New Highs, Still Low Conviction
A weekly look at what matters and how to trade it. (August 10th)
With a few choppy days in the middle, the S&P 500 and the MSCI World Index closed last week at new highs. A surprisingly weak jobs report on Friday took some heat out of the Fed’s tightening narrative. US markets now balance AI expectations on one side against a labour market that could limit Warsh’s hawkish hand on the other.
An interesting note from UBS this week highlighted that global semiconductor stock valuations imply abnormally strong profits will persist, which is at odds with historical patterns. Less than 20% of companies with cash flow return on investment levels running as high as the chip segment continue to deliver elevated returns. Still, semiconductors are up 20% from recent lows, and the buses feel empty.
Friday’s payroll report showed an unexpected fall by 23,000, while participation again dropped and JOLTS openings softened. Hiring demand is weakening, and workers are becoming less willing to leave existing jobs. The U3 rate fell to 4.1%. For a Fed that has spent much of the post-Iran war focusing on inflation concerns, this data print complicates the dual mandate.
The curve bull-steepened, and the dollar weakened as the next move from the Fed got pushed out from October to December, a strong shift considering markets had a 40% chance of a hike at the July meeting just weeks ago. There is also no longer a second hike priced in 2027.
The dollar faces some pressure, as the recent rally was partly driven by higher rate expectations, but the geopolitical backdrop and higher relative US yields still offer a floor for the dollar long trades. As for the USD/JPY intervention move, the jobs reports likely give the yen rebound more staying power, but we still look towards renewing carry trades.
Falling oil prices and more constructive tones between Iran and the US helped ease geopolitical risk last week.
Overall, the rates higher crowd felt pain, oil bears were rewarded, equity markets moved higher despite the disbelief of stock sceptics, and gold bugs got their groove back.
For access to our newly released Chartbooks, see the link here.
Let’s get into the guide to trades moving markets, where things stand, and where they may be heading.
“Equity Insights”
“Back Buying Bullion”
“The Risk on FX Rotation”
“Summary of House Views”
Equity Insights
We’re going under the equity hood this week… Total assets in US-listed leveraged ETFs have retreated from the highs and are now back to near start-of-year levels, reducing the short-gamma exposure and market impact from daily rebalancing.
Leveraged ETF short-gamma exposure has fallen from more than $9 billion per 1% move at the peak to about $6.5 billion. Strategist estimates say that leveraged US ETFs’ daily rebalances net sold ~$150 billion of equity exposure from early June through July 29 as funds deleveraged, with total assets shrinking about $70 billion from a June peak.
Near-term leverage demand in the US and Korea has eased, which has helped relieve pressure on short-dated equity financing costs, but volatility for the momentum trade in the US could persist in August due to sustained tech/AI mania. As we stated in our note Autopsy on the AI Selloff: “We therefore expect volatility to remain structural rather than temporary.”
Historically, weak and volatile momentum performance has often followed periods of extreme underperformance as seen in July, so we expect a more nuanced stock performance over the next month. That divergence has been noticeable among software stocks.
Software’s underperformance has brought it to its cheapest levels on value rankings since the tech bubble implosion in 2022. Meanwhile, the Q2 earnings season continues to argue for little damage from AI companies to their profits and outlook.