Scheduled Programming: __
Surface level vs. running in the background
Highlights
The “valuation” of companies only matters, when it matters and local trends are to be respected.
An abundance of noise, however, the cycle is still running in the background.
No monetary pivot in U.S. (shocker) and UK 10-YR GILT yields→ Vertical.
Holiday
Having a nice coffee and looking at the mountains under some early morning light as I compose this piece. Last weekend, I celebrated the wedding of one of my best friends and will be running it back all over again tomorrow. One of my other best and longest-standing friends (known since kindergarten) will be getting married on Saturday. Hopefully, everyone is able to take some time to get outside and enjoy the nice weather over the long weekend (Memorial Day Monday). Summer is here in the U.S. and the change of pace is entertaining. I want to express my gratitude to all those who have dedicated their lives to serving our country.
Whether it is the dramatization of the debt ceiling fiasco, artificial intelligence (AI), CPI releases, Fed monetary policy decisions, performance problems, or short squeezes, there is no shortage of crowds of people that are having an existential crisis on any given week. Not going to say much about Nvidia because I do not want to give any more attention to this subject, but I will mention three things.
First, the front-page headline of the Wall Street Journal this morning is, “How AI is Catapulting Nvidia Toward the $1 Trillion Club”.
Second, during the after/pre-market hours Wednesday morning and Thursday afternoon, this company’s value swung for approximately $200-225 Billion. I will acknowledge and respect the solid quarter and epic ramp in guidance the company provided for its forward outlook. I have held no position on this company long or short, however over the past couple of weeks I could not help but notice the crowd of people that started coming out of the woodwork on Twitter citing a “valuation” problem with this company. The summary of their comments was basically that the company is overvalued and then started throwing out arbitrary overall company valuation metrics based on price to sales, price to earnings, etc. Why do I say arbitrary? Two reasons:
Valuation only matters when it matters (specific points in cycle time). November 2021 to the early months of 2022 was a good example of this mentality. For the background, go look at price charts for profitless companies within the growth complex during that time. A couple of good examples are SE, SHOP, UPST, RIVN, and ARKK (index). There are 100s of similar charts but will leave these for study (click tickers for links).
Company valuation is only correct whenever the analyst is using the right numbers in their model. If forecasted numbers are too high, analysts often time believe that certain stocks are cheap, but those companies are not cheap if the realized earnings numbers keep going lower. If forecasted numbers are too low, analysts often believe certain stocks are expensive, but those companies are not expensive if the realized earnings numbers keep going higher. One of the biggest lessons that I have learned from Keith McCullough (CEO of Hedgeye Risk Management) is that valuation is never the starting point for a trading/ investment process. While valuation plays a role in certain junctures, it should not be the core focus of making decisions. For example, NVDA was in a bullish trend going into that earnings report. Anyone that was positioned “short” (bearish) into that earnings “event” based on the valuation of the company being “nonsensical”, just got run over by a freight train. While I cannot disagree that the company currently is trading at “bubble prices”, Trends are always to be respected.
Third, providing more context for readers that may not be familiar with the significance or appreciate this type of stock movement. This is a company that at Wednesday’s close was worth approximately $754 billion and by Thursday’s close settled for $938 Billion (+24.37% D/D). There were points in time during after and pre-market hours when the stock was pushing +30% D/D. Perhaps I am young in my investment career, however near $1 Trillion companies moving that amount of market capitalization is quite the spectacle. There are all types of human action embedded within that type of price movement. Behaviorally, I am not sure if I will ever witness anything like this again.
Macro
As mentioned above, there are multiple “headlines” and “buzzwords” that are capturing the attention of the public market eye. For weeks we have discussed the quiet background and today will be no different. Given there are so many distractions. Let’s focus on the cycle. A holiday weekend is here, so the market volume will be light today and the market will be closed Monday as well.
Global Data
The following “PMI” numbers are from the S&P Global Flash survey:
US Industrial Production +0.2% y/y (April 2023) vs. +1.5% (January 2023) and vs. +4.5% (September 2022).
France's manufacturing PMI is firmly contractionary at 46.1 (May) vs. 45.6 (April), however slight acceleration.
France’s Services PMI was 52.8 (May) vs. 54.6 (April), a modest deceleration
Germany’s Manufacturing PMI is firmly contractionary at 42.9 (May) vs. 44.5 (April), a deceleration and new cycle low.
Germany’s Services PMI was 57.8 (May) vs. 56 (April), an acceleration
Eurozone’s Manufacturing PMI is firmly contractionary at 44.6 (May) vs. 45.8 (April), a deceleration and new cycle low.
Eurozone’s Services PMI was 55.9 (May) vs. 56.2 (April), a slight deceleration.
UK’s Manufacturing PMI is firmly contractionary at 46.9 (May) vs. 47.8 (April), the third straight deceleration
UK’s Services PMI was 55.1 (May) vs. 55.9 (April), a slight acceleration.
United States Manufacturing PMI is contractionary at 48.50 (May) vs. 50.2 (April), a deceleration
United States Services PMI was 55.1 (May) vs. 53.6 (April), a slight acceleration.
Richmond Manufacturing Index is -15 (May) vs. -10 (April) and vs. -8 expected, which is near cycle lows.
UK CPI +8.7% (April) vs. +10.1% (March), a sharp deceleration.
UK Core CPI +6.8% (April) vs. +6.2% (March), in contrast to the headline number this was a large acceleration. Core CPI is ex-food and energy components.
German GDP -0.5% (Q1 2023) vs. +0.8% (Q4 2022) and vs. +3.8% (Q1 2022), this is recessionary and a new cycle low.
Seeing some of the data slow on the manufacturing side across the board and there are some new cycle lows in the manufacturing trends in Europe. Germany is one of the more significant economies in Europe and their GDP just went negative. A common trend across the board in Europe and the US is the falling manufacturing data, but acceleration or persistence in strength in the services data, which keeps inflation sticky as seen in the UK Core CPI acceleration.
UK Core CPI acceleration is quite interesting given the large deceleration in the headline number. One of the main reasons why I am interested in this report specifically is due to the manner in which the UK 10-YR GILT yield is moving. During the month of May, this bond yield is +51bps (3.8% to 4.33%). For those that may be unfamiliar with bonds, this is a massive increase in the cost of capital especially during a one-month period. The cost of capital is problematic for those with short-term capital needs and/ or those with debt maturities that need to be refinanced. Below is a chart to showcase this vertical movement.
UK-10YR GILT
The GILT yield is now approaching levels from late September/ early October 2022 that caused, a minor financial panic where the BOE had to intervene, GBP currency crash, global financial stress, and a head of cabbage that was able to last longer than Liz Truss was able to serve in office as Prime Minister (49) days. Not implicating any type of causality, but this has been one of the most interesting charts that I have seen this week. Just wanted to make a note of this.
Meanwhile, in the United States, the 2-YR yield is +45bps (4.05% to 4.50%). The short-term cost of capital has risen once again despite the repeated market calls for the Fed to pause its rate hike schedule and even cut rates. Two charts below are the U.S. 2-YR yield and the Eurodollar.
U.S. 2-YR Bond
Eurodollar
Based on these charts there will likely not be a rate cut anytime soon (unless realized economic calamity) and the short-term cost of capital may even rise once again at the next meeting. Not making any call on that however because I do not have a crystal ball. What is the Eurodollar and why am I showing this? These are US dollars deposits held at foreign banks outside the United States. They are not subject to US federal reserve regulation. Showing this chart because generally, this chart will start going vertical whenever the Fed is about to or is cutting rates. Just another jab at the crowd that has called for a pause or a rate cut after every meeting for over a year now.
Copper gold ratio vs. 10-YR yield (Tier One chart)
Lastly, will discuss the chart below which was provided by Tier One Alpha and the link to this specific publication will be found in the resources section.
*Tier One Alpha
Copper is a very economically growth-sensitive commodity, while Gold is an economically growth-sensitive currency. Copper will outperform during periods of accelerating inflation and accelerating economic growth, while Gold generally outperforms during periods of decelerating inflation and decelerating economic growth. Additionally, the US 10-YR yield is sensitive to growth and inflation. Accelerating growth and inflation will usually push this yield higher.
Over the previous weeks, we have observed the deterioration in various economic data sets specifically from the retail sales, industrial, and manufacturing complex. The Copper/Gold ratio which is the blue line is trending lower in a similar fashion to the economic reality shown in those reports. The US 10-YR yield which is the orange line has remained elevated. Historically over the last ten years, these two lines have moved together based on the chart above. The divergence between the two lines today is significant and noticeable. Not financial advice nor previous performance equals future performance, but if the orange line would converge to meet the blue line lower as it has historically, this would move to be an environment where bonds will outperform. Still early to tell as bond volatility has once again ramped up over the last month.
Conclusion
The “valuation” of companies only matters, when it matters and local trends are to be respected. There has never been more noise given the prevalence of media sources and outlets, however, the cycle is still running in the background. Evident based on the data that continues to become reality. There is no monetary pivot in the US, which seemingly continues to shock the market here. This dynamic is seemingly beyond me. As observed, the Fed continues to make decisions based on backward-looking data.
Sometimes it is important to have a boots-on-the-ground approach. The following is just something to keep in mind because this is happening in the background. What I mention is a small drop in the bucket, but perhaps an indication of a larger trend to come.
A friend mentioned to me that 10/15 of her team members were laid off yesterday. Earlier this week, another friend mentioned to me about Disney laying off some people as well. This brings me great sadness to hear about others that are adversely impacted. Mike Green has done an incredible job pointing out the lagging nature of unemployment claims. Once people are laid off, there is a severance package period, then there is an additional period that follows where that individual will look for a job, and finally, after some time has passed, they will apply for unemployment. Only mention this as a reminder of the economic reality that some are facing. Judging by certain media headlines and recent market prices, it would be exceptionally difficult to see these issues which are running in the background.
Happy Friday,
Aaron David Garfinkel
Resources
Tier One Alpha: Thursday 25, 2023 (link here)
Yahoo! Finance
Keith McCullough, CEO of Hedgeye Risk Management
Tradingview
Mike Green (Substack: Profplum99)
thanks for sharing all this important information. And enjoy this Weekend!