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Today’s theme song: Gold Digger by Kanye West
So far today, we see three key themes. First, while Microsoft (MSFT) was the latest stock to raise concerns that spending on artificial intelligence was slow to result in profitability, investors greatly preferred to hear from AMD that the spending nonetheless continues apace. Second, the relationship between tech stocks and the yen reversed, as the yen rallied sharply after the Bank of Japan raised rates overnight. Third, none of the month-end vibe shift could be occurring if investors had serious concerns about today’s FOMC meeting.
In yesterday’s piece we highlighted the risk that MSFT could report good numbers yet sell-off anyway. That proved to be the case. We also noted, but without detail, that AMD earnings could also prove consequential. How’s that for burying the lead? A classic investment adage is that when there’s a gold rush (in this case, AI), it’s usually more profitable to invest in those who supply picks and shovels and other tools to the miners (semiconductors) than it is to mine the gold itself (MSFT and friends). To be quite fair, it’s been highly profitable to invest in both for quite some time. But after Alphabet’s (GOOG, GOOGL) comments last week and MSFT’s cloud division’s results yesterday, it was becoming questionable about when these expensive investments in chips, data centers, and software will pay off.
Then AMD told us that they are selling chips as fast as they can make them, and that their order book remains full. It does seem unsustainable that companies would continue to load up on the infrastructure required to develop and implement AI if that isn’t an especially profitable activity, but that trend doesn’t seem to be abating yet. MSFT confirmed that they will be increasing their aggressive capital spending nonetheless. Throw in a well-timed Nvidia (NVDA) upgrade from Morgan Stanley along with investors who might have decided that they no longer want to appear underinvested ahead of month-end, and off we go.
Today’s rally broke the recent relationship between a stronger yen and lower NDX. There was a solid reason for that relationship – many leveraged investors had been borrowing low-yielding yen and using the proceeds to buy higher yielding or higher momentum assets – and the rapid rise of the yen – from about 162 to 152 in a matter of days – forced many to exit those trades. That ended today. The yen rose sharply today, trading briefly below 150 after the BOJ raised rates by 10bp, but that had no impact on the mad rush back into tech this morning. Again, we wonder how much of that was considered “excess” de-risking ahead of month-end, but once again, tech momentum triumphs.
Yet none of this would be occurring today if investors weren’t sanguine about this afternoon’s FOMC meeting. Bluntly, if folks were truly worried about what Chair Powell might say this afternoon, then they wouldn’t be bidding up stocks with abandon. And it’s not just stocks. Treasury yields are lower across the curve, led by the long end. While this morning’s rally has pushed SPX back into positive territory for July (up about 1%), and cut NDX’s losses to about -1.7%, the moves in rates have been quite dramatic. The 10-year yield is down about 35 basis points and the 2-year down about 40bp during the month. Much of that comes from the assumption that the Fed will cut rates at each of the three remaining meetings this year. Considering that this is at odds with the most recent “dot plot”, which projected just one, a key feature of today’s press conference will be to see if Powell confirms the FOMC’s projections or subtly backs the market’s enthusiasm for cuts.
Considering today’s broad-based equities rally, it is not surprising to see options traders carrying that enthusiasm into this afternoon and the rest of the week. The IBKR Probability Lab shows peak probabilities for SPX options expiring today and on Friday to be above current levels, about 5545 for today (vs. 5525 now) and 5575 for Friday. Investors are expecting “Goldilocks in a Suit” to tell us that the economic porridge is not too hot and not too cold – just right.
IBKR Probability Lab for SPX Options Expiring July 31st, 2024
Source: Interactive Brokers
IBKR Probability Lab for SPX Options Expiring August 2nd, 2024
Source: Interactive Brokers