LD Capital Macro Weekly Report Inflation Decline Ignites Another Round of Buying, Deflation Concept Strikes

LD Capital Macro Weekly Report Inflation Drop Triggers Renewed Buying Frenzy, Devaluation Fears Resurface

US stock market has risen for three consecutive weeks, recovering the previous three months’ decline. The recent market reaction reminds us of the market response after the first inflation cooldown this summer. The main theme of this round is the market rebounding due to the confirmation that the Federal Reserve has ended the current round of interest rate hikes. The supporting evidence is the Fed’s hint of a decrease in the magnitude of interest rate hikes and the unexpected drop in inflation and employment data. The shift in policy expectations and actual market interest rates is a positive factor for stocks, bonds, non-US currencies, and even cryptocurrencies. On Friday, President Biden is expected to sign an interim spending bill, officially avoiding a government shutdown this weekend, and the market has responded calmly to this.

Last Friday, the yield on the US 10-year Treasury briefly dropped below 4.38%, and the yield on the 2-year Treasury dropped below 4.80%, refreshing the intra-day low of the past two months. The UK 10-year yield also fell back to its low in May.

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In the short term, there is a high probability that the market will continue to trade expectations for the timing and magnitude of interest rate cuts, but the swings should not be too large. The timing is expected to fluctuate between May and July (currently expected to be in May), and the magnitude is expected to fluctuate between 75 and 150 basis points (currently expected to be 100, which was already quite exaggerated a month ago, as the Fed’s own expectation was only 20). Only under a relatively pessimistic background would the timing of the first rate cut be earlier than May, and the magnitude would exceed 100 basis points. Therefore, it can be said that the pricing in the short-term interest rate market has basically been completed, but it is difficult to say for the long-term, as there are still supply and deficit issues, as well as political chaos, which will only increase. Futures data also shows that the short-selling force has almost not weakened, but has risen in the past two weeks.

The US dollar has weakened recently along with the cooldown of interest rate expectations, with the US dollar index recording its largest weekly decline in four months. Non-US currencies, including the Chinese yuan, experienced rapid appreciation last week, with CNH quickly approaching 7.25 from around 7.30. Seasonal factors also support the tendency for the yuan to strengthen in the last two months of the year, which is related to the habit of many companies to convert their foreign currencies into yuan. Fundamentally speaking, the relative prospects for the dollar’s competitors are also not good, so the attractiveness of the dollar is difficult to be significantly eroded at the current stage.

In terms of positions, the net long position of the US dollar index is relatively high, which may provide motivation for closing out positions.

Benefiting from the weakness in the US dollar and interest rates, gold and silver have surged, while cryptocurrencies have experienced a volatile pullback, with altcoins showing relatively strong performance:

The pressure to cover short positions in US stocks continues to be released, with mixed performance among technology stocks. Non-profit technology stocks have risen sharply, while giant tech stocks have remained relatively flat. Regional banks and stocks with the largest short positions have also seen significant gains, while consumer staples have been heavily sold off.

The key characteristics of stocks that performed well last week were their benefit from lower interest rates, lower oil prices, and the previous underperformance of these stocks, indicating a significant rebound from recent shocks. The 10% correction from August to October had three clear stages or driving factors: a normal pullback in August, the impact of interest rate fluctuations in September, and a geopolitical crisis in October. The stock market rebound has now released the impact of interest rate fluctuations and geopolitical shocks, but from the performance of stocks, it has not yet reflected expectations of an upward cycle of growth.

Now it is not simply a matter of categorizing stocks as growth or value to determine whether the market is pricing in future growth, because we can see a clear internal differentiation. For example, consumer cyclical stocks and financial stocks, as well as transportation and delivery stocks, are still typically priced for a recession, while various technology stocks and energy stocks are priced very low or practically not at all:

【OpenAI board fires CEO Sam Altman】

There are two contradictions between the two. One is the controversy between security and commercialization: since the establishment of OpenAI, there has always been controversy over the safety and commercialization of AI technology (Altman and Greg Brockman, another co-founder who left with Altman, belong to the radical faction, while the board members who fired Altman, led by OpenAI’s Chief Scientist Ilya Sutskever, belong to the conservative faction). These controversies led to Elon Musk cutting off contact with OpenAI in 2018 and a group of employees leaving in 2020 to establish a competitor called Anthropic.

The second is Altman’s entrepreneurial ambition: Altman once attempted to raise billions of dollars from Middle Eastern sovereign wealth funds to create an AI chip startup that competes with Nvidia. This behavior has worsened the conflict with the board of directors.

This has caused Microsoft’s midday decline to rapidly expand to more than 2%, ultimately closing down nearly 1.7%. However, prior to this, Microsoft had been hitting record highs in intraday trading for several days. If OpenAI falls under the control of conservative factions that resist commercialization, it would undoubtedly be a negative for Microsoft. Microsoft CEO Nadella is “angry” about the dismissal, after all, without Sam, Microsoft’s control over OpenAI will weaken further. It’s strange that Microsoft invested $10 billion and didn’t even get a seat on the board, and Microsoft has been eager to commercialize OpenAI’s achievements. Currently, it seems that Ilya Sutskever is not good at communicating externally. There has been no additional explanation or clarification after the incident. It will be difficult to gain public support if things continue like this, and it is not impossible for current board members to resign under pressure from all sides.

In addition, Alphabet, the parent company of Google, which has postponed the release of its self-proclaimed “most powerful model” until the first quarter of next year, fell nearly 1.2%, falling from the high of October 24th (although the internal strife of OpenAI should be good news for Google AI).

Also affected is WorldCoin, the cryptocurrency created by Sam, which fell, while Bittensor (TAO), a leading AI concept in the cryptocurrency race, rose by 25%, and Render (RNDR) rose by 8%. (Do you think you have a chance now?)

[BX has achieved certain achievements but not in terms of the economy]

Xi visited San Francisco last week, with the dual mission of stabilizing Sino-US relations and restoring investor confidence in the Chinese economy. People’s expectations for this summit were not high, but the results met expectations. Biden said that the meeting made real progress, and it is reported that agreements were reached in military exchanges, fentanyl, and AI.

In the eyes of the Western world, Xi, who has always been aloof, showed a more gentle and graceful side in San Francisco. He reminisced with Biden about his first visit to the United States 38 years ago, publicly accepted an NBA team jersey from the Governor of California, and even promised to send giant pandas to American zoos.

The Wall Street Journal’s report was titled “Xi soothes American business leaders on China’s business environment: foreign capital is fleeing China. In his first visit to the US in six years, Chinese leader Xi Jinping did not spend too much effort to win back American companies and investors.” The report believes that Xi did not mention any measures that China may take in future trade and investment with the US, considering his speech to be “vague”. However, some commentators believe that his speech was very friendly, even if it was only vague. “He could have given a more radical and nationalist speech to defend China.”

Actually, President Xi did express that China will create a “world-class business environment” and improve mechanisms to protect the rights of international investors. He also said, “We will take more ‘heartwarming’ measures, such as improving policies for the entry and residence of foreigners,” he said, adding that access to financial, medical, and electronic payment services will become smoother. “All of this is to make it easier for foreign companies to invest and operate in China.” However, the problem is that access itself has been continually expanded, which is not news. Currently, foreign investment is more concerned with the protection of legitimate rights and fair competition. So, some people think this viewpoint is avoiding the real issue.

【Chinese stock market gives BX a valuation】

Last week, global stock markets continued to rise, but China’s Shanghai and Shenzhen 300 Index recorded its worst weekly performance in about a month. Foreign investors sold 5 billion yuan of Chinese stocks, exacerbating the market’s decline, and A-shares are facing an unprecedented third consecutive year of falling prices.

Of course, this is not entirely the influence of BX. The real estate industry remains the core of China’s entrenched downturn and once again became a source of concern last week. Data on Thursday showed the largest decline in new house prices in October in eight years, and the second-hand market saw the largest decline in nine years.

【Global action against inflation reaches turning point】

The latest data last week showed that the UK’s consumer price inflation fell to 4.6% (expected 4.8%), and the final harmonized CPI growth rate in the Eurozone in October slowed significantly from 4.3% in September to 2.9%. In addition to the previously released US CPI of 3.2%, this has strengthened expectations that central banks around the world may release the brakes and cut interest rates next year. The mainstream market expects the Bank of England to cut interest rates from May next year, followed by the Federal Reserve and the European Central Bank in June.

For most people, housing and medical costs are fixed by contract for a period of time. Taking the United States as an example, the inflation rate that households should face per month, excluding these two items, has dropped to 2.6%:

【Walmart worries about imminent deflation】

At an investor conference, Walmart’s CFO described the current state of US prices with the term “deflation,” pointing out that we may soon experience a period of deflation lasting several months. “The prices of general merchandise have been declining, and in the past few weeks or months, the decline has been greater than before… In the coming weeks and months, we may see a contraction or price drop in dry goods and consumer goods.” No one understands the fluctuations in everyday product prices better than large supermarket management. When they use the term “deflation,” it at least indicates that a certain part of the market is currently experiencing a decline in price indexes. The CFO also stated that in the last two weeks of October, they saw some worrying signs, with both sales and volume weaker than the rest of the third quarter.

Companies like Walmart and McDonald’s are typical consumer stocks and must-haves in the consumer goods sector. In the past two years of high inflation, consumer companies have been able to significantly raise prices, citing rising raw material prices and supply chain disruptions, and successfully pass on the costs to consumers. So, despite rising costs, most industries have actually increased profit margins, especially dominant monopolistic companies that have the power to raise prices.

Last week, the US October PPI was announced to have cooled down to 1.3% year-on-year, with a month-on-month decline of 0.5%, marking the largest monthly decline in three and a half years since April 2020.

Warren Buffett’s Berkshire Hathaway cleared out its holdings in consumer stocks including General Motors, Johnson & Johnson, Procter & Gamble, and Mondelez International in the third quarter. Now, the consumer stocks sector accounts for only 12% of the portfolio, which actually contradicts his investment philosophy of liking companies that are stable in operations and have brand value, thus being able to withstand economic fluctuations.

[Deflation does not necessarily bode well for the stock market]

If prices fall rapidly and the Federal Reserve starts lowering interest rates from the current high level – –

Impact on the US dollar (probability of bearishness):

Lowering interest rates means monetary policy becomes looser, which often reduces foreign investors’ demand for US dollar assets, potentially causing the US dollar to depreciate. Unless there is a major crisis that may trigger safe-haven demand, the US dollar may also temporarily benefit.

Impact on US Treasury bonds (usually bullish):

Lowering interest rates almost certainly leads to a decline in Treasury bond yields, which increases the market price of Treasury bonds. Therefore, US Treasury bonds, including most high-quality fixed-income products, tend to perform well during rate-cutting periods.

Impact on the stock market (uncertain):

The stock market’s response depends on the reasons and background for the interest rate cut. If the rate cut is aimed at addressing the risks of economic slowdown or recession, it may initially not directly benefit the stock market, as the market may be more concerned about the deterioration of economic fundamentals. However, in the long run, interest rate cuts usually lower companies’ borrowing costs and stimulate economic growth, which may eventually support a stock market rally.

Impact on commodities market (uncertain):

The reaction of the commodities market is also complex. On one hand, the depreciation of the US dollar may increase the prices of commodities priced in US dollars. On the other hand, if the interest rate cut is due to concerns about economic slowdown, it may imply a decrease in commodity demand, putting pressure on commodity prices.

Bank of America Fund Manager Survey (FMS)

Investors are reducing cash holdings and increasing bond allocations, and for the first time since April 2022, stock positions are overweight:

Cash levels have dropped from 5.3% to 4.7%, the lowest level since November 2021, with the largest decrease since January this year. The cash level of 4.7% is still slightly above the long-term average, indicating a neutral level. If the cash balance falls below 5%, it is considered a buy signal at Boa. If the cash balance continues to decline below 4%, FMS cash rules will issue a “sell” signal, reflecting investors’ further increase in risk assets and being overly optimistic about the economic outlook:

Individual investors currently have a significantly higher bullish sentiment for stocks compared to institutional investors. However, the gap between the two has been narrowing this year, with institutional investors improving their bearish sentiment for stocks. AAII data shows that individual investors currently have a stock position of more than 64%, while FMS surveys show that institutional investors currently have a net position of 2% long stocks:

Adding a Bank of America Private Banking client survey, stocks currently account for 59% of AUM, which is higher than the average value of 56% from 2005 to the present, but there has been no period lower than this level in the past decade except for the COVID-19 period:

Investors are over-allocated in technology and healthcare stocks and under-allocated in European stocks and utilities:

This month, the largest changes in positions are increasing holdings in bonds, technology, and telecommunications, while maintaining positions in commodities, cash, and industrial stocks:

The most crowded trading positions are long positions in large-cap technology stocks, short positions in Chinese stocks, and long positions in short-term government bonds:

Positions and fund flow

According to Goldman Sachs, “In the past 10 days, CTAs have bought nearly $70 billion worth of U.S. stocks… This is the largest 10-day purchase we have on record.”

Goldman Sachs estimates that global short positions of approximately $140 billion have been closed since the beginning of the month. It is expected that buying pressure will continue for at least one week. Some markets may have greater demand for closing positions, such as small-cap stocks, which still need more buying to cover shorts.

Of course, the cost is that after this wave of massive buying, CTA positions are now more balanced, and the momentum for additional purchases may be limited:

However, we are currently in a period of intensive share repurchases, which is expected to continue until mid-December. This will be a very strong supplement to buying, with an estimated repurchase amount of $40 billion last week:

According to Deutsche Bank’s statistics, the overall position of US stocks has been rising sharply since the end of October, but its level is still at the 49th percentile. The position of independent strategies rebounded significantly to slightly overweight (69th percentile), while the system strategy position was slightly increased and still at an underweight level (34th percentile).

CTA fund positions have rebounded to some extent:

Equity funds ($23.5 billion) received the strongest inflows in the past two months, mainly from the United States ($25.8 billion), while other regions saw outflows. Money market funds ($20.5 billion) received inflows in the fourth week, but at a slower pace than recently

CFTC data (as of November 14), net longs of US stocks have been rising for two consecutive weeks, with increases in major indices

In terms of bonds, overall net shorts increased, as the increase in shorts for 10-year bonds offset the decrease in other duration shorts

The overall balance of the US dollar position is still close to neutral. The net longs of the euro have increased significantly, offsetting the decrease in net longs of other currencies

In terms of commodities, investors further reduced net longs in oil to historically low levels. Copper shorts increased slightly this week, and gold longs decreased significantly from high levels

Sentiment

Goldman Sachs: Extreme

Bank of America: Buy

AAII: Not much change. Bullish

CNN Soars: Bullish

Focus this Week

On Thursday, November 23, the US stock market closed for Thanksgiving Day, and on Friday it only opened for half a day (many people took the whole day off). Therefore, Friday is usually one of the days with the lowest trading volume in the US stock market. It is expected that the market will hover around last week’s closing position with narrow fluctuations.

As the earnings season comes to an end, AI leader NVIDIA will bring it to a close. Wall Street expects Q3 revenue to be $16.079 billion, a 171% increase YoY; and adjusted net profit to be $8.419 billion, a 478% increase YoY. The average target price of analysts is $628.68.

This week will also see a $16 billion 20-year bond auction, which is seen as another test of market demand for US bonds. If the auction results are poor and it leads to further increase in yields, it could even trigger a softer stance from the Fed, which in the medium term may not be a bad thing.

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