Get Ready for Some Summertime Blues
Let me list all the reasons we can expect to see more lows ahead.
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Think we've seen the summertime lows? Think again.
It's been a very tricky market for traders and investors, and I see a market little changed from last week.
In fact, my "de-grossing/rotation" theme from last week remains in tact. We are still seeing reduced longs and shorts and cross-asset trades (de-grossing), while rotating out of big tech into banks and small caps. But at the same time, we're seeing few reduce overall exposure to equities (derisking).
Let's review the rotation action in numbers:
- The tech-heavy Nasdaq 100 was down 2.6%, while the small-cap heavy Russell 2000 gained 3.5%.
- The S&P 500 was down 0.8% while equal weight version was up 0.8%.
- Energy, which I like as our favorite hedge against geopolitical risk, was mixed. The Energy Select Sector exchange-traded fund XLE was down a smidgen, while the VanEck Oil Services fund OIH was up 1.6%.
As for derisking, when I look at the “frothier” end of things, like the ProShares Trust TQQQ, the ProShares UltraPro Short QQQ SQQQ. and the GraniteShares 2x Long NVDA Daily ETF (NVDL), I see risk-taking rather than derisking. That along with many other metrics tells me there is room for another downside leg.
Just look at the long-awaited interest rate cut. The Fed might just be the most priced in I’ve ever seen it. While some people are still complaining about inflation, and Fed members remain reluctant to start cutting too early, the market now expects cuts in September and I cannot see any reason the Fed won’t deliver. But it is so priced in, it seems difficult for the Fed alone to spark much of a rally from here.
And we have additional reasons to expect that we have not seen the summer lows yet. The jobs data is one. My base case is the worst of all possible scenarios on jobs – bad enough for people to question the “soft landing” scenario, but not bad enough to spur the Fed to move faster than what is already priced in.
Earnings and artificial intelligence is another reason. The biggest driver, which might be difficult to tease out, is whether the cost/benefit of AI is worth it now, or in the next year or so. I think disappointment will play out on this front, for several reasons. First, the cost of implementing AI has increased rapidly and is difficult given the lack of experts. We’ve all had long enough to engage with AI (particularly large language models) and it is unclear whether between the data they are trained on or how they look at the data is truly as revolutionary as was thought, or as it may be in the future. The best analogy that I have heard is the LLM’s are like reading a really good newspaper or magazine. The articles on subjects you know little about make a lot of sense. But you find a lot of issues in articles about your area of expertise.
Politics and geopolitical risks are another potential problem. Political first. I will limit this to my strongly held view that as the campaigning moves to policies, we will be forced to realize debt is going to grow. I see little evidence that any party will campaign on anything that would reduce the deficit.
The next obstacle is geopolitical. From the first time Russian and Chinese jets flew near North America together (happened last week) to attacks on the Golan Heights, to elections in Venezuela, the world seems ripe for more problems. With the U.S. inward looking right now and everything else going on in terms of domestic politics, there is an increasing risk of some enemy or competitor trying to take advantage and pursue their agendas more aggressively.
Bottom Line
Fed action will not be enough to end the risks. The rotation trades should continue to work, though the move has already been quite extreme, but look for it to occur in a falling market.
Look for some form of “not so good” landing to make its way back into the lexicon in the coming weeks.
Energy remains a favorite sector, and banks look good, too. Both the S&P regional banking ETF KRE and the S&P Bank ETF KBE have been doing very well. The risk is that we get data indicating stretched consumers and unrealized problems in some segments of commercial real estate such as office space in some specific cities. That could put some pressure on banks.
The worst might be behind us on risk assets, but the view here is that we have more downside to come and August, often a “trend following month,” will follow the trend of choppiness and losses for stocks.
