What Are We Thinking Now?
This may not be the most value-added weekly update I have done, but I wanted to showcase how “powerful” Microsoft Co-Pilot can be in generating content, albeit you need to tweak, edit and consider deeper thinking than what is usually provided. Imagine the productivity for the “office” worker who does many tasks over and over again that can be automated and/or the time reduced for each responsibility. We can conclude perhaps we need less workers as a result or the increased productivity will lead economies into a new-found stealth mode (higher profit per employee) which should increase margins and multiples. Regardless, it is imperative as investors to get the list of beneficiaries, true beneficiaries and those operating from positions of weakness or have a limited runway.
For example, what is the true data center peak spending and what will Nvidia revenues be when the market reaches that level? Will AMD actually have more than a me-too product that is able to penetrate Nvidia CUDA environments? Is the best pick and shovel investment ahead in the ASIC players Avago and Marvell or have their multiples already reflected such growth? And software, does it get helped or hurt in the short term as enterprises focus on AI? Can they charge incrementally for these AI services the way Microsoft is trying to with Co-Pilot? Steve Cohen, of Point72 and owner of the Mets fame, discussed his hedge fund saving $25m in operating expenses per year by taking their data and working it into LLMs. What is the cost to get the $25m savings? If it is even as high as $25m, isn’t it a no brainer 100% ROIC? Who is getting the $25m in “spend” here? Is it Microsoft and Amazon using their Azure and AWS to process workloads? Probably. Is it companies like UiPath that suggest automation potentials to enterprises? Yes. Is that spend by one company then magnify the capex cycle for GPU usage, higher for longer? Yes.
At the same time, there are real issues stock investors need to consider for market returns from here. Let’s plug them into Co-Pilot and see if they can help you see the issues on my mind: 1) Rates, 2) High Expectations, 3) 0DTE, 4) May seasonality.
Interest Rates and Market Implications: As we sail through these uncertain waters, the market grapples with a paradox: interest rates. Here’s the conundrum:
Rate Cuts and Economic Health:
Historically, rate cuts have been a lifeline during economic downturns. Lower rates stimulate borrowing, spending, and investment.
The market often cheers rate cuts, expecting a boost to corporate profits and stock prices.
The Good News Dilemma:
But what if the economy is doing well? If growth is robust, unemployment low, and inflation manageable, the market may decide it doesn’t need rate cuts.
In such cases, the Federal Reserve’s dovish stance can raise eyebrows. Why cut rates when things are humming along?
Higher Rates vs. Stock Valuations:
Conversely, higher rates can spook investors. Why? Because they impact stock valuations.
As rates rise, the present value of future cash flows (used to value stocks) decreases. Stocks suddenly seem less attractive compared to fixed-income alternatives. Yes, 5% money market returns are still juicy!
The Tug of War:
The market watches the Fed’s every move. Will they raise rates to tame inflation? Or keep rates low to support growth?
Investors weigh the implications: Is it a sign of confidence or a harbinger of trouble?
Second Half Challenges for Megacap Stocks:
As we enter the second half of the year, the comparisons for megacap stocks get tougher. Here’s why:
Exceptional Performance in H1:
Many megacap stocks (think FAANG: Facebook, Apple, Amazon, Netflix, Google) will deliver stellar returns in the first half of the year.
Expectations Soar: The bar is now set high. Can these companies maintain the same growth trajectory?
Any signs of slowing growth or missed targets could lead to market jitters. META is expected to grow revenues 26% in the 1Q and leave the 4Q 2024 at 13% growth (the stock is no longer cheap at 25x EPS). Google faces mass confusion on growth since they do not guide and even Bloomberg has estimates that do not add up (see below). How can they grow 16-18% each quarter but only 12% for the year (??). Hint, the annual doesn’t add to the quarterly.
Microsoft should continue to impress imho but the multiple is now 36x. Apple has to bridge the gap between business being awful and generating interest in new AI products beyond marketing (buy the print good or bad imho). Netflix faces a higher bar on sub adds. Tesla is off the megacap list and isn’t growing anymore. You get the point on so goes the megacaps, so goes the market given their representation in the indices.
Market Rotation:
As the economy reopens, investors shift focus from pandemic winners (tech) to cyclical sectors (travel, energy, finance).
Megacap stocks face rotation headwinds.
Research and Education:
Understand the companies you invest in. Read annual reports, analyze financials, and stay informed.
Knowledge is Your Best Shield against uncertainty.
The Human Element:
Remember, behind every stock ticker lies human psychology. Fear, greed, and herd mentality sway markets. As investors, we navigate these emotional currents. Equally, the prime brokerage updates show investors are full tilt gross and net long leaving it harder to find the incremental buyer.
0DTE (zero days to expiry) options have surged in popularity, drawing both retail and institutional traders. These contracts, which expire within a day, allow traders to profit from intraday market moves. However, they also pose risks to the broader market. Let’s explore why:
Rapid Decay: 0DTE options quickly lose value due to their limited time before expiration. Sellers aim to capitalize on this decay by selling contracts and buying them back at a lower price.
Market Manipulation: Some traders use large volumes of 0DTE options to influence short-term price movements. This can create challenges for other investors relying on fundamental analysis.
Volatility Shock: The daily notional value of trading in 0DTE options has reached about $1 trillion. If a sudden volatility shock occurs, it could ripple out to the broader stock market1.
Blindsiding Markets: 0DTE options suppress expectations of market volatility (measured by the VIX). This could lead to markets being blindsided by sudden outbreaks of volatility2.
In summary, while 0DTE options offer opportunities for quick gains, their impact on overall market stability warrants close monitoring. Traders and investors alike must navigate this corner of the market with caution.
The saying “Sell in May and go away” is a well-known adage in finance.
It refers to the historically weaker performance of stocks during the six-month period from May to October, compared with the other half of the year. Let’s break it down:
Historical Pattern:
Since 1990, the S&P 500 has averaged a return of about 2% annually from May to October, versus about 7% from November to April.
This seasonal divergence trend has been remarkably robust, even in stock markets outside the U.S.
The Strategy:
The idea is simple: sell stocks in May (or during late spring) and have the proceeds held in cash.
Then, come back in November when historical data suggests better stock market performance.
Theories for Seasonal Divergence:
Agricultural Influence: Financial markets were once tied to seasonal patterns related to agriculture. While farming’s economic weight has diminished, some seasonality in investment flows persists.
Bonuses and Tax Deadlines: Year-end financial industry bonuses and the mid-April U.S. income tax filing deadline may contribute to this pattern.
Market Crashes: The historical pattern became more pronounced after stock-market collapses in 1987 and 2008.
Recent Exceptions: The pattern did not hold in 2020, and it’s important to recognize that other pressing considerations often outweigh seasonality.
Drawbacks:
Historical patterns don’t reliably predict the future. If too many people follow this strategy, it could lose its effectiveness.
Year-to-year fluctuations can be significant, and other factors impact markets beyond seasonality.
In my mind, the 1Q earnings season will be the chief determinant in this year’s pattern. If JPM and its stock reaction are a tell from Friday, it could a summer to work on your golf game or a hobby!
Well, that is all for this weekend. Let’s hope and pray the Middle East doesn’t become the worry that Friday seemed to indicate with bonds up and stocks down. I will not use Co-Pilot often in my write-ups but it was fun to experiment and list the issues on my mind. Feel free to reach out on our WhatsApp text lists. Reminder, only paid subs receive the daily texts, market information, Street Research and discussion forum.
Rob’s Educated Guesses