volatility (when one is high, the other is low). In that case, current levels align with short- to intermediate-term market peaks and corrections.

Does this mean the market is about to crash? No. However, as Howard Marks previously noted:

We can infer psychology from investor behavior. That allows us to understand how risky the market is, even though the direction in which it will head can never be known for certain. By understanding what’s going on, we can infer the ‘temperature’ of the market. 

We must remember to buy more when attitudes toward the market are cool and less when heated. For example, the ability to do inherently unsafe deals in quantity suggests a dearth of skepticism among investors. Likewise, when every new fund is oversubscribed, you know there’s eagerness.

Currently, there is little denying the more excessive bullish sentiment that abounds. Investors are willing to take on risk, overpay for underlying valuations, and rationalize their actions. Historically, these actions have been the precedents of markets where expectations exceed underlying fundamental realities.

However, while that may indeed be the case, we must never forget the famous words from John Maynard Keynes:

“The markets can remain irrational longer than you can remain solvent.”

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Managing Risk And Reward

Whether you agree that current market deviations are important is mostly irrelevant. Every investor approaches investing differently. We spend much time researching current market environments to reduce the risk of catastrophic losses. Does that guarantee we will be successful in that endeavor? No. However, understanding the risks we are undertaking helps us quantify capital destruction in case something goes wrong.

Managing risk is far more crucial if you are nearing or have entered retirement. The reason is that your investment horizon is shorter than that of those much younger. Therefore, you are less able to recover from short-term market repricings.

There are some simple steps you can take to prepare yourself.

  • Avoid the “herd mentality” of paying increasingly higher prices without sound reasoning.
  • Do your research and avoid “confirmation bias.” 
  • Develop a sound long-term investment strategy that includes “risk management” protocols.
  • Diversify your portfolio allocation model to include “safer assets.”
  • Control your “greed” and resist the temptation to “get rich quick” in speculative investments.
  • Resist getting caught up in “what could have been” or “anchoring” to a past value. Such leads to emotional mistakes. 
  • Realize that price inflation does not last forever. The larger the deviation from the mean, the greater the eventual reversion. Invest accordingly. 

The increase in speculative risks and excess leverage leaves the market vulnerable to a sizable correction. Unfortunately, the only missing ingredient is the catalyst that brings “fear” into an overly complacent marketplace.  

Currently, investors believe “this time IS different.” 

“This time” is different only because the variables are different. The variables always are, but outcomes are always the same.

When the eventual correction comes, the media will tell you, “No one could have seen it coming.”

Of course, hindsight isn’t very useful in protecting your capital.

Orange Juice Is The Next Cocoa

In mid-March, we presented daily Commentary readers with a section entitled, Add Cocoa To The List Of “Mooning” Assets. When we wrote the article, the price of cocoa was up by 70% for the year, in line with year-to-date gains in bitcoin and Nvidia. Since then, cocoa prices have fallen by over 40% but have started rising again. Some of the price volatility is undoubtedly due to weather conditions and its impact on the cocoa harvest. But as we wrote, speculative fever also plays a role. Orange juice futures appear to be following a similar path.

The graph below shows that orange juice futures prices are “mooning.” Citrus greening, a disease affecting Brazil’s trees, is impacting the price of orange juice. Furthermore, draught and above-average temperatures in Brazil also weigh on crop yields. As a result, Brazil’s crop is expected to be 25% less than in average years. Further impacting the supply of orange juice, Florida’s recent hurricanes have damaged orange trees. The outlook for a busy hurricane season is also to blame.

However, similar to our thoughts on cocoa in March, it seems that orange juice prices are also swayed by the more mainstream speculative flows impacting the commodity markets. Commodities have always been a speculative arena, but with more traditional investors trading orange juice and other commodities, the correlation with crypto and hot stocks is rising as well.

orange juice futures prices

What To Watch Today

Earnings

  • No notable earnings releases.

Economy

Market Trading Update

Last week, we discussed that consumer data suggested the economy was weakening. That was confirmed this past week with downward revisions to Q1 GDP and weak personal consumption expenditures (PCE) reports.

The U.S. economy’s growth in the first quarter was revised to an annualized rate of 1.3% from the previously estimated 1.6%, reflecting weaker consumer spending and equipment investment. This slowdown contrasts sharply with the 3.4% growth rate in the final quarter 2023. Inflation for the first quarter was also slightly revised down to 3.3%.

On Friday, PCE, which is roughly 70% of GDP growth, also came in under expectations, adding more concerns to a growing list of economic data that has recently weakened.

In an interesting turn of events, “bad news” seemed to matter to the markets this week. Of course, the reality was that the market was overbought and needed a correction. Wall Street just needed a reason to liquidate some positions.

As noted last week, the 20-DMA crossed above the 50-DMA. On Friday, that support level held, with the market bouncing off of it, keeping the current consolidation in process. If the 20-DMA fails, the 50-DMA is the next logical support level. Below that will be the 100-DMA held during the April sell-off.

Crucially, the market has now registered a “sell signal,” which will limit any rallies in the near term. Therefore, use bounces to reduce exposure and rebalance portfolios as needed. The upside to the market is likely constrained to recent highs.

The Week Ahead

A new monthly cycle of economic data starts this week with the latest jobs data. JOLTs on Tuesday, ADP on Wednesday, and the BLS report on Friday will provide a new round of employment data. The market expects another relatively weak job number, with payrolls rising by 177k. The prior reading was 175k. We say “relatively” because payroll growth averaged approximately 250k a month. Also on the calendar are the ISM manufacturing and service sector reports on Monday and Wednesday, respectively. The jobs and prices sub-components will likely garner the headlines.

We get a reprieve from Fed speakers as they enter the media blackout period before the FOMC meeting on June 12th.

Electricity Demands And Debt

Traditionally, government debt has a negative multiplier. In other words, each dollar of debt ultimately reduces economic growth. While we have little doubt that will change going forward, there is one significant investment the government will be making that has the potential to create lasting economic growth. Following up on our soon-to-be three-part article (Link 1, Link 2) on investing in the coming power grid expansion, we present an article on how the massive upgrade and expansion of the power grid will affect the economy. The following comes from Electricity Demand Cures Debt Concerns.

However, building infrastructure is very labor-intensive, and CapEx is labor—and investment-intensive. Those dynamics change the economic growth dynamic. While corporations increase capital investment to build the power supply, the Government will likely enter the fray with further infrastructure-focused spending bills. This is because AI is a critical component of ensuring the defense and national security of the United States. However, instead of issuing debt to spend on domestic welfare programs, the debt used in infrastructure will create economic growth through labor creation.

Government spending on infrastructure differs from most other government spending because it can create both near-term economic growth in the grid’s buildout and, more importantly, lasting economic growth.

The article shares that Goldman Sachs thinks the infrastructure expansion could add 0.4% to GDP, as shown below.

power grid GDP growth scenarios

Increases in productivity, productive capital investment, and increased labor demand for the infrastructure buildout (which will also result in higher wages) should provide the economic boost needed.


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Lets Knock On Wood

We haven’t written lately on Cathie Wood and her ARKK Innovation ETF. But given the popularity of her funds, their horrendous results over the last three years, and Wood’s preposterous claims, let’s knock on Cathie Wood and ARKK.

Wood started the ARKK fund and others in 2014. The flagship fund, ARKK Innovation Fund, seeks long-term growth through investments in disruptive companies. In the stock market rally of 2020, ARKK flourished. Consequently, its assets (AUM) rose from $2 billion at the start of 2020 to its peak of $28 billion in early 2021. ARKK’s AUM today is $6.2 billion. Her fund was the poster child for the 2020 meme stock rally and has since become one of the worst-performing ETFs. Wood’s promises of outsized returns drove speculation in her fund. To wit is a comment from the fund on December 17, 2021:

“With a five-year investment time horizon, our forecasts for these platforms suggest that our strategies today could deliver a 30-40% compound annual rate of return during the next five years. In other words, if our research is correct – and I believe that our research on innovation is the best in the financial world – then our strategies will triple to quintuple in value over the next five years.” -Cathie Wood

The graph below shows the fund’s poor performance, which is even more troublesome when compared to her claims and the Nasdaq (QQQ). The point of knocking Cathie Wood and ARKK is to highlight that narratives and market actions can be substantial and, in the longer run, damaging to investor returns. As our ARKK example shows, reality always catches up with stocks; it’s just a question of when.

arkk vs QQQ cathie woods

What To Watch Today

Earnings

  • No notable earnings announcements today.

Economy

Market Trading Update

There are many narratives surrounding Bitcoin, from a shield to Government overreach to the future of digital money. However, regardless of your opinion on the cryptocurrency, it is a terrific “risk on” proxy.

From a technical perspective, Bitcoin recently ran to the top of its 2-standard deviation range and has likely started a short-term correction. With a MACD sell signal close to triggering, a reset of $60000 is likely as Bitcoin remains in a fairly wide trading range following the Bitcoin ETF buying frenzy.

Given Bitcoin’s history of being a good “risk on/risk off” proxy, if Bitcoin breaks below critical support, we should likely expect the broader market to follow suit. In such a case, we would likely see momentum trade shifting to a more defensive group of stocks in the index.

Just something we are watching.

The South Park Investment Curse

We stumbled across an interesting article showing an odd correlation between stocks mentioned on the TV show South Park and poor stock performance. Per the article:

Brent Donnelly, president of Spectra Markets, did the leg work and found that once a company or its product is featured prominently on an episode of the animated comedy series, its stock tends to underperform the S&P 500 by 7 percent over the following 12 months.

There may be some logic to the correlation. For instance, if a company’s product is popular but absurd, as is sometimes the case with South Park plot lines, might its market value also be too high? The table below from the article shows stocks featured on the show since 1998. While the average results affirm the author’s theory, the variance of returns is substantial.

south park investment curse

GDP Revised Lower

Monday’s Commentary shared information on the recent spate of economic data revisions lower. First quarter GDP is now included. It fell from 1.6% to 1.3% yesterday. As shown below, the revision was driven by a sizable downward revision of consumer spending. The price indexes also ticked lower by 0.1%. While the first quarter is weak, there are no indications that such weakness will be sustained in the second quarter. Currently, as we share in the second graph, the Atlanta Fed’s GDP Now is running at 3.5% for the second quarter.

q1 gdp revisions contributions
gdp now estimate

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Electricity Demand May Cure Debt Concerns

The future of electricity demand for everything from electric cars to Bitcoin mining to artificial intelligence may also be the cure for our debt concerns.

Before you dismiss that statement, let me explain.

One of the bears’ primary arguments against the financial market and the economy’s health is what is perceived as the surging increase in Government debt. That increase in debt supports their frantic calls for the “end of the dollar,” economic disruption, and essentially the demise of the U.S. as a global power. Looking at the increased Government debt in a vacuum, you can understand the concern.

Of course, the increase in federal debt results from excess government spending, particularly since the pandemic-related shutdown. We see the surge in the federal deficit, the largest since the financial crisis and the most significant deficit outside of a wartime economy.

It is also notable that economic growth has slowed markedly as both debts and deficits have increased. That decrease in economic growth is an essential point of our discussion.

In “40-Years Of Economic Erosion,” we discussed the difference between productive and unproductive debt. To wit:

The problem is that these progressive programs lack an essential component of what is required for ‘deficit’ spending to be beneficial – a ‘return on investment.’ 

Country A spends $4 Trillion with receipts of $3 Trillion. This leaves Country A with a $1 Trillion deficit. In order to make up the difference between the spending and the income, the Treasury must issue $1 Trillion in new debt. That new debt is used to cover the excess expenditures but generates no income leaving a future hole that must be filled.

Country B spends $4 Trillion and receives $3 Trillion income. However, the $1 Trillion of excess, which was financed by debt, was invested into projects, infrastructure, that produced a positive rate of return. There is no deficit as the rate of return on the investment funds the “deficit” over time.

There is no disagreement about the need for government spending. The disagreement is with the abuse and waste of it.

John Maynard Keynes’ was correct in his theory that in order for government ‘deficit’ spending to be effective, the ‘payback’ from investments being made through debt must yield a higher rate of return than the debt used to fund it.

Currently, the U.S. is ‘Country A.”

Read that carefully, as electricity demand may provide that needed change to the debt dynamic.

Electricity Demand To Surge

As noted, the United States power grid has lacked sufficient investment to handle the increasing burdens of electricity demand in previous years. It isn’t just a growing population that needs more housing, mobile phones, laptops, and computers. However, adding electric vehicles, bitcoin mining, and artificial intelligence will overwhelm the current electricity supply in the U.S.

For example, bitcoin mining demands an extreme amount of electricity. As noted by Paul Hoffman in Bitcoin Power Dynamics:

“The daily consumption of 145.6 GWh for Bitcoin mining in the U.S. is about 1.34% of the total daily power consumption in the country. Despite the small percentage this is still an enormous amount of electricity, keeping in mind that the U.S. is a heavily-industrialized country consuming a lot. When we extrapolate this daily consumption to a year, we get 53,144 GWh.”

Bitcoin mining is a relatively small industry with a large footprint on electricity demand. However, “generative artificial intelligence (AI)” is a different beast. According to S&P Global Commodity Insights, the electricity needed for AI remains unclear, but the technology will lead to a significant net increase in US power consumption. Medium recently had some charts detailing that growth.

“AI energy demand is projected to surge from approximately $527.4 million in 2022 to a substantial $4,261.4 million by 2032, with a robust compound annual growth rate (CAGR) of 23.9% from 2023 to 2032.”Medium.

“Simultaneously, the Utility Market is expected to experience even more significant expansion, increasing from $534 million in 2022 to a substantial $8,676 million by 2032, driven by a remarkable CAGR of 33.1% from 2023 to 2032.”

As S&P points out:

“Power demand from operational and currently planned datacenters in US power markets is expected to total about 30,694 MW once all the planned datacenters are operational, according to analysis of data from 451 Research, which is part of S&P Global Market Intelligence. Investor-owned utilities are set to supply 20,619 MW of that capacity. To put those numbers into perspective, consider that US Lower 48 power demand is forecast to total about 473 GW in 2023, and rise to about 482 GW in 2027.”

So, what does this have to do with the debt?

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Growing Our Way Out

We have used deficit spending for decades to fund social welfare programs. Those programs have a long-term negative multiplier on economic growth. However, the future requires building an electricity infrastructure, which is a different dynamic. However, using deficit spending for projects with a “return on investment,” such as power production (geothermal, nuclear, tidal) or broadband, which users pay a fee to consume, is valid. This is because the long-term revenue generated by these projects repays the debt over time. Furthermore, these projects are labor intensive, creating demand for jobs, commodities, and capital expenditures.

Since 1980, capital expenditures (CapEx) have dropped as economic growth slowed. The chart shows the 10-year average annual change in CapEx vs. GDP. If economic growth (primarily consumption) is slowing, then the demand to expend CapEx is also reduced. This is because corporations seek out cheaper alternatives such as offshoring, productivity increases, and wage suppression.

However, building infrastructure is very labor-intensive, and CapEx is labor—and investment-intensive. Those dynamics change the economic growth dynamic.

While corporations increase capital investment to build the power supply, the Government will likely enter the fray with further infrastructure-focused spending bills. This is because AI is a critical component of ensuring the defense and national security of the United States. However, instead of issuing debt to spend on domestic welfare programs, the debt used in infrastructure will create economic growth through labor creation.

The chart below assumes we will continue to issue debt at the average quarterly pace since 2021. However, instead of wasting money, we focus on productive investments while maintaining all current spending programs and obligations. Assuming some conservative growth estimates resulting from the investments, the “debt to GDP” ratio will begin declining in 2026 and revert to more sustainable levels by 2030.

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Conclusion

While the bears constantly ring the alarm bell about the current level of debt and deficits, the more dire economic consequences they forecast may fail to come to fruition.

As noted by Goldman Sachs:

“Generative artificial intelligence has the potential to automate many work tasks and eventually boost global economic growth. AI will start having a measurable impact on US GDP in 2027 and begin affecting growth in other economies worldwide in the following years. The foundation of the forecast is the finding that AI could ultimately automate around 25% of labor tasks in advanced economies and 10-20% of work in emerging economies.”

They currently estimate a growth boost to GDP from AI of 0.4 percentage points in the US.

Increases in productivity, productive capital investment, and increased labor demand for the infrastructure buildout (which will also result in higher wages) should provide the economic boost needed.

Will it solve all of the current socio-economic ills facing the U.S.? No. However, it may provide the growth boost necessary to revitalize economic growth and prosperity in the U.S., which we have not seen since the 1970s.

It may also just be enough to keep the demise of the U.S. from occurring any time soon.

ETF Fund Flows Confirm What We Knew

The graph on the left below, courtesy of Arbor Data Science, shows that $8 billion of funds flowed into U.S. large-cap ETFs, leaving every other broad ETF sector in the dust. Not surprisingly, U.S. large-cap stocks, consisting of the S&P 500 and, importantly, Nvidia, outperformed the market. The other ETF factors, such as small and mid-cap, staples and discretionary, and thematic, all saw flat to negative fund flows.

Every Tuesday, we give readers a glimpse of our proprietary relative and absolute analysis on SimpleVisor. The analysis helps us appreciate which sectors and stock factors are moving into and out of favor. For instance, the graphic on the right below shows ETF factor performance. The relative score is based on a series of technical readings of the price ratio of the specific factor ETF to the S&P 500 (SPY). The absolute score uses the same technical readings but only on the price of the ETF.

The factors in the table are sorted from most overbought (red) to most oversold (green). As we share, the two highest scores are variations of U.S. large-cap ETFs. While the fund flows recently shifted toward large caps, our analysis has pointed us to increasingly better relative and absolute performance of large caps for the last few weeks. The “spaghetti” graph on the right charts the intersection of the daily absolute and relative scores for S&P 500 Growth (IVW). The movement from the lower left quadrant to the upper right shows that its relative and absolute scores have steadily improved. Furthermore, IVW is now overbought using both metrics. Consequently, the analysis leads us to believe the sector may take a breather in the weeks ahead.

etf fund flows and simplevisor absolute and relative analysis

What To Watch Today

Earnings

Economy

Market Trading Update

The market has been quiet this week ahead of today’s earnings report from retailers, which will give us another look at the strength, or not, of the consumer. Furthermore, today’s and tomorrow’s economic reports will give the markets another reason to wrestle with the inflation/deflation debate and how much the Fed will cut rates. The markets will focus on the PCE (Personal Consumption Expenditures Index) price report and expenditures for clues on upcoming Fed policy.

As we have discussed, with the market back to more overbought levels, further price appreciation was going to be difficult. Such has been the case over the last couple of weeks, with the market consolidating near recent highs. The good news is that consolidation has allowed the 20-DMA to catch up with the market, providing some near-term support. The bad news is that the consolidation has caused the MACD signal to get close to crossing back into a “sell.” That sell signal does NOT mean a significant correction is underway, but it does suggest if it occurs, that market appreciation will be limited for a period.

There is certainly potential for the market to correct towards the 50- or 100-DMA, and any report suggesting a higher inflation read could catalyze a larger decline. However, I would expect the 100-DMA (blue line) to contain any decline near term. However, as is always the case, “something else” could happen so it is always prudent to manage risks accordingly.

  • Resize positions back to target weights
  • Add defensive positions
  • Raise cash levels
  • Sell underperforming positions as needed.

Corporate Bonds Send Unheeded Warnings

As we have noted on occasion, the credit spread, or difference between corporate bond yields and comparable maturity U.S. Treasury yields, is the tightest (smallest) in 25+ years, as shown in the first graph. Hence, the graph alludes that bond investors have minimal credit concerns. Should they? The second graph argues yes. The Financial Times graph highlights that the percentage of low BBB bonds moving to a negative outlook is increasing. A negative outlook is a warning by the rating agencies that the bond is at risk of downgrade. Assuming the bonds in the graph are rated BBB-, a downgrade would move them to junk status. Further, note the number of bonds on the positive watch is declining.

Typically, bond spreads move with potential changes in credit ratings and general economic trends. While economic trends remain solid, higher interest rates are slowly catching up with companies. Therefore, higher interest expenses will weigh on profitability and credit ratings. Consequently we must ask, might the bond market be ignoring a gasping canary in the coal mine?

bbb bonds credit spreads oas
bbb bonds on negative and positive watch

Auto Inventories Normalize Leading Car Prices Lower

The graph below from Wards Auto and Bank of America plots auto inventories for car dealers. The dark blue line tells us the dealers are now holding 52 days’ worth of sales in inventory. Such is still a little below the pre-pandemic levels. However, the amount of inventory is rising steadily, which points to a more normal supply-demand curve for cars. Not surprisingly, with rising inventories, dealers are losing pricing power. The second graph shows that CPI for new autos looks like a mirror image of the inventory graph. With CPI for new autos slightly below zero, further increases in inventories could lead to deflation in the sector.

auto inventories rising
cpi new autos

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The Power Grid Expansion – Part Two

This article follows Part One, which discusses the massive investment dollars that will be spent expanding and modernizing the power grid to facilitate demand from AI data centers and EV users. With the macro investment theory laid out, we explore which industries and companies may benefit from the power grid expansion. Part Two focuses on the traditional energy suppliers that will fuel the power grid. We do not present the industries and companies in any particular order.

As you read, please consider that picking the “right” power grid stocks is difficult. In the short run, money flows into and from stocks and sectors align with the popular narratives of the day, regardless of whether they prove correct. Narratives and the sentiment they spur can grossly distort a stock or industry’s valuations and create overbought or oversold conditions. However, over the long term, profits supersede narratives.

This article presents a longer-term view.

Before starting, we address a reader’s question regarding the electricity Bitcoin miners require.  

Bitcoin Mining

After reading Part One, a reader asked if Bitcoin mining contributes to the need to expand the power grid. The answer is mixed. Bitcoin mining requires a lot of electricity. However, as a percentage of total power usage, it’s not nearly as much as AI data centers and EVs will consume.

To put perspective on the amount of electricity that bitcoin miners use, we share some excerpts from a recent report by Paul Hoffman at Best Brokers.

Currently there are 450 Bitcoins mined daily and this costs the mining facilities a whopping 384,481,670 kWh of electrical power. This comes at 140,336 GWh yearly and is more than the annual electricity consumption of most countries, save for the 26 most power-consuming ones.

When this power expenditure was resulting in 340.82 BTC mined up until 20 April 2024 before the halving, it was still economically feasible to mine Bitcoin in the U.S. by using grid power entirely. This is no longer the case and the fact the U.S. mining facilities are still operational points to the notion that they are relying mostly on their own renewable energy sources and/or have special deals with suppliers.

From his report, the first pie chart below shows that the US accounts for over a third of the global power consumption used to mine for Bitcoin. While we are the most significant power user for mining, it is a relatively minor percentage of our total power consumption. To wit, Bitcoin miners use 1.34% of domestic electricity. While a small percentage, it is still a tremendous amount of electricity, as the second graphic shows. However, it is not single-handed enough to warrant the mass expansion of the grid.

bitcoin energy consumption by country
bitcoin energy consumption
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Natural Gas- “The Fuel That Keeps The Lights On

Per the EIA, natural gas accounted for 43.1% of domestic utility-scale electricity generation in 2023. No wonder they call it “the fuel that keeps the lights on.”

Natural gas is abundant in the US. As a result, its price is near 30-year lows, as shown below. In addition to being cheap, burning natural gas is cleaner than burning coal or petroleum products. It’s a win-win energy source for utility companies.

natural gas futures

The increase in natural gas reserves over the last fifteen years is primarily the result of shale oil fracking. About three-quarters of the nation’s natural gas comes from shale wells.

According to Wells Fargo analyst Roger Read, the demand for natural gas could increase by 10 billion cubic feet daily by 2030. If correct, that is a nearly 30% increase from what is currently used for electricity generation in the US.

natural gas reserves

The graphic below, courtesy of the Williams Company, illustrates the roles of the upstream and midstream participants who get natural gas downstream to our homes, schools, and businesses. 

upstream midstream downstream graphic

Upstream Producers

The largest US natural gas producers, aka upstream, are listed below. Of these, EQT, SWN, AR, and CNX predominantly drill for natural gas. The remaining companies have significant interests in other types of fuels as well as natural gas.

EQT, SWN, AR, and CNX share prices correlate highly with natural gas prices. Conversely, the other stocks are not nearly as connected to natural gas prices. Given the high correlation, EQT, SWN, AR, and CNX will benefit the most if natural gas prices rise. However, natural gas is plentiful in the US. Accordingly, prices could stagnate near current levels if the supply keeps pace with growing demand.

Unless they are estimating the supply of natural gas, we do not think this sector will benefit overly from the increased use of natural gas to fuel our growing power grid.

natural gas producers

Midstream

Natural gas distributors, referred to as midstream, will benefit proportionately from the increased demand. These companies transport natural gas via pipelines from the wells (upstream) to the end users (downstream).

Think of these companies as toll-takers on the energy highway. The more natural gas moves through their pipelines, the more revenue they make. Unlike producers, midstream stock prices are less correlated with natural gas prices and more so by the volume of energy transported.

Many midstream companies pay high dividends, which can fluctuate with profits. Some are organized as limited partnerships with unique tax reporting obligations.

Kinder Morgan (KMI) owns the nation’s largest natural gas network, accounting for approximately 40% of the natural gas consumed. Other large companies include Cheniere Energy (LNG), The Williams Companies (WMB), Energy Transfer LP (ET), Enterprise Products Partners LP (EPD), and Enbridge (ENB). Other than KMI, these companies also derive revenue from different energy sources.

Kinder Morgan (KMI), ONEOK (OKE), and Targa Resources (TRGP) are principally natural gas and liquid gas transporters.

Since midstream company profits depend more on the volume of gas being transported versus upstream producers who rely more on natural gas prices, we prefer midstream. The graph below compares the correlations of the four upstream and three midstream natural gas stocks versus the price of natural gas over the last two years.

upstream downstream correlation to natural gas
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Nuclear Energy

Nuclear energy is back in vogue. After being out of favor following Chernobyl and, more recently, Fukushima, countries are rediscovering its benefits. As the graph below from Our World in Data shows, nuclear energy is not only one of the safest energy sources but the cleanest.

nuclear energy is safe and clean

The graph below, courtesy of Statista, shows that nuclear power production has stagnated for over 20 years.

nuclear electricity generation

There are three main ways to invest in nuclear energy: uranium miners, constructing and maintaining nuclear power plants, and the utilities engaged in generating nuclear power.

According to the World Nuclear Association (WNA), 60 reactors are under construction, and another 110 are planned, 13 of which are in the US. For context, there are about 440 nuclear reactors in the world. Notably, some of the growth will replace old plants being retired. If the world truly embraces nuclear power, the number of new reactors will likely grow substantially.

While natural gas is now being liquified and shipped internationally, most natural gas is and will be distributed within the US. On the contrary, uranium miners and nuclear construction companies can benefit more from expanding power grids globally.

Uranium Producers

The graph below from Cameco shows that the price of uranium has tripled in the last few years but is still below its record highs.

uranium prices

Uranium production peaked in the US about forty years ago. Per the EIA, Canada and Kazakhstan now account for over half of our imports.

The four biggest uranium producers trading on US exchanges are BHP (BHP), Cameco (CCJ), NexGen Energy (NXE), and Uranium Energy (UEC). CCJ, UEC, and NXE primarily produce uranium. BHP, on the other hand, produces a wide variety of commodities.

Since 2021, when uranium prices started to increase aggressively, shares of the three pure uranium producers have grossly outperformed BHP. Given these significant returns, investors should exercise caution in the short run despite optimistic long-term predictions for more nuclear facilities.

uranium producer stocks

Nuclear Reactor Construction and Maintenance

Coming online later this year, Unit four of the Nuclear Plant Vogtle in Georgia expects to generate more than 1,100 megawatts of energy. This follows unit three, which went online in 2023. Construction of both units started in 2009. The total cost of the two units will exceed $34 billion. In the construction process, the lead contractor, Westinghouse, went bankrupt.

We share this because building a new reactor is time-consuming and very expensive, and as Westinghouse investors found out, it can be risky. Further, the permitting and approval process can take years. But if done correctly, it can be very profitable.

Brookfield Renewable Partners (BEP) and Cameco (CCJ) now own Westinghouse. 

In addition to Brookfield, other companies can profit from constructing new plants. One such company is GE Vernova (GEV), which owns GE Hitachi Nuclear Energy (GEH). Per their website:

GEH combines GE’s design expertise and history of delivering reactors, fuels, and services globally with Hitachi’s proven experience in advanced modular construction to offer customers around the world the technological leadership required to effectively enhance reactor performance, power output, and safety.

Quanta Services (PWR) is another beneficiary of the growth in the number of nuclear plants. They are certified by the NRC to repair nuclear plant substations and switchyards.

We think GEV and PWR potentially offer investors promising long-term returns, as they are involved in nuclear facilities and a wide range of traditional power generation operations.

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Nuclear Power Generation

Many utilities source electricity from nuclear plants. Some of the largest include Duke, Dominion, NRG, Southern Company, and Constellation. While their expenditures to build and service nuclear facilities are extensive, the benefits of this clean and safe energy will pay future dividends. Investors must carefully weigh the initial capital expenditure of building a nuclear facility versus its long-term benefits.

The graph below from the Nuclear Energy Institute (NEI) shows the US has 93 nuclear reactors of which the large majority are in the eastern half of the nation.

nuclear power across the us

Summary

Part Three will cover alternative energy sources and summaries of other industries and companies that may benefit from the expansion and modernization of the power grid. 

Might GE Vernova Be The Next Nvidia?

Nvidia shares have risen by 600% in the last two years. While some say its shares are now grossly overpriced, its earnings and sales growth argue otherwise. Nvidia’s surging stock prices typify what is happening with many stocks related to the AI boom. While technology sector stocks appear to benefit most from AI, other sectors may do equally well. For instance, as we recently wrote in AI Data Centers and EVs Create Incredible Opportunities, the power grid needs to be modernized and expanded at great expense to facilitate AI. At the forefront of this infrastructure investment is GE Vernova. GE Vernova (GEV) is a recent spin-off from GE. The company is involved in the power grid’s many traditional and alternative energy aspects. They also provide software and financial services to infrastructure projects.

SimpleVisor subscribers have been aware of GE Vernova for three weeks. Our weekly Friday Favorites provides a technical and fundamental summary of a company of interest. On May 10, 2024, we reviewed GE Vernova. We share the following from the article.

GEV is a supplier of industrial goods and services allowing utility companies to keep up with growing energy demand. As such, their upside growth potential is much more significant than most other utilities. GEV should profit as utilities are forced to spend and invest to upgrade and expand their power generation facilities to meet the surge in power needed by data centers and EVs. Consequently, their cash flows should look different than most utility companies. Accordingly, GEV is not only a bet that AI data centers will generate massive power needs, but it is a unique way to seek diversification within the utility sector.

We currently hold a position in GE Vernova in our equity model.

ge vernova gev

What To Watch Today

Earnings

Economy

Market Trading Update

Yesterday, we noted that from a technical perspective, the markets remain on a current MACD “buy signal” and have cleared all previous resistance levels. Furthermore, the 20-DMA crossed above the 50-DMA, providing additional support to any short-term market correction. The 20-DMA will now become running support for the market. As the market consolidates the run from the April lows, the 20-DMA is catching up to the current price, and some overbought conditions are reversing. While the market continues to jump from headline to headline for clues as to the Fed’s next moves, most is just media trying to find something to discuss.

For now, market signals remain bullish, suggesting traders remain exposed to equity risk. That will eventually change, but the “buy/sell” signals will alert us to that.

One Day Settlement

Starting yesterday, stock transactions will settle in one day, not two. Accordingly, if you buy or sell a stock today, the money and shares will move to and from your account tomorrow. As a result, the transaction settlement process will be less risky. According to CNBC, wild trading in the shares of GameStop in 2021 pushed the SEC to make the change. Per CNBC:

The latest change comes after the GameStop mania in 2021 put the settlement process under closer scrutiny. The wild swings in so-called meme stocks meant that the agreed-upon price for trades was significantly different from the market price when the trade was actually settled. There was also increased instances of “failure to deliver,” or trades where settlement did not occur, during that period.

While desired, same-day settlement is unlikely until the advent of digital securities, which is likely years away. For more on what that may look like, check out an article we wrote in 2021 on the topic—Bye Bye Brokers.

FedEx And Transportation Stocks Flounder

For yet another week, the transportation sector, using SimpleVisor’s sector and factor proprietary analysis, has been the weakest sector on a relative and absolute basis. The first graphic below shows the transportation sector is extremely oversold versus the S&P 500. Similarly, on an absolute basis, the transportation and energy sectors are the most oversold. The second graph shows that FedEx is the most oversold in the transportation sector on an absolute and relative basis. The third graphic shows how poorly FedEx stock has traded compared to the market since December. However, as a result, its valuations (on the left side of the graph) are now very reasonable versus the market’s. The last graphic shows that its revenues have been flat since 2020. Despite its poor performance, it is still overpriced, using multiple fair value calculations.

For SimpleVisor subscribers, this coming Friday’s Favorites will provide much more fundamental and technical insight into FedEx.

simplevisor sector analysis

fedex transportation sector simplevisor
fedex valuations stock performance simplevisor
fedex revenue and fair value simplevisor

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No, Corporate Greed Is Not The Cause Of Inflation.

Corporate greed is not causing inflation, despite the claims of many on the political left who failed to understand the very basics of economic supply and demand.

“If you take a look at what people have, they have the money to spend. It angers them and angers me that you have to spend more. It’s like 20% less for the same price. That’s corporate greed. That’s corporate greed. And we have got to deal with it. And that’s what I’m working on.” – President Biden via CNN

Yes, prices have certainly gone up due to inflation. However, that wasn’t the fault of corporations. The surge in inflation directly resulted from the supply-to-demand imbalance caused by shutting down the economy (supply) and increasing household purchasing power by sending them checks (demand).

For the majority of Americans who now get their “news” from social media, the uneducated masses now have a new target of hatred for their financial woes – corporate greed.

A Claim Of Absurdity

The problem, as with many of the narratives ramping up the ire of Americans on social media, is it is patently false.

As Michael Maharrey previously penned:

“One simply has to reason through the claim to uncover the absurdity. If corporations can willy-nilly raise prices and enjoy “excessive” profits, why don’t they do it all the time? Did corporations suddenly get greedy in 2021? And why did the Federal Reserve spend a decade fretting about inflation being ‘too low’ as it struggled to hit its 2% target? Was there not enough corporate greed before coronavirus?”

When you think about it this way, something else apparently happened.

Let’s begin with Powell’s assessment of the cause of inflation.

“The ongoing episode of high inflation initially emerged from a collision between very strong demand and pandemic-constrained supply. By the time the Federal Open Market Committee raised the policy rate in March 2022, it was clear that bringing down inflation would depend on both the unwinding of the unprecedented pandemic-related demand and supply distortions and on our tightening of monetary policy, which would slow the growth of aggregate demand, allowing supply time to catch up.”

It’s crucial to note the complete dismissal of the causes behind the “collision between robust demand and pandemic-constrained supply.” I suspect this was intentional in avoiding placing blame at the feet of the current or previous administrations or themselves. However, it muddies the impact of their actions that created the problem.

The following economic illustration is taught in every “Econ 101” class. Unsurprisingly, inflation is the consequence if supply is restricted and demand increases via monetary interventions.

  • Who had the power to shut down the entire economy and force everyone into their homes using a fear-driven campaign? Was it the war, corporations, or the Government?
  • Who then supplied trillions in stimulus checks directly to households to spend when no supply could be produced? Was that corporations? Russia? Or was it the Government?
  • Who supported the issuance of trillions in debt issuance to fund those stimulus checks and keep interest rates suppressed? Was that the Federal Reserve, Russia, or corporations?
  • Was it corporations that put a moratorium on student loans, rent, and mortgage payments, giving individuals a source of additional funds to spend? Or was it the Government?

Milton Friedman also had much to say on this issue.

Corporate Greed Does Not Cause Inflation

Regarding inflation, many armchair economists are quick to quote Milton Friedman.

“Inflation is always and everywhere a monetary phenomenon.”

The problem is there is much more to Friedman’s statement on the cause of inflation.

As Milton Friedman once stated, corporations don’t cause inflation; governments create inflation by printing money. 

“It is always and everywhere a result of too much money, of a more rapid increase of money, than of output. Moreover, in the modern era, the important next step is to recognize that today the governments control the quantity of money so that, as a result, inflation in the United States is made in Washington and nowhere else. Of course, no government any more than any of us, likes to responsibility for bad things.

All of us are humans. If something bad happens, it wasn’t our fault. And the government is the same way, so it doesn’t accept responsibility for inflation. If you listen to people in Washington talk, they will tell you that inflation is produced by greedy businessmen, or it’s produced by grasping unions, or it’s produced by spendthrift consumers, or maybe its those terrible Arab sheiks who are producing it.”

As he concludes:

“But none of them produce inflation, for the very simple reason that neither the businessmen, not the trade union, nor the housewife have a printing press in their basement on which they can turn out those green pieces of paper we call money. Only Washington has the printing press, and therefore, only Washington can produce inflation.”

The inflation surge has nothing to do with corporate greed taking advantage of consumers but rather the actions of the Federal Reserve and the Government. The cause of inflation was the economic consequence of “too much money chasing too few goods.”

Milton Friedman’s statement is supported by the chart below showing the M2 money supply compared to inflation (with a 16-month lag).

You can watch Milton’s entire speech on “Money and Inflation.”

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Corporations Respond To Inflation

So, if it isn’t corporate greed, why are corporations raising prices so much on everything?

Corporations have a responsibility to their shareholders to remain in business. If the costs to their business increase (i.e., wages, benefits, commodities, utilities, etc.), such must be factored into the selling price to maintain profitability. Crucially, corporations can only pass on higher input costs to consumers if demand remains higher than the available supply of those goods or services.

In 2020 and 2021, corporations could pass on most of the inflationary increase to consumers as they were willing to spend the Government’s money. However, as excess savings run out, inflation declines as consumers decrease spending. Corporate profits weaken as the ability to pass on higher input costs to customers fades. As shown, as inflation declines, the rate of change in corporate profits also weakens.

We see the same if you use a two-year average of corporate profits minus inflation. Again, when inflation surged in 2020, corporations could pass on the bulk of the cost increases to consumers. Today, as inflation slows due to declining demand, corporations must absorb the inflation to sell products or services.

Another way to view this issue is by comparing the spread between the consumer price index (what consumers pay for goods and services) and the producer price index (what corporations pay). When inflation rises, and consumer demand exceeds supply, corporations can pass on higher input costs to consumers. Corporations absorb higher input costs when inflation declines to sell products or services.

Here is the crucial point:

“Corporations don’t create inflation. They merely react to changes in demand and adjust pricing and supply to maintain profitability. When the consumer slows down, corporations cut prices to reduce supply.”

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Who Is Responsible For Inflation?

If there is a “greed factor” in inflation, it is more of a function of political policy and Wall Street. Let’s start with political policies.

Most government policies are passed to appease the masses in one form or another, but mostly to appease those who fund campaigns to keep them in office. We have already addressed the side effects of shuttering the economy and sending checks to households while halting debt payments. That had nothing to do with corporate greed, but the voting base was happy getting “free money.”

There are also policies pushed at the state level that result in higher inflation but keep politicians in office. For example, California’s minimum wage hike to $22/hour is an inflationary policy. Corporations’ obvious response is to raise prices to offset the higher wage costs.

As discussed in “$15/Hour Cost & Consequences,” wage increases are not a “free lunch.” To wit:

“Labor costs are the highest expense to any business. It’s not just the actual wages, but also payroll taxes, benefits, paid vacation, healthcare, etc. Employees are not cheap, and that cost must be covered by the goods or services sold. Therefore, if the consumer refuses to pay more, the costs have to be offset elsewhere.

For example, after Walmart and Target announced higher minimum wages, layoffs occurred and cashiers were replaced with self-checkout counters. Restaurants added surcharges to help cover the costs of higher wages, a “tax” on consumers, and chains like McDonald’s, and Panera Bread, replaced cashiers with apps and ordering kiosks.”

Furthermore, Wall Street itself is a factor. Prices of commodities are controlled by traders on the New York Mercantile Exchange. Those traders look for opportunities to place bets on commodities based on many events that could impact supply, such as weather, transportation disruptions, or geopolitical conflicts. Take a look at the commodity index below.

That surge in commodity prices, which resulted from the economic shutdown, raises the cost of input prices to corporations. That additional cost must be accounted for in the production process and is ultimately passed on to the consumer.

This isn’t corporate greed. The increased cost to consumers is a byproduct of Wall Street raising the price of commodities to gain profit from supply disruptions.

While it is easy to blame corporate greed for higher prices, it is not the fault of corporations. As noted, corporations are responding to higher input costs to maintain profitability for both shareholders and to remain in business.

No, corporate greed is not responsible for inflation.

Yes, it is a nice fantasy that corporations should eat higher costs and be benefactors to consumers.

However, corporations are not charities.

Food Also Points To Slowing Personal Consumption

Thursday’s Commentary led with a discussion of how sales at major retailers were slowing appreciably. The takeaway from the piece is that personal consumption, accounting for two-thirds of GDP, is slowing. A reader emailed us, “Not so fast with your judgment. “You may be right, but you should also look at spending on food for confirmation.” We agree. Grocery stores, restaurants, and beverage and food distributors can provide more clarity about personal consumption trends.

Our food analysis, shown below, is based on sales from the following companies: Albertsons (ACI- data since 2020), Kroger’s (KR), Starbucks (SBUX), McDonald’s (MCD), Coke (KO), Pepsi (PEP), Chipotle (CMG), YUM Brands (YUM), Sysco (SYY), and ADM (ADM). We took the same approach and compared each company’s current annual revenue growth to 2021-2022 and the three years before the pandemic. We also weighted their revenue growth and calculated a weighted aggregate sales growth. Remember that the graphs and the results from the first Commentary do not account for inflation.

The first graph shows that five of the nine food companies have higher sales growth today than in the pre-pandemic period (we exclude ACI as there is no data for the period). However, all ten companies except McDonald’s have lower sales growth than in 2021-2022. The graph on the right shows that the weighted annual sales growth is now the lowest since 2017.  This analysis confirms our prior work that personal consumption growth has slowed considerably. Now, considering inflation is about 2% higher than in the pre-pandemic period, our thesis strengthens.

food sales

What To Watch Today

Earnings

  • No notable earnings announcements

Economy

Market Trading Update

Last week, we discussed that the markets surged to all-time highs as a plethora of bad economic data and a weaker-than-expected inflation print lifted hopes of Fed rate cuts in the coming months. Over the last few trading days, the markets had to focus on the minutes from the last FOMC meeting and earnings from Nvidia.

The FOMC minutes revealed little new information. Inflation remains stickier than expected, keeping the Fed on pause from cutting rates. However, recent speeches by Fed members did not indicate any real consideration of hiking rates. The market was fairly calm following that release as all eyes focused on Nvidia earnings.

As has been the case over the last few quarters, Nvidia failed to disappoint. It announced earnings and revenue that beat expectations, announcing a 10-1 stock split in the process.

“Nvidia reported revenue for the first quarter ended April 28, 2024, of $26.0 billion, up 18% from the previous quarter and up 262% from a year ago. For the quarter, GAAP earnings per diluted share was $5.98, up 21% from the previous quarter and up 629% from a year ago. Non-GAAP earnings per diluted share was $6.12, up 19% from the previous quarter and up 461% from a year ago.”

Such lifted the stock by 10% on Thursday, but the rest of the market sold off as traders took profits from the FOMC announcement.

From a technical perspective, the markets remain on a current MACD “buy signal” and have cleared all previous resistance levels. Furthermore, the 20-DMA crossed above the 50-DMA, providing additional support to any short-term market correction. The 20-DMA will now become running support for the market. While corrections should be expected, any pullback should be contained by the 20-DMA, which will provide an entry point to add exposure as needed.

When the MACD signal crosses, such will provide the next signal to reduce risk and rebalance exposure as needed. For now, the bulls maintain control of the market narrative. Trade accordingly.

The Week Ahead

The holiday-shortened week should be quiet. The only notable economic release will be the PCE data on Friday. Core PCE, the Fed’s preferred gauge for inflation, is expected to increase by 0.2% monthly and 2.7% annually. Both are 0.1% below last month’s figures. Given the recent slowdown in retail sales and our recent sales analysis of retail and food distributors, it will be interesting to see if the PCE personal spending numbers confirm a weakness in consumption.

Mind The Revisions

At first glance, the March durable goods data was much better than expected, coming at +0.7% versus expectations of -0.8%. While the beat of 1.5% is very impressive, March was revised significantly lower from +2.6% to +0.8%. The graph below, courtesy of Zero Hedge, shows this is not a one-off instance. Per Zero Hedge:

Over the last 14 months, durable goods orders have been revised lower 9 times (and the downward revisions are considerably larger than the upward revisions).

durable goods revisions

It’s not just durable goods that have recently seen revisions lower. The four graphs below show significant downward revisions to the BLS payroll data, manufacturing new orders, industrial production, and new home orders. While not shown, PPI has been revised lower in four of the last seven months by a net -0.8%.

Most economic data is revised, as surveys and limited data make it challenging to furnish the market with both accurate and timely results. While this is widely accepted, we find the preponderance of negative revisions versus positive ones unusual. Some will blame the revisions on politics, and others will say these are clear signals that recession is near. Regardless of whether either or both are correct, it is essential to consider the current data points and the trend of the last three and six months, which capture revisions.

payrolls revisions
new orders revisions
industrial production revisions
new home sales revisions

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Nvidia By The Numbers

With the stock price of Nvidia (NVDA) now trading at over $1,000 per share, Nvidia stock has been up 270,000% since it went public. If you bought 1000 shares of Nvidia at its IPO in 1999 for a mere $376 and held them until today, congratulations—you are now a millionaire. We present a few numbers to help you better appreciate Nvidia’s meteoric rise.

  • Nvidia is now larger than the entire German stock market and five times the size of companies like Walmart, Exxon, and Visa.
  • Nvidia posted quarterly revenue of $26 billion, up 18% from last quarter and a whopping 262% from a year ago. Its data center revenue is up 427% from a year ago.
  • The aggregate market cap of the 174 smallest S&P 500 stocks is equal to that of Nvidia.
  • Its market cap is greater than the GDP of every state except California and Texas.

To accommodate AI, we need AI data centers. These require specific chips, of which Nvidia is the leading producer. Given its dominant position and surge in data center construction, Nvidia’s stock is today’s poster child for AI. However, other less-followed industries will also greatly benefit from data center growth. On Wednesday, we published Part One of AI Data Centers and EVs Create Incredible Opportunities, describing the enormity of building out the power grid to accommodate AI and EVs. We will follow up with discussions of stocks and industries that will likely benefit. While we can’t expect 270,000% gains like NVDA, many stocks involved in the power grid buildout and modernization will see substantial growth.

As hockey great Wayne Gretzky once said: “Go to where the puck is going to be, not where it has been.

nividia nvda

What To Watch Today

Earnings

Economy

Market Trading Update

As noted yesterday, the market was posting all-time highs ahead of the release of the FOMC minutes and Nvidia’s earnings report. However, as we have noted over the last several trading days, the market was overbought and deviated from its 20- and 50-DMA, which would likely limit upside in the near term. Even with blowout numbers from Nvidia, the market struggled yesterday as it continued consolidating recent gains over the last week. There is currently a 2% decline for a retest of support at the 20-DMA. With the market overbought and the MACD signal starting to close in on a short-term sell signal, a pullback and retest of that support seems highly probable.

Continue to manage risk accordingly. There is nothing currently “wrong” with the market that would suggest a deeper decline in the coming month or so. However, it is always a good practice to manage risk along the way.

Market trading update

PMI Surveys Scares Bond Investors

The Flash PMI manufacturing and services surveys were both better than expected. Manufacturing continues improving and has been in expansionary territory for two months. Services, which were trending lower, jumped from 51.3 to 54.8 and are now at their highest level in a year.

Bond yields rose on the news as PMI suggests the Fed will not hike rates this year. Bond investors are concerned that prices will remain at current levels, especially if the service sector remains strong. To their point, input and output prices rose, although manufacturing, not services, prices account for most of the price growth. Interestingly, companies are having trouble passing on higher prices to their consumers. Per the report:

However, the overall rate of selling price inflation remained below the average seen over the past year.

Of concern in the reports is employment. Despite what appears to be an optimistic outlook by business managers, the report notes the following:

Employment fell for a second successive month in May, contrasting with the continual hiring trend seen over the prior 45 months.

We caution that the Flash PMI is based on mid-month data and sometimes diverges from the monthly ISM report. We will wait for the next round of ISM and the regional Fed survey to confirm whether the Flash PMI survey is representative of economic activity.

flash pmi

Credit Losses Bring Back Memories of 2008

According to Bloomberg, investors in a AAA-rated CMBS tranche experienced their first loss since 2008. The graphic below, courtesy of Deutsche Bank and Bloomberg, shows that the 1740 Broadway CMBS security has wiped out holders of all classes except the highest-rated AAA tranche, which will receive 74 cents on the dollar.

CMBS, or commercial mortgage-backed securities, hold loans on one or more properties. Often, they are structured such that the loans cash flows are prioritized to classes based on risk. For instance, the AAA holders of 1740 Broadway were supposed to be paid first, then AA, and so on down the line. In this case, the loan holders went bankrupt, and based on the data in the graphic, the sale of the property, 1740 Broadway, was only worth a third of the original loan amount.

We suspect that, given that some commercial office real estate is selling for small fractions of its original worth, this won’t be the last CMBS-AAA loss we hear of.

aaa cmbs losses

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The Risk Of Recession Isn’t Zero

As we discussed recently, Wall Street economists increasingly believe the risk of recession has fallen sharply. To wit:

Economists don’t think the economy will get even close to a recession. In January, they, on average, forecast sub-1% growth in each of the first three quarters of this year. Now, they expect growth to bottom out this year at an inflation-adjusted 1.4% in the third quarter.” – WSJ

Of course, this outlook seems contradictory to numerous indicators with a long history of preceding recessionary onsets, such as yield curve inversions. As shown, we currently have the longest, consistent period in history where the yield spread between the 10-year Treasury bond and the 3-month Treasury bill is inverted. Yet, no recession has manifested itself this time.

Another historically reliable recession indicator is the 6-month rate of change of the Leading Economic Index. As with yield curve inversion, the current depth and duration of the LEI’s negative readings have always coincided with a recession. But again, the U.S. has avoided such an outcome.

Of course, the Federal Reserve’s tightening of monetary policy through one of its more aggressive rate-hiking campaigns also failed to push the economy into a recession.

Given that the economy has continued to defy recession expectations, it is understandable that economists have “given up” anticipating one.

But is the risk of recession gone?

The Risk Of Recession Isn’t Zero

There is a very funny meme circulating on social media. Yes, cute, cuddly animals seem safe, but “the risk of them murdering you is low but never zero.”

Such seems like an apropos meme, given that the economy’s recession risk may be low currently, but it isn’t zero.

As discussed previously, one of the primary reasons why the economy has defied the recessionary drag from higher borrowing costs has been the ample supply of fiscal support through previously passed spending bills such as the Inflation Reduction Act and the CHIPs Act. When combined with stimulus checks, tax credits, and moratoriums on various debt payments like rent and student loans, the amount of monetary support for consumption supported economic growth as the Federal Reserve tightened monetary policy.

What is crucial to understand is that the surge in monetary support acted as an “adrenaline” boost to the economy. Yes, many economic data series suggest the risk of recession is elevated. However, the surge of monetary injections sent the economy into overdrive, as evidenced by economic growth in 2021.

The crucial point to understand, and what eludes most economists, is that the economy slows as that “adrenaline” boost fades. Had the economy been growing at 5% nominal, as in 2019, the decline from the post-pandemic peak would already register a recession. However, given that nominal growth neared 18%, it will take much longer than normal for growth to revert below zero. To show this, we looked at the number of quarters between peak economic activity and the entrance into a recession. Using that historical analysis, we can estimate the reversion of economic growth into a recession could take roughly 22 quarters. Such would time the next recession in late 2025 to mid-2026.

Many things could certainly happen to lengthen or shorten that estimated time frame. However, the importance is that a reversal of growth from elevated economic growth rates can take much longer than normal. Another similar period was the 25 quarters of slowing economic growth before the 1991 recession.

For investors, while consensus estimates of economists put the risk of recession very low, it is not zero.

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Economic Data To Watch

Given the long lag between recessionary indicators and economic recession, it is unsurprising economists gave up anticipating a recession. However, while the recession has not happened yet, it does not mean that it still can’t. We should pay special attention to data historically correlated to economic growth.

For example, real retail sales have weakened materially since the peak of economic activity in 2021. As shown, retail sales make up roughly 40% of Personal Consumption Expenditures (PCE). Therefore, it is unsurprising that retail sales precede PCE changes. The importance of that lead is that PCE comprises nearly 70% of the GDP calculation. Therefore, as consumer demand slows, the economy slows, and inflation falls. Real retail sales are now negative as consumers run out of excess savings, likely slowing economic growth further in the quarters ahead.

Of course, without employment, it is hard to increase economic consumption further. Notably, while we count part-time employment, those jobs do not provide the wages and benefits of full-time employment to support a family. Unsurprisingly, a key leading indicator to every previous recession has been a reversal of full-time employment.

While it is certainly possible that the economy could avoid a recession given additional monetary or fiscal support, government and business investment comprise a much smaller contribution to GDP than consumer spending. As noted in “Bad News Is Good News,” with consumers strangled between declining wage growth and higher living costs, the ability to fuel the difference with debt is becoming increasingly challenging.

“The consequence of that lack of income growth is that they are the first to run into the limits of taking on additional debt.”

Pay attention to the economic data in the future. While it may take much longer than many expect, we suspect the risk of recession is likely greater than zero.

Targets Sales Woes Are The Norm In The Retail Sector

One repeated theme in the current round of earnings is that personal consumption is slowing down. Last month, McDonald’s, Starbucks, and many other retail-oriented stocks fell on weak sales. This week, we are reminded again via poor sales from Target, Lowes, and Macy’s. All three reported a decline in sales compared to last year. Target’s sales beat estimates slightly, while its earnings per share fell short. While that may not seem too bad, expectations for Target’s sales were meager. Target, which opened down 8% on Wednesday, had the following to say:

Higher interest rates, economic uncertainty, high credit-card balances and other factors have [consumers] concerned, and consumer confidence took a meaningful dip in April.

To put a broader context into the declining retail sales growth in companies like Target, Walmart, and, in general, the “cheaper” retail sectors, we compile revenue growth data for a number of similar companies and compare them to prior earnings and in the aggregate. The graph on the left shows that only two companies, Walmart and Dollar Tree, have increased sales growth compared to the 2021-2022. Walmart is the only one showing higher sales growth today versus the three years before the pandemic. The second graph weights the annual sales growth for the ten companies. As we share, the aggregate weighted sales growth has reached its lowest since 2017.

retail sales growth is slowing target walmart amazon costco

What To Watch Today

Earnings

Economy

Market Trading Update

In yesterday’s commentary, we discussed how the release of the FOMC minutes could well impact the market. Such happened as the market sold off after its release as the minutes reiterated much of the commentary from recent Fed speakers that rate hikes are likely on hold near term. While there is always some dissension among Fed members, there were a couple of quotes that spooked the market.

Various participants mentioned a willingness to tighten policy further should risks to inflation materialize in a way that such an action became appropriate.

Although monetary policy was seen as restrictive, many participants commented on their uncertainty about the degree of restrictiveness.

Participants suggested that the disinflation process would likely take longer than previously thought.

While these points were just discussions during the meeting, the Federal Reserve unifies around the decisions it makes with Chairman Powell leading the way. From all of the recent speeches from Fed members as of late, they remain clear that rate cuts will likely begin at the September meeting with the reduction of the Fed balance sheet beginning in June.

Nonetheless, with the markets overbought and well deviated from longer-term means and sentiment becoming exceedingly bullish, the market was ripe for a pullback. The 20-DMA, which has now crossed above the 50-DMA, will return as key support for the market advance, as we saw at the beginning of this year. A pullback to support should be expected; all that is needed is a short-term catalyst. Use pullbacks to add exposure as needed.

Sahm And Kantro Models Call For A Recession

The Sahm and Kantro recession indicators are closely related but process the data differently. Both rely on the unemployment rate and its current status versus prior readings. Unemployment tends to be very cyclical. It is either rising, and the economy is in or near a recession, or it is falling and the economy is growing. Neither model has missed a recession since 1953 nor given a false positive since 1970.

Given the recent uptick in unemployment, the Kantro model signals a recession, and the Sahm model is very close. The model rules and a graph showing prior data are below. In the graph, the black vertical denotes the recession signal.

sahm and kantro recession signals
sahm and kantro recession signals

Bitcoin Mining Consumes Enormous Amounts Of Electricity

Bitcoin’s halving in April means it will now take twice as much computing power to mine one bitcoin as it did prior to the halving. To put perspective on the amount of electricity that bitcoin miners use, we share some excerpts from a recent report by Paul Hoffman at Best Brokers.

Currently there are 450 Bitcoins mined daily and this costs the mining facilities a whopping 384,481,670 kWh of electrical power. This comes at 140,336 GWh yearly and is more than the annual electricity consumption of most countries, save for the 26 most power-consuming ones.

When this power expenditure was resulting in 340.82 BTC mined up until 20 April 2024 before the halving, it was still economically feasible to mine Bitcoin in the U.S. by using grid power entirely. This is no longer the case and the fact the U.S. mining facilities are still operational points to the notion that they are relying mostly on their own renewable energy sources and/or have special deals with suppliers.

electricity consumption graphic

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Market Divergence Prompts An Important Question

Recently, we have had confusing divergences in the major stock market indexes,” starts a reader’s question. He goes on to ask why there are days like Monday when one index is down by a decent amount and another posts moderate gains. On Monday, for instance, the Dow Jones Industrial Average fell by 0.50%, The Nasdaq 100 rose by 0.70%, and the S&P 500 split the difference, being up slightly.

Appreciating the weighting and composition of market indexes when considering why such divergences occur is important. For example, Nvidia was up 2.50% yesterday. It has a 6.37% weight in the Nasdaq 100, a 5.10% weight in the S&P 500, and is not in the Dow. Here’s another: Goldman Sachs fell by 1% yesterday. It is the second largest holding of the Dow at 7.7%, but it only represents .34% of the S&P 500 and is not in the Nasdaq.

As the examples highlight, the stocks in the index matter, as do their weightings. The Dow is weighted by price and is composed of stocks from a wide swath of the economy. The S&P 500 represents the largest 500 stocks by market cap traded in the U.S. Unlike the Dow, the stocks are weighted by their market caps. The Nasdaq is also market cap-weighted and comprised of large-cap companies, many with a technology orientation that is determined by a committee. The graph below shows how weightings can vary significantly between indexes. Given these significant weighting and composition differences, it’s unsurprising that stark market divergences can occur when certain stocks and sectors are in favor, and others are out of favor.

weightings of the dow versus market cap

What To Watch Today

Earnings

Economy

Market Trading Update

Yesterday, we discussed the extended deviations in most major markets and sectors, particularly gold and gold miners. Of course, today is probably the season’s most anticipated earnings report, which Nvidia (NVDA) will announce after the bell. There is little guesswork at their earnings report will be a beat of estimates, however, it will be the forward guidance on GPU sales that makes or breaks the stock after hours. As we have seen this year, stocks that provide in-line or weaker guidance have been decently punished. Stocks that have provided optimistic guidance have been rewarded. We can lay out a basic risk/range analysis for NVDA post-earnings with that knowledge.

First, NVDA is already trading well into the top of its 52-week range. Estimates for the current quarter are $5.59/share for the current quarter and $5.95 for the next quarter on expectations of $24.645 billion in revenue. That part is set pretty high going into next year, with full-year revenue estimates at $144.427 billion. (This data chart is found in SimpleVisor)

The chart below uses a standard Fibonacci retracement sequence to estimate the potential gain and loss following the earnings announcement. This is just a guess, and reality could be anywhere along or outside the current spectrum, depending on the announcement. However, our best guess is that if the announcement exceeds expectations, we should probably expect a 10%ish gain, given that NVDA is already trading 2 standard deviations above its 50-DMA. A disappointment could lead to a decline to retest the April lows, which would border on 20%.

Nvidia earnings chart

Given a risk/reward ratio of 2:1, such is why we reduced our position in NVDA back to model weight yesterday. Once we are past earnings, we can decide the next entry point to add back to our holdings if warranted.

Skillman Grove Research Offers Caution

In their latest piece, Jim Colquitt provides readers with a needed perspective on where the market is and what may lie ahead. To wit;

All else being equal, this would suggest that you should skew towards being long the market. With that said, there are times when the most prudent thing to do is to take some risk off the table.

While a grind higher is certainly possible, in his opinion, he offers readers caution, particularly if a recession is in the near future. He notes that the market drawdowns of the last three recessions ranged from -35.4% to -57.7%. Equally importantly, returning to prior highs can take a lot of time. While 2020 was unique and only required half a year to recover its losses, the recessions of 2008 and 2001 took 5.5 and 7.3 years, respectively.  

Throwing additional caution to the wind, Jim brings up a concerning model. To wit:

The market may continue to move higher from here; however, leveraging the work I’ve done with my “Average Investors Allocation to Equities” model (read more here), I would suggest that extended bull market runs typically do not begin from this point in the economic cycle.

His graph below shows that forward returns tend to be low when investors have high equity allocations. Based on the graph, a negative return over the next ten years is a reasonable forecast. However, the graph doesn’t show how the returns of the next ten years will play out. Might the market continue higher for five years, fall significantly in year six and then grind higher? There are infinite iterations. The advice is to be aware of the current situation and be ready to protect yourself. However, understand that bull markets are hard to predict and can often run longer and higher than most investors expect.

investor allocation to equities jim colquitt

Underlying Inflation Pressures Are Easing

The graphic below from STCA and Bloomberg shows that the share of CPI categories with more than 3% inflation (yellow) is falling rapidly. At the same time, the share of components with negative inflation readings is increasing. While this is a good measure of the breadth of inflation, it does not account for weighting. As we have noted, shelter prices account for 40% of CPI. So, as shelter prices go, so goes CPI.

breadth of inflation

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AI Data Centers And EVs Create Incredible Opportunities

Some winners from the artificial intelligence (AI) and electric vehicles (EV) boom are easy to spot. For instance, shares of Nvidia, Microsoft, Tesla, and other companies have posted significant gains, anticipating a surge in future revenue and profits.

The development of AI data centers and the continued growth of EVs will benefit industries and companies that are not yet as closely followed. As a result, the stock prices of some companies in these industries may have some catching up with those mentioned above.

This article focuses on the potential beneficiaries of the significant investment necessary to upgrade, expand, and run the nation’s power grid to accommodate AI data centers and the continued growth of EVs. We follow up with Parts Two and Three to drill down to the industries and companies that may benefit most from the coming changes to the power grid. 

To help appreciate the power grid expansion needed to run AI data centers, consider the following comment from Lal Karsanbhai, CEO of Emerson Electric.

AI data center racks consume significantly more power than traditional data centers with a search on ChatGPT consuming 6 to 10 times the power of a traditional search on Google.

A Lesson From Levi Strauss

Before revealing the lesser-appreciated beneficiaries of the AI and EV booms, we share the genius of Levi Strauss. Born in 1829, Levi Strauss opened a branch of his family’s dry goods business in San Francisco during the gold rush. Gold miners were flocking to the region and stocking up on goods. They needed items like pickaxes, food, and clothing to help them in their quest to make fortunes.

In 1873, Levi invented a more durable brand of pants for miners, made of denim and using metal rivets. Today, these pants go by the name of blue jeans. Levi smartly realized that handsome returns could be had by supplying the miners. Therefore, one needn’t risk their fortunes or life and limb to profit from a game of chance like gold mining.

Levi profited dearly from the gold rush. But, unlike most gold miners, his profits were consistent and lasting. His ingenuity still pays big dividends to his descendants.

Let’s uncover the next Levi Strauss of the AI/EV rush. These not-so-obvious companies serve as critical lynchpins to maximize AI and EVs’ value via the power grid.

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Status of the Power Grid

We start with a brief summary of the power grid from the EIA.

Electricity generated at power plants moves through a complex network of electricity substations, power lines, and distribution transformers before it reaches customers. In the United States, the power system consists of more than 7,300 power plants, nearly 160,000 miles of high-voltage power lines, and millions of low-voltage power lines and distribution transformers, which connect 145 million customers.

Local electricity grids are interconnected to form larger networks for reliability and commercial purposes. At the highest level, the United States power system in the Lower 48 states is made up of three main interconnections, which operate largely independently from each other with limited transfers of power between them.

us power grid map

The EIA estimates the US generated 4,178 billion kilowatt-hours (kWH) of electricity in 2023. Fossil fuels account for 60% of the total, with natural gas and coal being the two largest. Nuclear and renewable sources account for most of the remaining 40%.

In the future, not only will the power grid need to be modernized and expanded to supply more power, but the political and public pressure to make it environmentally cleaner will likely be more powerful. The EIA expects global power-generating capacity to increase by 30% to 76% by 2050.

Given the size of the US economy and the number of US-domiciled companies leading the global AI and EV industries, a good portion of the increased global power needs will likely occur on US soil.  

Starting From Behind

As many of you can attest, the power grid increasingly exhibits outages due to extreme temperatures. The problem is multifaceted. As renewable energy resources become a larger share of the electric generation resource base, the system grows inherently more sensitive to extreme weather events. Traditional resources that are ill-prepared for new extremes are also showing vulnerabilities. Consequently, expanding the power grid requires utility companies to also invest in significant upgrades. For example, among these upgrades are new federal regulations requiring additional cold weather preparations for electric generators.

Per the WSJ

A report last year by the American Society of Civil Engineers found that 70% of transmission and distribution lines are well into the second half of their expected 50-year lifespans. Utilities across the country are ramping up spending on line maintenance and upgrades. Still, the ASCE report anticipates that by 2029, the US will face a gap of about $200 billion in funding to strengthen the grid and meet renewable energy goals.

The article estimates that the investment shortfall could accumulate to $338 billion by 2039. That estimate will, unfortunately, prove to be too low. The article was written in February 2022, before the massive energy demands for AI data centers were fully appreciated.

The bottom line is that utility companies, other power distributors, and municipalities must invest hundreds of billions of dollars over the next decade to modernize and expand our power grids.

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The Impact of EVs and AI Data Centers on the Power Grid

EVs

Assuming the acceptance growth rate of EVs continues, the electricity demand will increase substantially. The EIA estimates that US EV sales could surpass 3.5 million in 2025. That number could rise to over 8 million by 2030. Furthermore, if improvements to EV batteries to boost the driving range per charge and the number of charging stations increase rapidly, the EIA 2030 estimate could fall well short of reality.

On a side note, as we wrote in Is Toyota The Next Tesla, solid-state batteries, expected to be produced by Toyota as early as 2027, could be a game changer that dramatically boosts demand for EVs.

For context, EV sales increased from 1 million in 2022 to 1.6 million in 2023 (per MarketWatch). Edmunds estimates there are about 3.3 million EVs in the US, accounting for only 1% of the total vehicles. 

us electric car sales

Estimates suggest that if EVs were to replace a significant portion of internal combustion engine vehicles, electricity demand could increase by 20% to 40% over the next few decades. Based on the quote below, that may be a gross underestimation.  

PG&E expects system demand to increase up to 70% over the next two decades as more EVs are added.” – Utility Dive

Not only is more electricity needed, but the power grid must also be upgraded to account for the timing of EV-related energy demands. EV charging, mainly if done simultaneously during peak hours, like early evenings, can lead to higher than current peak loads.

AI Data Centers

AI data centers alone are expected to add about 323 terawatt hours of electricity demand in the US by 2030, according to Wells Fargo. The forecast power demand from AI alone is seven times greater than New York City’s current annual electricity consumption of 48 terawatt hours. Goldman Sachs projects that data centers will represent 8% of total US electricity consumption by the end of the decade.CNBC

From the same article comes the following quote from Robert Blue, CEO of Dominion Energy

“Economic growth, electrification, accelerating data center expansion are driving the most significant demand growth in our company’s history, and they show no signs of abating,”

Dominion Energy projects that demand from data centers in Virginia will more than double by 2030. Northern Virginia hosts the largest number of data centers in the country.

While researching this article, we came across many forecasts and comments like the ones above. The bottom line is that AI data center growth will be explosive. Consequently, the power demand will grow substantially.

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Summary

AI and EVs can potentially increase the nation’s productivity growth, which would go a long way toward boosting economic growth. However, with the potential benefits come significant investments. Some companies have already made massive investments in those industries. Others, like those involving the power grid, are just getting started.

We will follow this article with two more focusing on the industries and some stocks best situated to benefit from the modernization and expansion of the power grid and those that can help the utilities meet environmental goals.

Nvidia Earnings: What To Expect

This Wednesday’s Nvidia (NVDA) quarterly earnings announcement will be the most watched earnings report of the quarter. Not only will Nvidia’s shareholders pay close attention, but many non-shareholders will watch as the results could have a big impact on the entire market. Quite simply, not only has Nvidia’s stock been the poster child for all that AI offers, but its earnings have been a massive driver of S&P 500 earnings. The graph on the left, courtesy of BofA Global Research, highlights that Nvidia’s earnings have accounted for about a third of the entire S&P 500 earnings growth over the past two quarters.

So what is the market expecting? Wall Street consensus expectations are for revenue growth of more than +230% and earnings growth of +400%, year over year. As shown on the right side, options prices imply a +/- 8.5% move on Nvidia’s earnings report. That equates to roughly $200B in market cap. Put another way, Nvidia is expected to add or lose McDonald’s market cap ($196B) Wednesday afternoon. Beating expectations may not be enough to push Nvidia’s stock higher. Given its incredible outperformance, investors may not only want revenues and EPS to come in above estimates but also be banking on the company to increase its earnings guidance for the coming quarters.

nvidias earnings

What To Watch Today

Earnings

Economy

Market Trading Update

As discussed yesterday, the market continues to trade bullishly but is getting overbought on many levels. Such was evident in this weekend’s risk/range report, with many sectors and markets trading well above long-term moving averages. As noted, double-digit deviations from long-term means tend to be corrected over time. However, in the short-term, these bullish trades, driven by momentum and narrative, can last longer than you think.

One of the more extreme deviations is in gold and gold miners, which are extremely overbought and extended from long-term means. As shown in the chart below, historically, large deviations in gold from the 200-DMA typically correlate with peaks in the metal. Those peaks typically lead to larger corrections to revert those deviations. Therefore, if you are long gold and gold miner stocks, they have had a great run. Don’t forget to take profits. (That doesn’t mean sell everything.)

Is AI A Bubble, A Sustainable Trend, Or Both?

As explemplified by Nvidia, stocks related to AI have been the market leaders recently. The incredible performance of some AI stocks leads some to compare the current period to 1999. At that time, tech stocks related to the web were flying high on expectations for massive earnings growth. So, we must ask ourselves whether AI is also a bubble or if the market might be correctly pricing for significant earnings growth in the future. We rely on George Soros, one of the most successful investors, to opine.

George Soros’s theory on how stock market bubbles are formed and popped states, “Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend.”

ai bubble george soros

The Basic Materials Sector Takes The Week

As the first graph below shows, basic materials led the week up over 3%. Despite the outperformance, the sector remains oversold, as shown in the second graphic, courtesy of SimpleVisor. Utilities remain the most overbought sector. SimpleVisor allows us to compare utilities to the materials sector to see if a new rotation, away from utilities toward materials, may be at hand. The top graph in the third graphic shows the price ratio of utilities to materials. The nearly year-long downtrend has recently broken higher as utilities have significantly outperformed materials over the last month.

The relative outperformance may still have more room to run. Still, the technical indicators below the utilities materials ratio graph show the ratio will likely consolidate or trend lower in the coming weeks. The relative performance is now 2.35 standard deviations extended (fourth graphic below), which also argues for a break in the trend, even if temporary.

weekly sector performance materials
sector performance simplevisor
utilities vs materials technical indicators
utilities vs materials z score excess return

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