One week / one topic: 'Tis the season to be long?

What happened?

Allegedly, the broad equities bull market post ‘Liberation day’ has been relying on three assumptions:

1. Tech hyperscalers can afford to continue spending hundreds of billions per year to finance the AI arms race

2. The Federal Reserve is going to cut interest rates by more than it would normally do, helping to reinflate asset prices everywhere

3. The US economy – and its almighty consumers – can keep spending as they usually do

However, this week’s developments pointed in a different direction – that is, if markets actually cared to take notice?

Tech earnings were mixed: Alphabet, Apple and Amazon were strong, but Microsoft was ok at best and Meta outright bad.

(Nvidia keeps playing a different game and it has now a $5tn market cap)

Chairman Powell went out of his way to emphasize that a December rates cut is not a foregone conclusion, and acknowledged that there are “strongly different views about how to proceed” inside the Fed.

For now, the market seems relatively comfortable with the Fed’s carefully crafted forward guidance (below) – but for how long?

Recent quarterly earnings calls confirmed that “low- to middle-income (consumers) face headwinds from unemployment, student loan repayments, and slower real wage growth” (Chipotle) and “one of the worst consumer sentiments we’ve seen in decades” (Kraft Heinz).

Indeed, the ‘K-shaped economy’ seems to be more and more entrenched.

And yet – as of time of writing – prices have barely moved since last week.

How to make sense of it?

Our observations

• Fundamentals: One would be excused for thinking that the word ‘fundamentals’ is often abused and overused, either as a fig leaf or to signal intellectual sophistication. Arguably, in the end the fundamental that matters the most is perhaps risk appetite?

• Price action: Perhaps the AI theme is strong enough to propel very concentrated equity indices ever higher, but small caps, regional banks and discretionary names look fragile.

• Investor beliefs: Snake oil or not, there are widespread expectations that it’s time for the ‘Santa rally’ to begin for a glorious melt-up into year-end… Let’s see!

So what?

Glass half full: runaway demand for AI is spilling over into new segments, the economy is holding up and the Fed has got your back.

Glass half empty: valuations are very expensive, cracks are starting to appear and AI ROI looks dubious.

However – if indeed risk appetite is a plausible contender for the ‘fundamental’ that ultimately matters the most – it would take a lot of hubris to confidently call the top on any given day.

Being broadly invested remains a sensible course of action then, and – while we have recently taken profits in European and Japanese banks – we keep prioritizing diversification across asset classes, sectors and regions with a deliberate tilt towards less expensive opportunities.

Mood music: Led Zeppelin – When the Levee Breaks

By popular demand, here is the One week / One topic playlist