In this issue I write about how US and global liquidity is changing. I think this is the defining factor affecting US stock markets this year.

Before I start talking about US and global liquidity, I want to discuss a rather interesting tit-for-tat between Coinbase and the CME Group (the company operating the US’s largest financial derivatives and commodities exchange).

As you know, Coinbase runs the US’s largest crypto exchange and earns most of its revenues from trading fees.

The CME Group, on the other hand, runs an exchange that trades commodities (e.g. oil, orange juice, coffee beans) and derivatives (e.g. options).

Interestingly enough, on May 16th, both companies launched opening salvos into each other’s markets.

The Financial Times reported that the CME Group plans to launch spot markets for cryptocurrencies and Coinbase announced that it’s launching markets for oil and gold.

Caveat: technically CME Group already runs Bitcoin and Ether futures markets but these markets have been active for a long time and Coinbase earns a large chunk of its trading revenues from spot markets rather than futures.

At face value, it’s surprising that Coinbase would find itself facing staunch competition from a company that’s as foundational and deeply embedded into the traditional financial markets as the CME Group but on closer inspection, it does make sense.

Bitcoin and Ethereum are considered commodities by US financial regulators so why shouldn’t the CME Group run spot Bitcoin and Ether markets?

At a high level, I think Coinbase will be fine. It’s still the retail investor’s most trusted company for the trading and storage of crypto and the company has always faced staunched competition from other crypto exchanges.

The CME will be slow to grow its market share, partly because it’s a new entrant to a market with entrenched habits and partly because it doesn’t have as long of a track record as Coinbase of securely storing cryptocurrencies.

At the same time, Coinbase is working hard to diversify its revenues away from trading fees, which is crucially important for the company’s long-term growth.

📈 Liquidity Bazooka

Okay, back to the matter at hand.

We’re discussing how the US stock market is moving based on global money flows.

There are three important factors that will drive global money flows in the next few months:

1. First, the US housing market is getting a big boost from the US federal government.

2. Second, there’s a strong possibility that Japan’s rapidly devaluing of the Yen is being used as a tool to pressure the Chinese economy. There are interesting second effects based on how China counters.

3. Third, the Ukraine War continues to escalate and it presents the most pressing, yet undefined, risk for markets.

Let’s start.

Read more

In this issue I write about where I think markets are headed given recent news, and share strategic ideas based on this news.

Before I start, James Gorman, 14-year CEO of Morgan Stanley, recently announced his retirement.

Here are some fun and informative excerpts on M&A deal-making from his parting public interview:

“I flew to Japan overnight to meet with my counterpart, Nobu Hirano (Chairman of Mitsubishi UFJ Financial Group).

We met at the Westin Hotel in Tokyo and it started with me pulling out a napkin, literally on the table, a paper napkin drawing a line down the middle of it and putting on the left hand side of it ‘Nobu wants’ and on the right hand side ‘James wants’.

And I said, What would you want? What do you want out of this?

And he told me his things, and I told him my things and I crossed off the ones that sort of matched and put circles around the ones that didn't.

I said, ‘This is where we need to focus.’

We got a deal done which resulted in what has been phenomenal for Morgan Stanley and phenomenal for MUFG.

You've got to seize the moment to get deals done.”

To get deals done…

“To get deals done, there are four things that matter.

One is the strategic fit. If it’s off strategy, just don’t do it.

Number two is the culture can’t be damaging. It can be neutral, doesn’t have to be additive.

…

The third is the timing of it.

When the door opens, you walk through it. You don’t wait for when it’s convenient for you. You have to act.

…

And finally, obviously, price, and I would say price is the least important.”

Okay, back to the issue at hand.

The Federal Reserve is facing significant domestic and foreign pressures to ease monetary policy (cut interest rates, print more money etc.).

At the same time, the inflation battle is far from over yet.

Energy prices are high and geopolitical risks are the highest they’ve been for years.

The Federal Reserve has recently caved to pressures to ease monetary policy rather than stay tough on inflation.

The Headline: the Federal Reserve has signaled that it’s going to support financial markets for the foreseeable future. The reason is unclear, though it has many good reasons to do so.

This issue dives into the second order effects of this and also discusses an ongoing significant shift in US government policy that must not be ignored.

The Macro Details

Imagine the US financial system as a classroom.

The players in the system are students milling about the room.

In this scenario, the US Treasury is the biggest student in said room, waddling around, clumsy under his own weight, and pushing everyone else around.

The US Treasury was not always like this. Only since a major sickness 4 years ago did he really start overindulging in culinary delights and sized up.

Now, everyone else has to make space for him.

This includes the Federal Reserve, who’s the coolest kid in class. The Federal Reserve sets the mood and the energy of the whole class.

These days, the Federal Reserve constantly has to accommodate the US Treasury.

As awkward as this off-the-cuff analogy I came up with is, it’s quite an accurate representation of the US financial system today.

The US Treasury is indeed the largest player in the financial system. It has to not only refinance $34 trillion in existing debt this year (by reissuing the same treasuries), it also has to issue $2 trillion of new debt.

$2 trillion is a LOT of new debt to push onto the rest of the system.

The schedule for the new debt issuance this year looks like this:

1. Q1: $850 billion

2. Q2: $260 billion

3. Q3: $850 billion

4. Q4: $100 billion ← Presidential Election in November

It’s no wonder the Federal Reserve decided to add ~$50 billion of extra US treasury buying demand each month starting in June.

Inflation is still far from the Federal Reserve’s 2% goal, but the Federal Reserve has signaled that supporting the market is a higher priority than fighting inflation.

Not only does this benefit the US financial system, foreign economies benefit as well.

When the Federal Reserve lowers interest rates / prints money, it weakens the US Dollar. This gives foreign central banks the ability to loosen their own monetary policy without their currencies depreciating too much against the Dollar.

And foreign central banks, especially Japan, are currently chomping at the bit to loosen their own monetary policies.

They’re just waiting on the green light from the US Federal Reserve and the US central bank has given them the green light.

Alright, so what I just wrote about is a super high level view of what’s happening with the global financial system.

Now let’s discuss its second order effects on the US stock market.

Read more

As always, let’s start by reviewing my prediction last week for where the S&P 500 is headed.

Below is the chart of the S&P 500 at the end of last week, annotated with my prediction arrows (the red arrow is the new prediction, the orange arrow is from the week before).

This is how the S&P 500 looks today.

It’s gone up a lot higher than I thought it would, back to the top Bollinger Band.

I think a big part of this upwards climb was driven by the Federal Reserve’s surprise massive cut to Quantitative Tightening in the May FOMC meeting last week.

Although a large reduction of the pace of QT doesn’t make headlines as much as changes to interest rates, this was nonetheless a significant easing of monetary policy.

On wards to next week. I’ll share where I think the S&P 500 at the bottom of this newsletter issue.

In this issue I want to talk about US government debt issuance.

As I alluded to in the prior newsletter issue, “Market Pulse: Buffett and Druckenmiller Speak”, I think US government debt issuance is the most important issue facing the market in the next couple years.

The US Treasury has to dump a colossal amount of debt on the market at historically very high interest rates.

Just this year alone, the US Treasury needs to issue $2 trillion in new debt.

As an aside, this is the Treasury’s quarterly debt issuance plan for this year:

• Q1: $816 billion in extra debt issued

• Q2: $243 billion in extra debt issued

• Q3: $847 billion in expected extra debt issued

• Q4: $100 billion in expected extra debt issued

Why is debt issuance so low in Q4? I don’t think it’s a coincidence that the Presidential Election takes place squarely in the middle of Q4 on November 5th.

If interest rates don’t fall, then the US government’s annual interest burden will rise from $1 trillion this year to $1.7 trillion next year!

The big open secret on Capitol Hill and on Wall Street is that this debt situation is going to become untenable.

Warren Buffett is talking about it, Stanley Druckenmiller is talking about it, Jamie Dimon is talking about it. And many more.

👉 The Big Story that I’m talking about here is that the trillions and trillions of dollars of US government debt that is going to be unleashed on markets in the next few years is going to significantly move markets in a bad way. Policymakers will try to get ahead of this by finding new and creative ways to shore up treasury demand. This will move markets in other ways.

These moves are unavoidable because the scale of the problem is on the order of multiple trillions of dollars. This issue starts a conversation on how one should think about and prepare to navigate this US government debt crisis.

Read more

Below is the annotated S&P 500 chart that I shared in the previous Market Pulse Premium issue sent out last Friday (4/26).

Let’s see how the market has moved since then.

I expected the S&P 500 to consolidate around the mid Bollinger Band line after the large bounce last week and so far, despite lots of volatility over the past few days, it looks like it’s doing just that.

This was another successful probabilistic call for the past week, and now it’s time to look forward to what’s next.

To have a sense of where we’re headed next, it’s important to review the events of the past week.

This past week, we saw several major economic events happen. The three most important ones that I think should be discussed are:

1. The Federal Reserve’s May FOMC meeting

2. The US Treasury’s Quarterly Refunding Announcement (QRA)

3. The ongoing collapse of the Yen

As expected, we saw the US Treasury announce that the government needs to raise a significant amount of new debt in the next two quarters. Over $1 trillion!

The Federal Reserve wants to help the US Treasury with such a heavy lift in new debt issuance by make a massive surprise reduction in quantitative tightening, from -$60 billion in US treasuries each month to just -$25 billion.

At the same time, on the other side of the globe, the Yen has been free-falling as the Bank of Japan continues to insist on 0% interest rates.

What a busy week!

Here’s what I think are the second and third order effects of the events on the stock market.

💡 But First, Where Is The S&P 500 Headed Next?

Two weeks ago, we saw the market sell off aggressively.

Six red days for the S&P 500. This was something we haven’t seen since the summer of last year.

The market staged a big rebound after the massive selling and now we are going through sideways consolidation.

All this market volatility comes against a backdrop of sticky US inflation, war intensifying in Eastern Europe and the Middle East, and the US Treasury having to issue a huge amount of new debt over the rest of this year.

Given this context, this is how I think the market moves next week.

Chart with prediction arrow below.

Read more

I shared this annotated daily chart of the S&P 500 in Sunday’s inaugural Market Pulse Premium issue.

How did the market move this week?

Looks like the annotated arrow was very prescient.

I mentioned that we were likely going to see the S&P 500 move up to the mid Bollinger Band line and that was exactly what it did (see the top wick in the last candle).

Sweet, this was a good probabilistic call for the past week.

Now it’s time to focus on the future.

ℹ️ Aside: Overall Framework

The overall trading framework that this issue is based on can be summarized as:

1. Having a point-of-view, with probabilities, is better than no point-of-view.

2. You cannot predict the future, so you must be okay with making wrong decisions.

3. Lean into the arithmetic mean over the geometric mean through fractionalization of bets.

   1. Each idea gets a small portion of capital dedicated to it. Ideas with more conviction get more capital. Ideas with less conviction get less capital.

   2. Concurrent bets should have minimal correlation so that a single market event doesn’t break several ideas at the same time and significantly hurt the overall portfolio.

4. Lean into asymmetrical risk-rewards.

   1. In other words, the pay-off for being right should be significantly larger than the loss for being wrong.

   2. If you’re only 10% better at coming up with right ideas than wrong ideas, with reasonable bet sizing and asymmetrical risk-rewards, you can generate significant returns.

   3. Options is an example of an asset with asymmetrical risk-rewards. When an idea is expressed as an options position, it can pay off tremendously if you’re right (Keith Gill turned $53,000 to $50 million in two years) while if you’re wrong, you’ll at most only lost 1x.

5. Iterate fast.

   1. Iterate fast on idea generation and trade execution. Fail fast, succeed fast, and review results often.

For more details, check out these two prior newsletter issues:

1. Two Key Principles of Effective Investing

2. Thinking In Probabilities

For premium subscribers, I elaborated on this framework in the document “Retail Multi-Strat Hedge Fund Emulation” that I’ve shared in the Premium Subscribers spreadsheet.

ℹ️ Aside: Determining Probabilities

I will share a series of probabilities below. You may be wondering how I came up with them.

They represent quick and rough point-of-views based on the qualitative aspects of the market’s recent historical behaviors.

One should interpret them as, “this is more likely to happen, here’s why”, instead of, “here’s a mathematical framework to show why the probability for this happening should be exactly X”.

Every new market environment is different from past environments with many unknown unknowns, so any process to quantify exact probabilities could itself be wildly wrong.

In the face of many unknown unknowns, I find it often better to rely on intuition (Daoism) rather than complicated and time-consuming processes to determine event probabilities.

However, I’m not saying that one should entirely eschew complicated and time-consuming processes. They have their place and I’ll use them when I feel that they’re appropriate.

As Charles de Gaulle observed in his meditation on leadership, The Edge of the Sword (1932), the artist ‘does not renounce the use of his intelligence’ – which is, after all, the source of ‘lessons, methods, and knowledge’. Instead, the artist adds to these foundations ‘a certain instinctive faculty which we call inspiration’, which alone can provide the ‘direct contact with nature from which the vital spark must leap’."

ℹ️ Aside: Fiscal Dominance

Don’t miss the latest newsletter issue on Fiscal Dominance.

I think it’s a very important concept for understanding what’s going on in the market. The Federal Reserve’s economic influence, although still significant, has become increasingly less relevant in this environment of Fiscal Dominance.

In the parting wake of the Federal Reserve emerges the US Treasury which is now dictating the tempo of markets and the economy.

Thoughts On Next Week

So where do I think the market is headed next week?

I think the probabilities are in favor of sideways consolidation around the mid Bollinger Band line towards the top BB band (2 standard deviation move from the 20 simple moving average).

Why do I think so?

Read more

So this is a quick follow-up to the Market Pulse Premium issue I sent out on Sunday evening.

In it, I wrote that I expected a bounce this week and I think this bounce has legs until around the mid Bollinger Band line.

These were the probabilities I gave for this move:

What are the probabilities? Here’s what I think:

• Bounce next week (65%) / Selling continues over the next week (35%)

• Bounce in two weeks (85%) / Selling continues over the next two weeks (15%)

The past two days have shown that this was the right call.

Below is the chart I shared in that issue for the S&P 500. This is a daily chart.

Let’s see what this chart looks like now.

Perfect!

So where are we headed to next? Here’s another look at the chart I shared last issue showing how the S&P 500 moved in a down market from late July to late October.

Be prepared to see choppy movement like this, if we’re really in the start of a major downtrend (which I think is likely to be the case).

What are the probabilities of this?

• Major downtrend for the next quarter (80%) / Bull market returns after this bounce (20%)

Why do I think so?

Read more

This is the inaugural Market Pulse Premium newsletter issue.

The goal of this issue is to be straightforward on exactly what I’m thinking about for the markets right now:

1. Sharing predictions, with probabilities (Thinking In Probabilities)

2. How I plan to express these ideas in the market

3. Reviewing past ideas

The first Market Pulse Premium issue is open for everyone but future issues will be for Premium subscribers only.

ℹ️ Aside: Overall Framework

The overall trading framework that this issue is based on can be summarized as:

1. Having a point-of-view, with probabilities, is better than no point-of-view.

2. You cannot predict the future, so you must be okay with making wrong decisions.

3. Lean into the arithmetic mean over the geometric mean through fractionalization of bets.

   1. Each idea gets a small portion of capital dedicated to it. Ideas with more conviction get more capital. Ideas with less conviction get less capital.

   2. Concurrent bets should have minimal correlation so that a single market event doesn’t break several ideas at the same time and significantly hurt the overall portfolio.

4. Lean into asymmetrical risk-rewards.

   1. In other words, the pay-off for being right should be significantly larger than the loss for being wrong.

   2. If you’re only 10% better at coming up with right ideas than wrong ideas, with reasonable bet sizing and asymmetrical risk-rewards, you can generate significant returns.

   3. Options is an example of an asset with asymmetrical risk-rewards. When an idea is expressed as an options position, it can pay off tremendously if you’re right (Keith Gill turned $53,000 to $50 million in two years) while if you’re wrong, you’ll at most only lost 1x.

5. Iterate fast.

   1. Iterate fast on idea generation and trade execution. Fail fast, succeed fast, and review results often.

For more details, check out these two prior newsletter issues:

1. Two Key Principles of Effective Investing

2. Thinking In Probabilities

For premium subscribers, I elaborated on this framework in the document “Retail Multi-Strat Hedge Fund Emulation” that I’ve shared in the Premium Subscribers spreadsheet.

ℹ️ Aside: Determining Probabilities

I will share a series of probabilities below. You may be wondering how I came up with them.

They represent quick and rough point-of-views based on the qualitative aspects of the market’s recent historical behaviors.

One should interpret them as, “this is more likely to happen, here’s why”, instead of, “here’s a mathematical framework to show why the probability for this happening should be exactly X”.

Every new market environment is different from past environments with many unknown unknowns, so any process to quantify exact probabilities could itself be wildly wrong.

In the face of many unknown unknowns, I find it often better to rely on intuition (Daoism) rather than complicated and time-consuming processes to determine event probabilities.

However, I’m not saying that one should entirely eschew complicated and time-consuming processes. They have their place and I’ll use them when I feel that they’re appropriate.

As Charles de Gaulle observed in his meditation on leadership, The Edge of the Sword (1932), the artist ‘does not renounce the use of his intelligence’ – which is, after all, the source of ‘lessons, methods, and knowledge’. Instead, the artist adds to these foundations ‘a certain instinctive faculty which we call inspiration’, which alone can provide the ‘direct contact with nature from which the vital spark must leap’."

📉 We’re likely at the start of a new major downtrend

The S&P 500 sold off sharply last week.

6 red daily candles in a row, each pushing the bottom Bollinger Band (a 2 standard deviation negative move, with respect to the last 20 days).

At the same time, RSI collapsed from 65 to almost 30 after hanging above 60 for almost 5 months (since early November).

This was an extreme downside move that we haven’t seen for many months.

Typically, after such large downside moves, the market is liable to bounce and hit the mid Bollinger Band line, before selling off again.

Quick Bollinger Band TLDR: the middle BB line, as seen below in orange, plots a 20-period Simple Moving Average (SMA). The blue lines above and below are 2 standard deviation moves from the 20 SMA.

For example, below is how the S&P 500 traded last year from the start of Q3 (August) to the end of October. Lots of selling, a big bounce to the mid Bollinger Band line, more selling, another big bounce, and then even more selling.

In the past few years, S&P 500 has often exhibited this bouncy downtrend pattern during prolonged sell-offs.

💡 As such, I think that the market will more likely than not make one of these big bounces after last week’s significant selling.

What are the probabilities? Here’s what I think:

• Bounce next week (65%) / Selling continues over the next week (35%)

• Bounce in two weeks (85%) / Selling continues over the next two weeks (15%)

ℹ️ Aside: RSI and Bollinger Bands

Price indicators are derivatives of price movements.

Investors use indicators to have a better sense of short-term price action.

Why?

One principle is that short-term price movements are very probabilistic.

For example, the longer price has been pushing the 2 standard deviation line below the 20 simple moving average, the more likely it is to bounce in the short-term.

RSI and Bollinger Bands are very simple and popular indicators that, in my opinion, present the simplest view of short-term probabilities.

Don’t take it from me. These two indicators, especially Bollinger Bands, are very popular among options analysts, and options analysts are the best probability traders in the market.

📉 Shorting the short-term bounce

If the S&P 500 bounces within the next two weeks, the probabilities start to skew toward more selling when it touches or crosses the mid Bollinger Band line.

💡 At that point, I’m going to start looking to short the market.

What are the probabilities?

If a bounce to the mid Bollinger Band line happens within the next two weeks, the probabilities of the next move are:

• Selling continues after the bounce (70%) / The market bounces or levels off (25%)

📈 Start preparing early for a long-term bounce

Although it’s very early to start thinking about a long-term bounce (assuming this is the start of a period of prolonged selling), it doesn’t hurt to keep the next long-term bounce in mind.

When the bounce comes, it’ll likely be large and very profitable, even if you don’t time the entry perfectly.

The market in the past few years has consistently and strongly trended upwards after a period of prolonged selling.

Just look at the non-stop buying from last November to the end of March. You don’t need precise timing to profit from such strong long-term upwards moves.

💡 When does this long-term bounce happen?

If I were to guess, I think the market sells off during the summer and bounces in early H2 (second half of the year). Perhaps at the end of July.

What are the probabilities of this happening? My rough guess is:

• Long-term bounce starts in early H2 (80%) / Selling continues into the election (20%).

Why?

For one, stocks tend to rally hard in the few months before a Presidential election. The US Treasury, which works for the incumbent President, will work hard to add liquidity to the market to increase the chances of their boss winning.

In a Fiscally Dominant financial environment, the US Treasury has a lot of power to set the market’s tempo.

Another reason is that prior periods of prolonged market sell-offs in the past 4 years have not lasted for more than a quarter or two. It’s unlikely for this current sell-off, assuming it’s another big one, to be different from the others.

How could this idea go wrong? More war and more inflation later this year.

ℹ️ Interest Rates and Big Tech

One idea I’ve been thinking about for a while now is how high interest rates actually benefit, rather than hurt, Big Tech companies.

Big Tech companies make so much money that they’re effectively liquidity suppliers for the rest of the market and don’t need to borrow money to sustain or grow the business. As such, they’re largely unaffected by high borrowing costs and instead will earn a lot more money lending out their constantly refilling or overflowing corporate treasuries at high interest rates.

Below are three charts showing how, as the Federal Reserve rapidly hiked interest rates over the past two years, Big Tech interest income has soared alongside rising interest rates.

Reviewing New And Existing Ideas

1. Short TQQQ (technology sector)

   1. Ongoing idea. Working very well. Started the position on April 11th and I should’ve doubled down last week but made the mistake of obsessing over a perfect entry.

2. Short TLT (long-term US treasuries)

   1. Ongoing idea. Working very well. A summer of hot inflation means greater expectations for higher interest rates. When interest rates rise, bond prices fall and vice versa.

3. Long ITA (defense sector)

   1. Ongoing idea. ITA hasn’t moved much since I expressed the idea but the US House just passed a $95 billion foreign defense aid bill (Ukraine, Israel, and Taiwan) and this should be a big boost for the US defense sector (the Democrat-majority Senate is likely to ratify the House’s decision).

4. Long Z (Zillow)

   1. With hot inflation, which means higher interest rates, the Z idea is not doing well. However, it’s a long-term idea (one year) and I see it as just being a bit early. Z has materially out-performed the real estate industry in the past year and I think it will continue to do so.

   2. On the off chance that inflation does fall in the summer for whatever unforeseen reason, the Z idea will start working early.

   3. In a way, the Z idea is a hedge against interest rates falling more than expected, even though my opinion started to shift towards higher inflation throughout the summer and thus higher interest rates.

5. Long INTC (Intel)

   1. I still think Intel is a great hedge against TSMC troubles if China-Taiwan tensions worsen.

   2. I was expecting the new CHIPS Act grants to be very positive for the stock, but didn’t expect fab costs to be so high, pulling the stock down overall (The Register headline: Intel's effort to build a foundry biz is costing far more – and taking longer – than expected).

   3. I think most of the bad news for Intel is out of the way now. This idea is also a long-term idea (one year) and still has a lot of time to play out.

6. Long NKLA (Nikola)

   1. I remain very bullish for Nikola.

   2. This idea played out very nicely in the short-term, with the stock rising from $0.60 to almost $1.20 in the last week of March.

   3. A broad market sell-off coupled with a large stock dilution proposal with little communication from the company sunk the stock afterwards. I don’t see a stock dilution plan as a significant problem. Authorized shares != issued shares and Nikola’s modus operandi has always been to secure enough funding for operations for the next year.

   4. The company’s fundamentals, as it pertains to the build-out of hydrogen fueling infrastructure and sales of hydrogen and battery truck have never been better and the company continues to execute vigorously and successfully towards both.

   5. With the recent large rise in oil prices, alternative fuel sources become more and more valuable. Geopolitical tensions near some of the world’s largest oil-producing regions are very high right now are very high right now and I won’t be surprised if oil continues to climb over the next few months.

   6. Nikola’s achievements

      1. IMC, the largest marine drayage firm in the US, expands its hydrogen trucks order from 10 trucks to 50.

      2. Edmonton, Alberta hydrogen fueling station complete. This came shortly after the completion of the Ontario, California hydrogen fueling station.

      3. Loblaw Companies, a major Canadian supermarket conglomerate, is rumored to be testing Nikola trucks.

      4. Sold 40 hydrogen trucks in Q1, significantly outperforming analyst expectations of 30 trucks.

This past week was a big week for the market with many significant events happening:

• Treasury Quarterly Refunding Announcement (QRA)

• January Federal Open Market Committee (FOMC) meeting

• Non-Farm Payroll data

• Big Tech earnings

• Another regional bank is in trouble

In this issue, we aim to simply and intuitively explain each event and its implications.

For paid subscribers we’ll go over how we plan to navigate markets given these events, discuss AMD’s earnings, and share new trade ideas.

Let’s start.

💡 Treasury Quarterly Refunding Announcement (QRA)

First, what’s the QRA?

The US Treasury announces the amount of debt it expects to issue and the distribution of the debt across different maturities for the next two quarters through QRAs.

QRAs were typically a non-event for the market until last year when it became apparent the US government’s spending (already elevated since the pandemic) was about to surge.

Specifically, the US Treasury is expected to nearly DOUBLE treasury issuance this year to $2 trillion!

The market is worried about this year’s massive increase in government debt, fearing higher long-term interest rates (already at historical highs) and falling bank reserves.

The ultimate effect of both are cuts to spending and valuations across all parts of the economy.

Not good.

As such, how the Treasury expects to issue new debt has become increasingly important and the previously mundane QRAs have recently become market-moving events.

So what happened with the QRA last week?

There was some good news and the market took it in stride.

First, the Treasury expects to borrow $760 billion in Q1, which is $55 billion below estimate (small win) and for Q2, it expects to borrow a reasonable $202 billion.

More importantly the Treasury will reduce borrowing in short-term and long-term treasuries and increase borrowing in the “belly” of the debt maturity curve (AKA 2-year to 7-year treasuries).

This is strategic.

Short-term treasury issuance puts pressure on short-term dollar funding markets, a crucial pillar of financial markets while long-term interest rates hold disproportionately more influence over the economy due to their relationship with significant industries like real estate.

We think it’s a good move by the Treasury to reduce debt issuance in the tail ends of the debt maturity curve. It’s an even-handed approach that reduces turbulence for financial markets.

💡 January Federal Open Market Committee (FOMC) meeting

Over the past few months, the market has picked up hope of the Fed starting to cut interest rates in the March FOMC meeting.

As such, the market is looking for affirmation of this expectation in last week’s January FOMC meeting.

That didn’t happen.

Leading up to the meeting, the market was pricing in chances of a March rate cut to as high as 65%. After the press release, the odds plummeted to just 36%.

The key issue at hand is inflation. Powell wants to see further evidence of inflation falling without specifying what exact threshold is.

At face value, cutting interest rates is a good thing as it makes money cheaper, and thus more available, in the economy. However, rate cuts could also be a negative signal of an impending recession.

In fact, did you know that almost all recessions in the past few decades have started shortly after the Fed started cutting interest rates.

By keeping interest rates high, the Fed is indirectly signaling that it thinks the economy is still strong and doesn’t need support from rate cuts.

As such, counter-intuitively, it’s arguably good news for the economy when the Fed chooses to delay rate cuts.

💡 Non-Farm Payroll Data

In this lop-sided economy, is good news good news, good news bad news, bad news good news, or bad news bad news?

The good thing is the market tends to go up by default so when there’s ambiguity on how to interpret the news, up it is!

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Markets move incredibly fast and we use a combination of up-to-date macro market insights and market structure monitoring (e.g. net MM gamma exposure) to formulate asymmetrical trade ideas with positive convexity and capped downside.

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💡 Big Tech Earnings

I wanted to specifically discuss Google after this round of Big Tech earnings.

Google’s stock fell by almost 8% post-earnings and it’s clear the market is pricing Google as having the most to lose among Big Tech from the emerging AI supercycle.

The crux of the issue is that Search is an incredibly profitable business for Google, running with a 75% profit margin.

However, there’s a growing view in the market that AI-powered Large Language Models like ChatGPT are superior products to Search and will likely take significant market share.

Even if Google launches an LLM that’s on-par or better than ChatGPT, Google’s complete dominance and high margins in Search means that if LLMs do replace Search, Google will lose market share in all cases.

In addition, the market is disappointed with Google’s operating efficiency.

While Meta almost tripled its earnings per employee in the past 15 months, Google’s earnings per employee only increased by 60%.

The market wants from Google a definitive answer for the AI revolution and higher operating margins but the company is dragging its foot on both fronts.

Not good.

💡 Another Regional Bank is in Trouble

The New York Community Bank’s (NYCB) stock price was cut by almost half from its earnings report this week.

After the regional banking crisis early last year, the market is understandably nervous when yet another regional bank comes under stress.

The bank’s commercial real estate portfolio experienced large draw-downs in the quarter and dividends were cut to increase capital on the balance sheet to protect against the losses.

Fortunately, market consensus is that NYCB’s bad earnings report is idiosyncratic to the bank and ultimately a “tempest in a tea cup” scenario.

💎 Important Market Update (for paid subscribers)

For the rest of this issue, we’ll discuss how we think this market will move based on the news this week.

We’ll also have a quick work on AMD’s earnings and update existing trade ideas while sharing new ones.

Read more

Before I start this issue, here’s a quick word on AMD.

On December 14th, I wrote to subscribers in that day’s Market Pulse issue: “On AMD, I’m exceptionally bullish. I think the stock will, at the very least, run up to its Q4 earnings report in late January on excitement from new orders for the MI300X.”

Then on December 28th, I published 2024 is AMD's Year. Here's Why to all subscribers, presenting my full research on the company.

Since then, the stock was upgraded numerous times by analysts and its price soared from $138 to over $184 earlier this week.

• 1/4: Bernstein’s Stacy Rasgon raises price target: $100 → $120

• 1/4: Piper Sandler’s Harsh Kumar raises price target: $150 → $165

• 1/4: KeyBanc’s John Vinh raises price target: $140 → $170

• 1/5: Mizuho’s Vijay Rakesh raises price target: $130 → $162

• 1/8: Melius Research’s Ben Reitzes sets price target to $188

• 1/16: KeyBanc’s John Vinh raises price target target: $170 → $195

• 1/16: Barclay’s Tom O’Malley raises price target: $120 → $200

• 1/19: Raymond James’s Srini Pajjuri raises price target: $140 → $190

• 1/22: Cantor Fitzgerald’s C. J. Muse initiates with an overweight rating and a $190 price target

• 1/24: NewStreet Research’s Pierre Ferragu upgrades rating from Hold to Buy, price target $100 → $215

• 1/25: UBS’s Timothy Arcuri raises price target: $135 → $220

We put our money where our mouth is and traded on this idea. Last week, we closed out 3 massive trades with a combined profit of $138,262.31.

AMD was a good call and a massively successful trade.

Back to our regularly scheduled programming.

In 8 minutes, understand what systemic liquidity means and why it's such an overwhelming factor in determining stock prices.

What is systemic liquidity? Put simply, it’s the general availability of money in a financial system.

Liquidity is determined by a variety of factors but the institutions with the most control over it are central banks. Central banks can pour liquidity into markets by printing money or lowering interest rates, or they can drain liquidity by shrinking their balance sheet or raising interest rates.

The world’s most powerful central bank is the US Federal Reserve.

For US markets, given their global nature, the two most important pools of liquidity are US liquidity and global liquidity (which US liquidity is a part of).

Why are we discussing liquidity today?

The reasons are three-fold:

1. Liquidity has an overwhelming impact on stock prices.

2. It’s an excellent tool to help explain the current bull market.

3. It also provides important clues on when this bull market will stall.

💡 Liquidity > Fundamentals

The general consensus on how markets price stocks is something along the lines of the company’s fundamentals. For example, many analysts value companies by predicting and discounting future cash flows to determine a present-day price target for its stock.

However, in practice, the market is not a fundamental investor, especially in short time frames.

In fact, there are studies that show that even in time frames as long as 10 years, liquidity plays a more dominant role in driving stock prices than fundamentals.

Here are a few recent practical examples:

• The pandemic crash didn’t start until February’s Options Expiry (OpEx) day, even though the world knew about the virus since December and was furiously searching about it in January and early-February.

• During the pandemic crash, the S&P 500 dropped to almost 2,200. In a span of just 9 months, the index more than doubled and hit a high of 4,800!

• Then as the Fed tightened liquidity in response to a significant bout of inflation, the S&P 500 fell 27% to 3,500 in just 10 months.

These are gargantuan moves that the most sophisticated discounted cash flows spreadsheet could never predict.

Liquidity pushes markets around in fast and furious ways. Ignoring it is incredibly costly for traders and investors alike.

Hedge fund manager Cem Karsan likes to use an excellent analogy to describe how fundamentals and liquidity relate to stock prices.

Imagine you’re on a plane.

A stock’s fundamentals is the altitude the plane is flying at and liquidity is the engine and the fuel. When the engine is working and there’s fuel, the plane will fly no matter what altitude you’re at. The altitude (fundamentals) only becomes important in preventing the plane from crashing when the engine is not working or the fuel runs out (a liquidity shock).

In this sense, fundamentals is like an insurance policy to mitigate losses during crises. In times of normalcy, liquidity is what drives prices forwards.

💡 What about 2023?

If liquidity was really that important, why are we steeped in a bull market with the S&P 500 pushing all-time-highs, when the Fed is keeping interest rates high and shrinking its balance sheet by almost $100 billion a month?

In other words, if the Fed is pulling liquidity out of the system, shouldn’t the stock market fall as well?

Surprisingly, the 2023 bull market is yet another story of liquidity.

While the Fed is pulling liquidity from the system at face value, behind the scenes, liquidity is actually rising.

The modern stock market dances to the tune of liquidity and if you want to understand why it moves the way it does, the first place to look is liquidity.

💡 How Is This Useful, Practically?

So I’ve already written a lot about what is liquidity and why it matters but the most important thing is, how can we make money from this?

One way to do so is to monitor general liquidity trends in the US financial system.

This is definitely not a precise science given how complex the US financial system is but thankfully with all the free information out there, there’re a myriad of ways to get a rough estimate.

As a side note, it’s clear that simply looking at top-line monetary policy metrics like interest rates and the rate of quantitative easing (QE) or quantitative tightening (QT) is not enough given that if we followed just these two metrics, we’d have completely missed the current bull market.

As such, a more detailed and sophisticated approximation is necessary and one of my favorite approximations is Lyn Alden’s US liquidity equation.

The equation uses free public data from FRED, the Fed’s open data platform.

The S&P 500 tracks this indicator pretty well. For example, the indicator turned positive in September of last year, two months before the S&P 500 V-shape recovered in November.

For those that want the details:

• The equation is:

  • Year-over-year change in total assets on the Fed balance sheet MINUS

  • Year-over-year change in the US Treasury General Account’s balance MINUS

  • Year-over-year change in the Fed’s Overnight Reverse Repo balance

• You can play around with the graph here

The general ideas for the equation are that:

• A growing Fed balance sheet means the Fed is conducting QE and thus increasing liquidity.

• A shrinking US Treasury General Account means the US government is spending money in the economy and thus increasing liquidity.

• A shrinking Overnight Reverse Repo balance means Money Market Funds are spending this money in the economy rather than parking it statically in the Fed, which also increases liquidity.

💎 Lifting The Veil - All Our Research Made Available

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• Research

• Trade ideas

• Day-to-day market insights

Markets move incredibly fast and we use a combination of up-to-date macro market insights and market structure monitoring (e.g. net MM gamma exposure) to formulate asymmetrical trade ideas with positive convexity and capped downside.

Paid subscribers get full access to the process, ideas, insights, past trades, and active trades.

Upgrade to Paid (Free Trial)

💡 Liquidity Suggests the Market Is Teetering

The most important topic I want to touch on in this issue is an impending liquidity crunch that’s likely to emerge in a couple months.

First, the Fed’s Overnight Reverse Repo (ON RRP) balance is about to run out and many project this to happen in late March / early Q2.

The ON RRP balance is where trillions of dollars that the Fed printed during the pandemic ended up. You can read more about it in a previous newsletter issue: Market Pulse: The Federal Reserve's 2 Trillion Dollar Hole.

Here’s a 10,000 foot view of the flow of money from the Fed’s “printing presses” to the ON RRP:

1. Fed conducts quantitative easing, printing trillions of dollars and buying US treasuries.

2. This money shows up in the economy as bank reserves.

3. Banks are flush with bank reserves and to reduce balance sheet costs, they offload some reserves to Money Market Funds to earn a higher yield.

4. Money Market Funds park money in the ON RRP as interest rates rise and the supply of short-term treasuries in the economy shrink during 2022.

5. The ON RRP balance rises from $0 to over $2 trillion!

6. In 2023, the debt ceiling was lifted and the US Treasury flooded the market with trillions of short-term treasuries. Money Market Funds redirect QE money from the ON RRP to buy short-term treasuries.

7. By using money in the ON RRP to buy treasuries, Money Market Funds are essentially pouring this money into the economy, supporting interest rates and funding the US government.

8. The ON RRP balance falls from a peak of $2.5 trillion to around $600 million now.

When the ON RRP balance runs dry, a major buyer of US treasuries (Money Market Funds) bows out of the market, potentially pushing interest rates higher.

Not good.

In addition, this is not a good year for weak treasury demand. The US Treasury is expected to nearly DOUBLE treasury issuance this year to $2 trillion to meet government spending.

With the ON RRP balance depleted and the US Treasury issuing treasuries at a record pace, if the Fed doesn’t intervene, bank reserves will start falling drastically throughout the year as reserves bear the brunt of buying the flood of new treasuries.

Not good. Bank reserves are a direct measure of liquidity.

Finally, the Bank Term Funding Program (BTFP), an emergency bank funding facility created by the Fed to stave off the worst effects of last year’s regional bank crisis, is set to expire in March.

The BTFP’s expiration is yet another significant blow to liquidity that will emerge in March.

As such, all eyes will be on the March FOMC meeting (March 19th) to see how the Fed will respond to this impending liquidity crunch. In the meantime, we think an anxious and overheated market will likely sell off in the weeks leading up to this FOMC meeting.

💎 Important Market Update (for paid subscribers)

We’re in a post-OpEx lull period in the market and it’s good to take it slow from here.

Here’s where we think markets are headed as well as single stock opportunities that we’re eyeing.

Read more

In August 2021, prominent CNBC anchor Carl Quintanilla posted an annotated chart of SPY over the past year.

The annotations showed that SPY consistently sold off around the middle of the month for the past 4 months. Each time, the index would immediately bounce back the next day.

A few astute commenters correctly pointed out that each dip happened not just in mid-month but exactly on the month’s options expiry day (otherwise known as monthly OpEx).

In this quick issue, we’ll go over:

1. What monthly OpEx is

2. Why it’s significant to the market

3. And discuss what happened after Quintanilla posted the chart to his 400k+ followers

💡 What’s Monthly OpEx?

Historically, options were only available with monthly expiration dates. This expiration date would fall on the 3rd Friday of each month and is called OpEx.

Although many stocks now have weekly options expirations and SPY even has daily expirations, monthly options still attract the most liquidity from options traders.

💡 What Makes OpEx Important?

Because so much liquidity goes into monthly options, they attract an out-sized amount of open interest (# of open options contracts).

On OpEx, all these open contracts expire en masse and the entire market goes through a mini “reset” process.

The “reset” process is too complex to dive into for this issue but the general idea is that a LOT of money changes hands on OpEx.

This elevated trading volume is caused by a myriad of market dynamics like Options Market Makers unwinding their hedges as expiring contracts fall off their books and options traders actively managing their positions by closing out expiring contracts and opening new ones.

The above is a chart of the S&P 500 over the last six years with monthly OpEx annotated as red dots.

Most dots follow the trend but notice how a few of them occur right on important market turning points.

The paramount example of this is the 2020 pandemic crash.

People were already furiously searching about the virus in January yet the market plodded on, seemingly with nerves of steel.

It was not until mid-February, right after February OpEx, did the crash begin. The stock market free fell throughout March but guess when did it recover? Right after March OpEx.

This is the power and importance of OpEx.

💡 Bounce. Bounce. Bounce. Bounce… And then?

Back to Carl Quintanilla’s tweet.

He found a really consistent pattern in SPY where the market will crash and bounce after every single OpEx.

He shared this pattern with his massive audience. Everyone started to talk about it.

When the next OpEx rolled around, the market started selling off earlier than the prior OpEx’s and then… the very next trading day after OpEx the market gapped down hard instead of jumping back up as before.

This wiped out all the short-term traders piled into this mean reversal trade that Carl Quintanilla was hinting at.

After this OpEx broke the prior trend, future OpEx’s also stopped exhibiting the same consistent sell-off and bounce-back behavior.

The moral of the story? Beware of crowded trades.

When someone as popular (in financial media) as Carl Quintanilla is talking about it, that means the edge has likely been whittled down.

💎 Important Market Update (for paid subscribers)

This week gives us a great roadmap for the rest of Q1. Here’s what I see.

Read more

In 7 minutes, understand how 0DTE options work and how they have profoundly impacted the stock market.

Over the past year, there has been a spectacular rise in the trading of 0DTE (zero-day-to-expiry) options.

The majority of the 0DTE options that are issued and traded have been for the US stock market’s quintessential index, the S&P 500.

Because these options are tied to the S&P 500, their tremendous trading volume has had a profound impact on the entire stock market.

This is why it’s important we talk about them.

Before we discuss this impact, let’s start with a brief primer on options in general and 0DTE options in particular.

💡 How do options work? (in 2 minutes)

An options contract has three fundamental properties: the Underlying Stock, the Strike Price, and the Expiration Date.

When you purchase an options contract, you are purchasing the option to buy (or sell) the Underlying Stock at the option’s Strike Price. As long as you own this contract, you can execute the trade at any time until its Expiration Date.

Here’s an example. Say you own a $160 call option for AMD that expires on June 21st, 2024. Between now and June 21st, 2024, if you don’t see the contract, you have the option to execute it and buy 100 shares of AMD at $160 (each options contract represents 100 shares).

This could be a very profitable deal if AMD goes above $160 during this time.

A CALL option let’s you buy shares at its strike price and a PUT option let’s you sell shares at its strike price.

📈 📉 Options are volatile

Option prices are volatile and can swing both ways much more violently than just holding the stock. Here’s why.

At the time of writing, AMD is at $146. If I own a $160 June 21st call option, there’s no point in executing the contract since I can just buy AMD at $146 on the market, rather than $160.

However, because there’s a chance AMD can go above $160 by June 21st, the call option still has value.

Let’s say the price of the contract is $2 per share right now with AMD at $146. If AMD went up to $170 in the next week, then the contract will have to be worth at least $10 per share.

Why at least $10?

Because I can execute the contract and buy AMD at $160, then immediately sell the shares at $170 for a guaranteed $10 profit.

As such, while the contract's price surged by 400% from $2 to $10, AMD’s price went up by only 16.5% from $146 to $160. That’s a lot of upside volatility!

On the flip side, if AMD’s price is still at $146 after June 21st, the $160 call option would be worthless since there’s no point in a paying a higher price than what the market is offering. However, if you’ve just held the stock, you wouldn’t have lost any money holding it past June 21st.

With significant upside volatility comes significant downside volatility.

💡 What are 0DTE options?

0DTE options, or zero-day-to-expiry options, are options contracts that expire on the same day they are traded.

This makes them exceptionally volatile, being sensitive to any slight price changes in the underlying stock.

In addition, the majority of 0DTE contracts will decay to $0 given their short lifespan (e.g. a $470 call quickly becomes worthless at the end of the day if SPY never gets to $470 or above).

While most stocks have options that expire at the end of each trading week or month, the SPX and SPY have options that expire every single day of the week.

💡 How do 0DTE options impact the stock market?

The recent prevalence of 0DTE options trading has resulted in a corresponding surge in attention and research interest.

Here’re our favorite high level insights from several major financial institutions (big credits to market data firm SpotGamma for their 0DTE impact video).

Who trades 0DTE options?

JP Morgan found that retail investors accounted for a small fraction of 0DTE options trading, making up just 5% of SPX 0DTE volume and 20% of SPY 0DTE volume.

Institutional traders are responsible for the majority of 0DTE options trading.

From Ambrus Capital: “However, when we surveyed ten different market makers that handle electronic and voice orders in the SPX complex, we found a much more diverse set of market participants including wealth managers/RIAs, market makers, speculators, event hedgers, volatility hedge funds, as well as retail. Our survey indicated that institutional flow was actually a much larger proportion of 0DTE volume than retail.”

How are 0DTE options traded?

Traders predominantly buy puts and calls in the AM and close out the positions in the PM.

This is in contrast to long-dated index options where investors largely use them for portfolio protection (i.e. sell calls and buy puts). As such, there is a large skew towards put contracts for long-dated index options.

The ratio of puts and calls is more balanced for 0DTE options, suggesting that they’re more often used for speculation rather than portfolio protection.

This makes sense given their significant volatility.

Most importantly, the prevalence of 0DTE options trading reduces volatility BUT increases the likelihood of flash crashes

0DTE options trading exhibits a curious mean reversion behavior. In other words, 0DTE traders like to bet on market reversals after large intra-day market moves.

We don’t see the same “dip-buying” phenomenon for long-dated options.

0DTE’s mean reversion flows dampen market volatility but many suspect the market is also more vulnerable to flash crashes.

For example, if an unexpected event causes a surge in selling that overwhelms mean reverting 0DTE trades, these trades will shift from a stabilizing force to one that increases volatility as a large number of 0DTE positions go in the red and have to be aggressively hedged against or closed out.

This cascade will push the market much farther in one direction than if the 0DTE positions didn’t exist.

In a February 2023 research note, a J.P. Morgan analyst stated that they believe 0DTE options could drop the market more than 20% in one day, citing it as “Volmageddon 2.0”.

From Ambrus Capital: “0DTE options create a new form of risk because of their ability to accelerate negative situations. This is not different from other better known reflexive effects in markets. However, it’s notable that in an already highly reflexive market, we’re taking the heat on the pressure cooker and turning it up to HIGH.”

📣 Shout out to my friend Antonio’s newsletter where he does excellent deep dives into stocks like Robinhood, Duolingo, Palantir, Amazon, and Meta. You can find it here:

Investment Ideas by Antonio

Early AMD and Tesla investor, with a 2,500% return since 2014. Gain insights into my research process by reading my deep dives. One free deep dive per month. Deep dive updates for paid subscribers only.

By Antonio Linares

💡 In Conclusion

The rapid rise of 0DTE options trading is a fascinating phenomenon that underscores a greater-than-expected appetite for high-risk-high-reward trading in the market.

It’s surprising that the vast majority of 0DTE volume comes from institutions given the contracts’s highly speculative return profile. In addition, the overall trading behavior around 0DTEs seems to encourage mean reversion in the underlying asset which reduces volatility.

Put together, 0DTE options appear to be a valuable asset class for financial markets.

However, the risks of prevalent 0DTE options trading are not fully explored. Many suspect that their volatility-suppressing effects during “normal” times could aggravate volatility during times of market stress, causing sudden and deep flash crashes.

Until something really breaks, expect regulation to be light and slow.

💎 Portfolio Update (paid subscribers section)

We’ll share updates on our Macro Market Insights and Active Trade Ideas below.

These next two weeks will be very interesting for markets.

Read more

✅⚡ In 7 minutes, understand what the Federal Reserve’s Overnight Reverse Repo facility is, why it dropped by $2 trillion in 8 months, and why this matters for stock prices.

The Overnight Reverse Repo facility is a key Federal Reserve tool that’s used to stabilize interest rates.

Ominously, $2 trillion has been sucked out of the facility since May 2023. That’s “trillion” with a T!

In this newsletter issue, let’s go over what the Overnight Reverse Repo facility is, why its balance fell by so much, and why this is ultimately good for the stock market.

💡 What Is the Overnight Reverse Repo (On RRP) Facility?

ON RRP allows non-bank institutions like Money Market Funds (MMFs) to lend cash to the Fed and earn interest.

The loan duration is short, 24 hours, but it can be refreshed everyday.

The interest earned is set by the Fed and is currently 5.30% annualized.

The Fed uses the ON RRP to control interest rates in the economy. In other words, if the Fed wants the economy’s risk-free interest rate to be 5.30%, the ON RRP is one of the tools it uses to keep it there.

Because of the vast amount of money that’s parked at the ON RRP, it has a profound effect on the stock market.

💎 Lifting The Veil - All Our Research Made Available

We just updated FinanceTLDR premium to include more our:

• Research

• Trade ideas

• Day-to-day market insights

• Past and open trade positions

Markets move incredibly fast and we use a combination of up-to-date macro market insights and market structure monitoring (e.g. net MM gamma exposure) to formulate asymmetrical trade ideas with positive convexity and capped downside.

Paid subscribers get full access to the process, ideas, insights, past trades, and active trades.

Upgrade to Paid (Free Trial)

💡 Why Did the ON RRP Get $2 Trillion in 2021?

The ON RRP balance started climbing from $0 to over $2.4 trillion in early 2021.

This was around the same time when the Fed started raising interest rates in March 2021 and there is certainly some causation here.

The main culprit behind the rising ON RRP balance is Money Market Funds (MMFs, remember this acronym). MMFs grew to become a massive industry over the past decade with over $4 trillion in funds parked in them.

MMFs can only invest in short-term debt that matures within 397 days. As such, one of their favorite debt instruments to invest in is short-term US government bonds (aka Treasury bills).

However, the value of Treasury bills falls when interest rates rise and this makes Treasury bills a bad investment for MMFs.

This is because MMFs need to be highly liquid.

Customers expect to be able to withdraw money from an MMF at any time. If the Treasury bills on an MMF’s balance sheet are losing value, and there are large customer redemptions, then the fund could be forced to sell at a loss.

As a side note, Treasury bills could appreciate or depreciate during their lifetime but will always pay back the full principle and interest at maturity.

Selling too many assets at a loss could eventually crash a fund. MMFs want to avoid this as much as possible.

As such, as interest rates rose and Treasury bills fell in value, MMFs directed trillions of dollars to the Fed’s ON RRP rather than Treasury bills.

Because ON RRP doesn’t lose value as interest rates rise since they’re a short overnight loan that’s guaranteed by the Fed, MMFs consider it a safe investment in a rising interest rates environment.

💡 Why Did the ON RRP Lose $2 Trillion in 2023?

The ON RRP balance started falling in May 2023 when the Fed stopped raising interest rates and the US government’s debt ceiling was lifted.

This had two primary effects that made Treasury bills an attractive investment for MMFs again:

• First, after the debt ceiling was lifted, the US Treasury started flooding the market with Treasury bills to raise money.

• Second, with interest rates plateauing and possibly even falling, Treasury bills are less likely to fall in value and might even appreciate if interest rates fall.

As such, MMFs started redirecting cash away from the ON RRP into Treasury bills and here we are, 8 months from May and the ON RRP is down $2 trillion.

💡 This Is Good for Stocks, Why?

The ON RRP sucks liquidity from the economy.

Cash in the ON RRP is cash parked at the Fed and not doing anything. This cash could instead be used in the economy for capital investments or buying stocks.

As such, diverting cash away from the ON RRP is ultimately better for the stock market and the economy. That is, unless it triggers more inflation!

This is why it’s a good thing that the ON RRP balance fell by $2 trillion since May. That’s $2 trillion that was returned to the economy.

In addition, because this newly available cash was largely used to buy Treasury bills (aka funding the US government’s deficit), when the ON RRP balance runs dry, the US government could run into serious funding issues and the Fed is forced to intervene by easing financial conditions to buy US government debt.

If the Fed doesn’t intervene, short-term interest rates could sky rocket when there are too few buyers for US government debt. Next year, a record high of $8 trillion in US debt needs to be refinanced and the US government seriously needs a bid for new debt issued next year.

Turns out, an easing of financial conditions is exactly what the Fed is signalling.

At the current rate of ON RRP depletion, it’ll likely run out sometime in March.

This is why Dallas Fed President Lorie Logan said last Saturday that the Fed is considering reducing Quantitative Tightening when the ON RRP runs out.

In layperson’s terms, this means the Fed will ramp up money printing again to buy more US government debt.

Money printing is good for stocks.

💡 Putting This Into Practice: Ides of March

With the ON RRP on track to deplete by March, all eyes are on the Fed’s actions in the March FOMC meeting.

If the Fed doesn’t do anything, the market will likely sell-off given the high risk of greater interest rate volatility as MMFs, a major buyer of US government debt, disappears from the market (all their spare cash from ON RRP depletion have been used up).

If the Fed does decide to print more money to buy US government debt, the market will likely rally on easing financial conditions.

As such, March will be a volatile month (risk to the downside) as market anxiety rises on uncertainty around what the Fed does at the March FOMC meeting (March 22nd).

It’s best to pare back on portfolio risk during this month.

In addition, the Fed is expected to start cutting interest rates at this FOMC meeting and all recent recessions have started shortly after the Fed’s first rate cut. It’s an ominous trend that exacerbates market anxiety.

The Ides of March marks the anniversary of the notorious assassination of Julius Caesar and subsequently became an annual deadline for settling debts in the Roman Empire (cue “how often do men think about the Roman Empire?” questions).

Beware the Ides of March. It’s a fitting analogy for the stock market this March.

💎 Portfolio Update

Here’s a summarized update of our thought process over the last week for our:

• Macro market insights

• Active trade ideas

• Recently closed convexity trades

We had a good week last week with our convexity trades. We closed out one AMD position netting 🟢 230% and another AMD position netting 🟢 93%. We also had a failed AMD trade that was down 🔴 42%.

Overall, the net gains were large and positive with the help of convexity on winning trades and good risk management on losing trades.

The details:

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In 7 minutes, we summarize the 2024 market outlooks of 5 major financial institutions including JP Morgan and BlackRock.

We reviewed the 2024 market outlooks of JP Morgan, BlackRock, Citi, Mastercard, and Charles Schwab. This is a summary of their overarching themes.

Themes

💡Inflation and interest rates will fall

The five firms agree that inflation will continue to fall throughout 2024, giving central banks room to cut interest rates. Even JP Morgan, the only firm that published a bearish outlook, predicts US inflation will drop to 2.1% with the Fed starting to cut interest rates in the third quarter.

Falling interest rates is generally good for stocks but it’s important to keep in mind that the past three recessions started right after the Fed started cutting interest rates. As such, expect the market to be more antsy as we near the first rate cut later this year.

💡CapEx returns

CapEx, short for capital expenses, are the costs companies incur when they invest for the future. An example of CapEx would be the money Microsoft spends to bring up a new AI data center.

Last year, companies (and pretty much everyone else in the economy) were nervous about an impending economic slowdown and companies cut back on spending. Much of these fears were assuaged as economy remained strong throughout the latter half of the year. With economic angst subsiding this year, CapEx is expected to bounce back.

More CapEx means higher revenues and faster growth. This is ultimately good for stock prices.

💡US election year

2024 is a US election year. As much as the Fed would deny it, we believe that politics has a meaningful sway on the Fed’s actions and they will try their best to avoid drastic changes to monetary policy this year to keep the waters calm for the election.

Less policy volatility is good for markets.

In terms of election outcomes, all five firms don’t expect large changes to the current market regime no matter which party wins. If the Democrats win, it’s business-as-usual with little to no changes to the overall policy direction of the last four years. If the Republicans win, the markets will probably react favorably given the party’s generally market-friendly stance (less regulations, more open to mergers and acquisitions). However, a Republican victory is bad news for war stocks since Republicans are more skeptical of the Ukraine war than Democrats and are less likely to fund it.

As a side note, in 2016, many were expecting a large market sell-off following a Trump election but the market roared upwards instead.

💡First half angst, second half gains

Citi predicts that economic growth will be slow in the first half of 2024 before accelerating in the second half. They don’t see a recession happening. BlackRock also sees the economy slowly recovering this year in a “U-shaped” fashion. JP Morgan is the only firm of the five that forecasts an economic slowdown.

Citi’s outlook aligns with Fundstrat Managing Partner and frequent CNBC contributor Tom Lee’s outlook. He predicts that the S&P 500 will be flat or down 5% in the first half of the year before rallying to 5,200 by year-end.

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💡Everyone is bullish on AI

Everyone is unsurprisingly bullish on AI.

The Mag 7 is a good way to get AI exposure, as are chip designers like Nvidia and AMD. Citi is particularly bullish on chip manufacturers given their relative under-performance last year (e.g. TSMC).

In addition, Citi believes that AI has the most potential to uplift these industry segments:

1. Mag 7 (mega cap tech)

2. Infrastructure (chipmakers, semiconductor equipment, data centers)

3. Robotics

4. Drug discovery

5. Cybersecurity

💡International: Japan, China, and India

For international markets, the five firms are generally bullish on Japan, China, and India while being lukewarm on Europe.

Charles Schwab made a particularly astute point on the under-discussed disproportionate power Japan has over the global financial system:

Moves by the Bank Of Japan (BOJ) could overshadow those by the Federal Reserve and other central banks if Japanese investors begin to sell foreign bonds, stocks, and currencies. Decades of current account surpluses have accumulated, giving Japan the world's largest net international investment position (even more than China) with $3.3 trillion of investments held abroad according to the International Monetary Fund (IMF). Although the U.S. has the largest economic influence in the world, Japan may have the largest influence in the asset markets due to these account surpluses. Should the BOJ begin to substantially tighten monetary policy next year, as signaled by the end of yield curve control at the BOJ's meeting in October, the potential for a reversal of decades of outward flow of capital may be felt by investors worldwide. With rates rising in Japan contrasting with rate cuts elsewhere, the yen could surge along with Japanese bond yields, prompting Japanese investors to bring their money home and invest in Japanese assets.

The high level bull case for Japan is that the BOJ will finally have to seriously raise interest rates this year. This will lead to a stronger yen, attract more foreign investment into the Japanese economy, and ultimately drive up the dollar value of Japanese tech and finance stocks.

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Risks

💡Economic risks

Interest rates and inflation are top of mind.

The general worry is that we haven’t felt the full negative effects of 2021-2022’s large interest rate hikes (perhaps they surface this year?) AND there’s a high chance we’re entering into a high interest rate and high inflation economic environment.

This is largely why JP Morgan is so bearish, predicting that the S&P 500 will fall almost 11% from current levels to 4,200 by year-end. The other firms acknowledge the economic risks but are cautiously bullish.

💡Geopolitical Risks

Every firm warned about geopolitical risks in 2024, from the ongoing wars in Eastern Europe and the Middle East to tensions in the South China Sea. A couple firms recommended defense and energy stocks as a hedge against these risks.

We have a slightly contrarian opinion. We think that 2024 is a year of geopolitical normalization with the major geopolitical hot spots of yesteryear cooling down. The Eastern European conflict will likely wind down as Western support for the war wanes and the Middle East conflict should also subside given the significant power imbalance between the two sides. The Taiwan conflict will continue to ineffectually simmer, creating catchy headlines that continue to end up as nothing burgers.

The Red Sea shipping crisis is an annoying thorn on the side of the global supply chain. Maersk, the world’s largest shipping company, recently had to walk back its decision to resume sending ships through the Red Sea when another one of its ships was hit by a missile on December 30th.

The extent of the damage to global trade and inflation due the crisis remains unclear but we know that it’s non-trivial. The Red Sea trade route is incredibly important to the global economy. Here are some stats:

• 12% of global trade

• 30% of global container shipments

• $1 trillion worth of goods every single year

• 10% of global oil shipments

• For ships traveling between Europe and Asia, this route is 25% faster than the alternate route around Africa

• For ships traveling between North America and Asia, this route is 8% faster

Summary

With the exception of JP Morgan, everyone else seems to align on a general theme of “economic normalization to growth” for 2024. Citi sees the US economy going through three major phases from the start of the pandemic:

1. 2020-2021: emergency low rates and quantitative easing to stimulate the economy

2. 2022-2023: bear market caution as a result of rapid interest rate hikes and quantitative tightening

3. 2024-2025: normalization to growth

We agree with this prediction and see more upside for US stocks in 2024. Last year, the S&P 500 almost returned to all-time-highs despite having to climb a wall of worry from a myriad of economic and geopolitical risks. This year, many of those risks are subsiding, opening the way for stocks to go higher.

Barring black swan events, this stock market has time and time again demonstrated that it pays to be default bullish and tactically bearish. Currently, we don’t see a reason to be tactically bearish in the near future.

To read our full summaries of each firm’s market outlook, including links to the full outlooks, click here.

Portfolio Update and New Trade Ideas

An update on the FinanceTLDR portfolio and our thoughts on the market’s movements in the first two trading days of the year.

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Our new high conviction trade idea is $BABA.

The reasons are straightforward [disclaimer: informational purposes only, not trade advice]:

1. Positive macro backdrop after the Fed’s recent dovish pivot means big recoveries for heavily shorted stocks (see what’s going on with HOOD, AFRM, Z, etc. recently)

2. Alibaba is notori…

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FinanceTLDR Premium contains our most up-to-date and actionable Trade Ideas and Market Insights.

The team is constantly monitoring the latest news and conducting deep market research and we created FinanceTLDR Premium to share our sharpest ideas and insights.

Premium subscribers can also ask us questions through email (financetldrblog@gmail.com) or in the comments section of each Premium newsletter issue.

Links to our Trade Ideas and Market Insights can be found below.

Here’s the inevitable disclaimer: we provide insights and ideas, not investment advice.

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In 5 minutes, understand why yesterday’s pivotal Fed meeting signaled the start of the next bull market, barring black swans.

Yesterday, the markets roared upwards after the Federal Reserve held its December FOMC press conference.

Why?

Because the Fed has finally acknowledged that inflation might be cooling for good after very defensive messaging in previous press conferences. In addition, the Fed signaled that they’re not just going to stopping rate hikes, they’re on the cusp of cutting them starting next year.

In many ways, the Fed is forced to cut rates given the tenuous fiscal situation of the US government. If rates remain high, the US government’s debt burden is set to explode in the next few years as the government has to refinance vast swathes of maturing debt and fund a massive and growing deficit, all at historically high rates. This could result in a catastrophic debt spiral.

The only thing standing in the way of the Fed cutting rates is inflation, and inflation is rapidly cooling. This gives the Fed an open field to cut and they’re signalling at least 3 cuts next year. Falling interest rates is great for the economy but they usually happen when the economy is in trouble. The Fed cutting rates without an ongoing recession is the Goldilocks economic outcome the bulls have been hoping for, and we might just get it.

No wonder the market is celebrating.

Cooling inflation is driven in large part by collapsing energy prices ($95 a barrel of WTI crude in September to under $70 now) and a normalization of trade relations with China (except for the semi industry). Energy prices are the primary driver of short-term inflation and the US government has been working behind the scenes to keep prices down, even if that means turning a blind eye on Russian oil flooding global markets.

It’s been widely reported that Russia has created a shadow fleet of oil tankers that are circumventing sanctions to export its oil. Bloomberg even published an exposé on YouTube with reporters filming two oil tankers illegally laundering Russian oil by transferring the oil from one tanker to another in the Gulf of Laconia just off the Greco coast. The shadow fleet’s illicit activities to sidestep US sanctions on Russian oil have been extensively reported over the last year but little is being done to stop it. For the moment, it’s too beneficial for the economies of the major parties involved (US, Europe, and Russia) to stop the flow of Russian oil into global markets.

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The Details

Cooling Inflation

Inflation is falling, and it’s falling hard. The Fed’s target inflation rate is 2% and November’s CPI fell to a comfortable 3.1%. All the while, leading inflation indicators like the job market and energy prices have also been cooling. Energy prices have been hit especially hard this fall and they’re a major contributor to prices throughout the economy. This increases confidence that inflation will continue to fall heading into next year.

Why Is Cooling Inflation So Important?

The Fed considers inflation one of the most important threats to the US economy. Once it emerges, it can be very persistent and difficult to reverse. The Fed’s primary inflation-fighting tool is raising interest rates, but high interest rates also hurt the economy, albeit in a way that’s much easier to fix.

As most of us know, the US economy experienced a severe bout of inflation in the past two years which has forced the Fed to rapidly raise rates and keep them high. With inflation cooling, the Fed now has the option to drop rates and this is sorely needed as the US government is drowning in debt and unable to shrink the deficit with two foreign proxy wars going on.

The economy gets boosted when rates fall and that’s what the market is cheering for.

The Fed Dot Plot

The Fed dot plot shows the estimates of top Fed policymakers for interest rates at the end of the next several years and over the long run. The forecasts are represented by dots arranged along a vertical scale — one dot for each of the Federal Open Market Committee members.

Each Fed meeting, a new dot plot is released. Yesterday’s dot plot showed that no Fed policymaker wants to raise rates next year and more than half think there should be at least 3 rate cuts instead. That’s a lot of rate cuts, and a significant shift from the Fed’s hawkish tone earlier in the year.

What could go wrong?

The market is rising on anticipation of the Fed cutting rates next year but we’re still far from that actually happening. The biggest risk to the rate cut narrative in 2024 is rising inflation, and this could be triggered by worsening tensions between the US and China or unexpected escalations in the Eastern European and Middle Eastern conflicts. In addition, if the conflicts intensify, the US government may be forced to issue significantly more debt than expected to finance the conflicts which pushes long-term rates up.

For now, the horizon appears to be clear.

Portfolio Update

In this portfolio update, we share a few trade ideas we’re excited about as the new year approaches, and also add a very promising stock to the FinanceTLDR portfolio.

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Let's talk about interest rates – you know, that topic that keeps cropping up in financial news, almost like a celebrity that won't leave the headlines. But why are we constantly hearing about them? Well, it's because interest rates are not just some financial jargon tossed around by economists; they're the foundation upon which our entire economy stands.

In this issue, we're diving into how interest rates work and why understanding interest rates is crucial, not just for Wall Street, but for everyone else. Believe it or not, interest rates are pulling more strings in your life than you might think – they're like the silent puppet masters of your personal finances.

Fundamentally, interest rates are the cost of using someone else’s money for a period of time. In this way, they are often referred to as the price of money.

Who sets interest rates?

One of the most obscure and yet important aspects of interest rates is how they are determined.

For example, why is it that in 2021 the interest rate for mortgages was around 3% and today it’s closer to 8%? Salaries haven’t fallen and houses aren’t significantly harder to build, so what caused mortgage rates to go so high?

In the US, the central bank (aka The Fed) and the market determine the country’s interest rates. During periods of economic normalcy, the Fed has the most control. Here’s how it works.

Let me introduce you to the Fed Funds Rate and US Treasuries. In broad strokes, these two financial instruments form the bedrock with which interest rates across the country, and even the world, are determined.

One important thing to know about interest rates is that they are also a measure of risk. Generally, the longer a loan is, the more risky it is. As such, we can categorize interest rates by loan duration. The Fed Funds Rate and US Treasuries span a wide range of loan durations, from overnight (Fed Funds Rate) to 30 years (30-year Treasury Bond).

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☝️ But wait, who controls the Fed Funds Rate and US Treasury rates?

The Fed fully controls the Fed Funds Rate. This is the interest rate that is being changed whenever you see headlines like “Fed increases rates a quarter point and signals a potential end to hikes” and “Fed signals it will raise rates one more time this year before it ends hiking campaign”.

US Treasury rates are controlled by the market through the constant buying and selling of US Treasuries, similar to how stock prices are determined. However, the Fed could also intervene by literally printing money out of thin air to buy Treasuries. This is known as Quantitative Easing (QE) and it’s an extreme way to keep interest rates low, with the end goal of stimulating the economy. During the pandemic, the Fed printed trillions of QE dollars to keep the economy afloat.

The Yield Curve

When you graph the interest rates of the Fed Funds Rate and US Treasuries against their loan durations, you get a graph that’s commonly referred to as the “Yield Curve”.

The Yield Curve should theoretically go up and to the right; after all, the longer the loan is, the more risky it is, and the more interest it should pay.

Practically, this is not always true since the market ultimately controls Treasury rates and it can change these rates however it wants. For example, if the market thinks rates will go down in the future, it could buy long-term Treasuries while selling short-term Treasuries until the Yield Curve slopes downwards.

Side note, a Yield Curve that’s sloping downwards is known as an inverted Yield Curve and this is a historically reliable predictor of recessions.

The Fed also has control over the Yield Curve. It can adjust the Fed Funds Rate to move the Yield Curve up or down or even reshape it. For example, if the Fed Funds Rate increases, the interest rates of every other loan duration should increase as well but if the former increases too fast, the Yield Curve could invert as the market is slow to respond to the Fed’s actions.

All this is to say that the whims of the Fed and the market can cause the Yield Curve to look all sorts of ways.

Today, the Yield Curve looks like this.

What about mortgage rates?

Now that we’ve explained the Yield Curve, let’s talk about how other interest rates in the economy are set.

The prevailing global wisdom is that loans to the US government are the safest loans in the world. That’s because if the US government can’t pay, then a resource-rich country could be forced to make up the difference through a visit from a couple US carrier battle groups. Just kidding 😅 Not really.

As such, rates on the US Yield Curve represent the absolute bottom of interest rates. They are also known as risk-free rates. Every other loan has added risk and so to determine their interest rates, you simply add to their corresponding rate on the Yield Curve to get interest rates that account for the added risk.

In other words, everything added on top of the Yield Curve rate depends on the loan’s perceived risk.

The most important corollary to this is that when the Yield Curve rises, interest rates across the economy rise.

This is why mortgages in 2021 cost ~3% while mortgages cost ~8% today. The Fed raised the Fed Funds Rate and rates across the Yield Curve also rose. Then, for mortgages, you add more interest on top to account for the extra risk. The 30-year Treasury is currently yielding 4.23% and the market has added 4% on top for mortgages because they are riskier than 30-year Treasuries.

How do interest rates determine our quality of life?

If interest rates are the price of money, then higher interest rates mean more expensive money. When money is more expensive, there is less money going around. When less money is going around, the economy slows down. Besides this direct causal chain, there are also many second-order effects that ripple through the economy to significantly reduce the total money in the system.

This goes both ways. When interest rates go up, money in the system decreases even more. When interest rates go down, money in the system increases even more.

I like to call this the Interest Rate Money Multiplier Effect.

You may be wondering, if the Fed raised the Fed Funds Rate from 0 to 5% over the past year and a half, why hasn’t the economy slowed down? If interest rates really do matter, why is the economy unfazed and continues to march onward?

This is because the Interest Rate Money Multiplier effect takes a long time to occur and in the mean time, weak economic growth can be staved off through:

1. Relying on excess money that’s already existing in the system

2. Borrowing money at high interest rates to keep the money flowing in. This comes at high cost to future generations

The US government has been heavily leaning into (2) to keep the stock market up and the people happy. However, this has also caused a significant rise in long-term US treasury interest rates as the global market rejects increased US debt issuance. FinanceTLDR has written at length about the ballooning US budget deficit.

All this is to say that interest rates have a profound impact on economic activity. The higher rates go, the less likely people will spend money and the less people spend, the less people make. The less people make, the lower the average quality of life.

I have to admit that this issue’s title, “Interest Rates Will Determine Your Life”, is hyperbolic but it has a profound morsel of truth that’s evident once you understand how interest rates work in the economy.

It’s no wonder rising interest rates have dominated financial headlines in the last two years.

Portfolio Update

The market is pulling back this week after a euphoric November. Palantir is down almost 15% since the start of the month. Even Coinbase is showing weakness even though it’s still significantly up for the month.

Here’s how we are positioning the portfolio for the rest of December…

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