Market Pulse: AI and US Treasuries
In 5 minutes, understand exactly why the market only cares about AI and US government bonds right now.
In 5 minutes, understand exactly why the market only cares about AI and bonds right now.
The stock market is on fire. It took the S&P 500 three months from August to the end of October to fall almost 11%. In November, we climbed all the way back up to July’s highs in just one month!
What’s behind the optimism?
If we take a peek under the hood, it might be jumping the gun to call this “optimism”. The stock market is being levitated by a small group of mega cap stocks aptly dubbed the “Magnificent Seven”:
AMZN
AAPL
GOOG
META
MSFT
NVDA
TSLA
The rest of the market, the S&P 493, is not doing so hot.
Why’s that? We think that there are two main reasons causing the market to behave this way: AI and US government bonds (aka treasuries).
Right now, US treasuries are yielding almost 5% a year. Treasuries are considered the safest investment around and 5% is an extraordinarily high risk-free yield when compared to the anemic 0-3% yield of the past decade pre-pandemic. Today, with such a high yield, you can actually own treasuries over stocks without feeling bad.
Money flowing into bonds is one reason why the S&P 493 is struggling. The second reason is Artificial Intelligence (AI).
There’s a prevailing market sentiment that AI will revolutionize society and the Magnificent Seven are the de facto leaders in this burgeoning industry. This has led investors to pour money into these seven stocks and it doesn’t matter what treasuries do; if you believe AI is on the cusp of revolutionizing society, you don’t want to be stuck with 5% or even 10% treasury yields, you want to own a piece of ChatGPT.
What we got as a result is a very polarized stock market where the Magnificent Seven soars while everyone else languishes. This is not a healthy stock market… but… it’s unproductive to time market tops since it’s incredibly hard to predict the future given the current period of extreme flux. Who knows will happen when we mix rapid technological progress with an increasingly violent and bifurcating global economy.
Navigating this new polarized market will be the focal point of my research in the coming weeks.
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The Details
Here’s another look at the Magnificent Seven
Both the S&P 500 and the NASDAQ 100 are highly concentrated in the Mag 7. This concentration is at historical highs with the Mag 7 representing 30% of the S&P and 62% of the NASDAQ.
If the Mag 7 falls, the whole stock market falls with them.
Inflation is cooling
Inflation is steadily declining. Yesterday, October’s core PCE inflation came in at 3.5%. Although this is still above the Fed’s 2% inflation target, it’s down from September’s 3.7% and that’s what the market cares about.
Falling inflation has helped fuel the optimism for the Fed to start cutting rates early next year.
We think that’s unlikely. Here’s why.
The economy is still going strong, very strong
The US economy grew 5.1% this past quarter. It’s the fastest pace of expansion since Q4 2021 and significantly faster than the average 2.4% growth of the previous four quarters. The economy is kinda on fire, in a good way, and it’s doing this despite super high interest rates and quantitative tightening (aka the Fed taking money out of the system).
When the Fed started raising interest rates last year to quell inflation, many were skeptical that the economy could be slowed without a crash. These past few months’s economic data is crumbling this skepticism. Could we actually kill inflation without blowing up the economy? If they pull this “Goldilocks” soft landing off, the Fed could even start cutting interest rates next year.
That would be very good for stocks.
However, an important question needs to be asked: if the economy is growing healthily despite high interest rates, why should the Fed lower them?