Heat Check
#92: Can anything stop this train? Plus an update on the 2024 macro and micro ideas.
Don’t leave the table when you’re on a heater.
This is fallacious advice in Vegas, where the sequence of blackjacks and busts are only connected in the gambler’s mind. The mantra holds more truth in a market of animals. Price leads sentiment, sentiment drives price. Optimism breeds enthusiasm breeds euphoria. Momentum is a feature, not a figment.
Since late October, this market has been on heater. At the index level, U.S. equities large and small have notched gains of 20% - 25%, representing approximately $9 trillion in market value in less than a quarter.
In the hottest corners of the market — signs of mania abound. The Artificial Intelligence capex bonanza continues with NVIDIA up 50% or YTD, Softbank-backed ARM doubling on a benign earnings, and of course the legendary daily candlesticks of SMCI.
But it isn’t just AI. A list of top 2024 gainers is actually dominated by pre-revenue biotech stocks (PYXS, ADCT, ELEV, CRBP, JSPR, ADVM, etc.) which have multiplied in value in just several weeks. Perhaps some have announced some meaningful results, but then there are cases like Pyxis Oncology, which has more than tripled without so much as a press release1.
One might wonder what efficient market factor has tripled SMCI’s value in the past month, or what valuation multiple one should ascribe to a cyclical sector in its boom phase. One might be curious about the sudden, simultaneous enthusiasm for notoriously speculative biotech names.
Such mundane considerations may eventually prove relevant, but they are not today. Today, the market eschews the prudence of the probable for the art of the possible. And to the victor go the spoils.
But it’s disingenuous to describe the markets only in terms of its most extreme winners. For much of the past year, this column has noted the positive backdrop for equities. Tech earnings have rebounded and are firmly on the upswing. There has been improvement in manufacturing, consumer sentiment, asset prices, and money aggregates. Nearly $1.6 trillion of liquidity has been released from the RRP since last June. The real economy continues to chug forward despite lingering concerns.
Despite the five-handle Federal Funds Rate, financial conditions are now easier than before rate hikes began in March 2022, as measured by the Fed’s own index. Most practical borrowing costs — i.e. for homebuyers or corporates — are unchanged over the past sixteen months.
Indeed, this has always been the plan. So long as the disinflation story stays on schedule, the Fed has guided the market to front-run “official’ policy easing, and the market has happily obliged. Without overwhelming evidence to derail the goldilocks scenario of steady growth, easing inflation, and accommodative policy, there is little standing in the way of further gains.
But there is some evidence for caution.
First, the market hit a speed bump at the January FOMC meeting, as the Fed pushed first cut beyond March. And this Tuesday, an undeniably hot January CPI print prompted a brief butt-puckering plunge, sending all indices deep into the red and leading the small-cap Russell 2000 to its worst day since June 2022, down 4.1%.
On Tuesday, we even saw a rare but notable bid for volatility, with the VIX quickly ramping from 14.7 to 18.0, briefly inverting the forward VIX curve, before volatility-sellers bludgeoned the gauge back into submission.
The market’s concern was unsurprisingly short lived. A delay in rate cuts and a single uncooperative CPI release is not enough to stall this stock market heater, even as long-term yields have risen.
Of course, the recent inflation data is either a red-herring or a harbinger, depending entirely on who you ask. I don’t attempt to adjudicate. But since disinflation is a critical and consensus assumption for markets and policy, it’s worth asking what if…
What If
What if the immaculate disinflation hits a snag in the last quarter mile? What would an inflation re-acceleration actually mean for the market?