For the past month, the number and severity of risks to the bond and stock markets has risen, with some pundits wondering just how the market can trade so confidently higher when there are so many large-scale events unfolding that threaten to pose a systemic risk to the United States and global financial markets.
Let’s start with an easy one—a “sleeper” that caught everyone off guard. At last week’s 30-year Treasury auction, in which a mere $26 billion in debt was being bid for, the Industrial and Commercial Bank of China (ICBC), the world’s largest lender by assets, said its financial services experienced a ransomware attack that reportedly disrupted their trading of Treasurys. That attack prevented the ICBC from settling trades and rendered the bank unable to clear commitments that forced the bank to send the settlement details to its counter parties by a messenger carrying a thumb drive—a heroic effort to limit the damage.
The ransomware attack was orchestrated by a suspected perpetrator with ties to Russia. Bloomberg reported last Friday: “The incident spotlights a danger that bank leaders concede keeps them up at night—the prospect of a cyberattack that could someday cripple a key piece of the financial system’s wiring, setting off a cascade of disruptions. Even brief episodes prompt bank leaders and their government overseers to call for more vigilance. ‘This is a true shock to large banks around the world,’ said Marcus Murray, the founder of Swedish cybersecurity firm Trusec. ‘The ICBC hack will make large banks around the globe race to improve their defenses, starting today.’ This particular hack affected about $9 billion … But imagine if the hackers were able to force the auction to seize up and sever trading altogether.”
Even so, the auction was rated ‘D-’ by CNBC’s Rick Santelli, after primary dealers had to take in 25 percent of the auctioned paper that didn’t sell. The bond and equity markets rallied sharply at the next trading session, led by mega-cap technology stocks on lower-than-forecast consumer sentiment data and AI euphoria.
Here’s where it gets a bit weird. On Friday, the University of Michigan Consumer Sentiment report for October crossed the tape at 60.4 versus consensus expectations of 63.7, marking the fourth straight monthly decline. The Current Economic Conditions Index dropped to 65.7 from 70.6; year-ahead inflation expectations rose to 4.4 percent from 4.2 percent, hitting their highest level since November 2022, and five-year inflation expectations rose to 3.2 percent from 3.0 percent, the highest reading since 2011. After all that, the market rallied 1.6 percent, with Nasdaq bolting higher by 2.0 percent, led by none other than the Teflon-like tech sector.
Despite new restrictions on chip exports to China, semiconductor and semiconductor equipment stocks raced higher in front of this week’s meeting between President Joe Biden and Chinese leader Xi Jinping at the Asia-Pacific Economic Cooperation summit in San Francisco, California. The two leaders have met only once since President Biden was elected, and I do not expect this meeting to go well at all. Mr. Xi wants President Biden to reject the independence of Taiwan, and to reiterate America’s commitment to “business as usual” with Mr. Xi’s regime in China.
The Coming AI War Between ‘Mr. Softie’ and Mr. Musk
On a completely different note—and one that I find fairly stunning—on Nov, 5, before the tech sector scored its big week—led by none other than “Mr. Softie” (Microsoft) and the “all the rage” ChatGPT open generative AI tool, Elon Musk revealed his own artificial intelligence bot, Grok, to challenge ChatGPT, claiming the prototype is already superior to ChatGPT 3.5, across several benchmarks.
According to CNBC: “It’s the first product of Musk’s company and is now in testing with a limited group of U.S. users. Grok is being developed with data from Musk’s X, formerly Twitter, and is thus better informed on the latest developments than alternative bots with static datasets, the company’s website said. It’s also designed to answer ‘with a bit of wit and has a rebellious streak.’”
xAI launched in July with a team stacked with former employees of OpenAI, DeepMind and more.
Here’s the crazy thing: even after the Musk announcement that Grok can run laps around ChatGPT 3.5, shares of Microsoft traded to a new all-time high. Why? My guess is that Microsoft is considered the quintessential “underinvested fund manager year-end performance pressure safety trade.” But its fortress balance sheet—a company running on all cylinders and first to market AI leadership—is now in question.
Let’s not forget that Mr. Musk was part of OpenAI in the founding days, but stopped backing the company after a disagreement with senior management over the speed and nature of AI’s technological advancement, suggesting that OpenAI wasn’t doing enough to ensure safe development.
Now, X is rumored to offer Grok at $17 per month. One of the standout features of Grok is its access to real-time data from X, a unique advantage by allowing it to provide the latest information on current events and happenings, not available on ChatGPT and other chatbots.
My point is that on any other day, news of the Grok release would have had a wrecking ball-like impact on the leading AI player. But with no way to invest in Grok, the market took the news as if the AI race to become the superior large language model is a catalyst to bid up shares of leading AI stocks and the rest of the tech sector against what was largely just a so-so earnings season for the broader sector.
A lackluster earnings season was forgiven when bonds rallied, implying lower rates would fix all things.
In any event, investors are in a lopsided market. A closer look at last week’s impressive rally for the major averages showed that only the tech sector was a true standout. The rally in tech stocks masks a lot of other areas under stress. The one-year charts of consumer staples, financials, health care, materials, real estate, energy, and utilities look downright ugly. Except for tech, nearly all other charts are lagging.
In terms of investing in the world outside of big-cap tech stocks, it takes intense stock picking to buck what is a very challenging investing landscape for small caps. For instance, the Russell 2000 Index tried to make a stab at breaking its primary downtrend, but failed. Maybe this next retest will provide the proverbial double-bottom, higher-low technical formation that chartists get all excited about.
Investors are in a super top-heavy market, where dips in tech will very likely continue to be bought into. With the China summit coming, the Israel-Hamas war ongoing, the Nov. 17 deadline for another congressional continuing resolution, and the data pointing to a consumer dialing back consumption, be thankful there is a winning sector that is the biggest, the fastest growing, the most liquid, and the most trusted to pad portfolio gains in an otherwise chaotic world.
