Now that earnings season is virtually over, I’d say our energy stocks have emerged as market leaders and exhibited tremendous relative strength in an otherwise weak August market. I have often written that I do not like August, since it is a month too often characterized by light trading volume and some resulting trader shenanigans, as algo-driven traders often take advantage of light volume to manipulate prices.
The latest market shenanigans come from “zero-day options,” causing sharp sell-offs or short covering rallies. Amazingly, zero-day options (which expire on the same day they are issued) now account for 43% of all options, up from only 6% back in 2017. This essentially means that the “tail is wagging the dog” via daily market swings generated by ultra-short-term trading. In our firm, as I said on Friday’s podcast, we like to call these option gyrations “Skynet,” after the Terminator movies – where AI takes over the world.
Speaking of AI, I am ecstatic with the results delivered by both Nvidia and Super Micro Computer, since they are both characterized by explosive sales and earnings. AI is essentially our machines studying us – which is essentially no different than our pets studying us for clues about what we like. Whether our machines are merely observing us and providing a solution or plotting against us is always up for debate.
On Wednesday, Nvidia posted massive sales and earnings surprises of +20.9% and +29.2%, respectively, while raising their guidance 37.5% above analyst estimates! Wow, I think we can all agree that AI is hotter than hot and Nvidia is the leader of the pack. Nvidia posted a 101.6% annual sales increase ($13.51 billion vs. $6.7 billion) and a 429.4% annual earnings increase ($2.70 per share vs. 51 cents per share).
These two great stocks fell after releasing great news. Why? This is another August “shenanigan,” led by big trading firms. For instance, Citadel’s trading algorithms are largely based on mean revision, or “what goes up must come down,” so after Super Micro Computer reported second-quarter annual sales growth of 70.3%, it and other AI stocks got hit with profit-taking. Mean reversion in Citadel’s algorithm tries to shake out investors who don’t think Nvidia or Super Micro Computer’s sales and earnings are sustainable.
Fortunately, the energy stocks have been an oasis as the AI stocks were hit with profit-taking, but I also believe that SMCI and NVDA will revive. I should add that a noted perpetual bear, Morgan Stanley strategist Michael Wilson, said that Thursday’s reversal in Nvidia shows that the 2023 market rally is “exhausted,” predicting more declines to come. To his credit, Wilson recently admitted that his recent bearish calls were wrong, so far, but it is easy to explain why he and Morgan Stanley are often so bearish.
Morgan Stanley sells a lot of private credit and alternative investments to its clients, so it needs a prominent bearish strategist to divert its clients away from the stock market into their more profitable alternative investments, where Morgan Stanley collects big fees. As a result, Michael Wilson’s views, in my opinion, have no credibility, since he and Morgan Stanley have a major conflict of interest.
Regarding AI, self-driving cars are still a work in progress, not ready for prime time. Test cars in San Francisco occasionally drive on wet concrete or hit fire trucks. When the 5G network in San Francisco had a glitch, all self-driving cars abruptly stopped, awaiting new instructions. Please do not worry about AI too much, since AI can be unplugged anytime it annoys you. In the meantime, Bloomberg reported that San Francisco residents are becoming increasingly annoyed with the Waymo self-driving taxis.
I can tell that many of you are over-concentrated in AI stocks and do not own any energy stocks. I have been saying that energy stocks benefit from a seasonal surge in demand in the summer, but since they were down early in the year, some did not believe me, even though this seasonal demand has happened every year I have been alive. I want you to own AI, energy, and other stocks, too!
As long as you remain diversified, you can invest confidently. Even though the financial media constantly tries to scare you to boost ratings, if you have a diversified portfolio of fundamentally superior stocks, you can invest confidently and not worry about all the external distractions that can derail a fundamentally superior stock portfolio.
Another sub-sector that is serving us well now is shipping stocks, which continue to perform well due to the fact that many cargo ships remain at sea longer than normal. Initially, that was because energy is being shipped from all over the world and the shipping routes are longer than ever. Another glitch is that the Panama Canal is suffering from a drought, with low water levels, so there is a big backlog, since some ships have to unload some of their cargo due to low water levels. Cargo ships have priority in the Panama Canal, which is causing ships transporting LNG and refined products to wait longer to traverse the canal.
In addition, Europe’s Rhine River in Germany is at a seasonal low, and our Mississippi River has also failed to recover from last year’s low levels, so river traffic is backing up and resulting in shipping delays.
The Ukraine/Russia War and China’s Deflation Have Slowed Global Growth
Speaking of slower ships fighting low tides in tight places, the shipments of goods, excluding defense and aircraft, declined 0.2% in July, so the manufacturing sector remains suppressed. That may be one reason why the Commerce Department announced last Thursday that durable goods orders declined 5.2% in July after a big surge in June. In July, commercial aircraft orders declined 44%. Excluding transportation, durable goods orders rose 0.5%. Also, July defense orders rose 2.5% after declining in previous months.Speaking of defense orders, the Presidential debates on Wednesday triggered a big reaction when Vivek Ramaswamy called for ending our proxy war between Ukraine and Russia. When Chris Christie tried to defend spending more on Ukraine, the crowd started to boo. Clearly, the billions of dollars being sent to Ukraine, while major U.S. cities decay and Maui struggles to recover, is now a very contentious issue.
Amazingly, the Ukraine war has cost the U.S. more in the past 18 months than 20 years of occupation and war in Afghanistan. Russia has pivoted to Northeastern Ukraine and is trying to retake territory Ukraine recaptured last fall. Complicating matters further, the Biden Administration last week urged U.S. citizens to flee Belarus immediately, warning against any travel. Officially, the State Department categorized Belarus as a Level 4 risk, as there is a growing chance that Russia may try to invade Ukraine via Belarus.
Ukraine has now lost as many as 400,000 soldiers and well over 100,000 injured, so even if Ukraine wants to continue to fight, it is running out of troops. The cost and human casualties of this war are now becoming increasingly intolerable, so it will be interesting to see if a ceasefire agreement will be possible.
I should add that Russia closed its airports three times last week due to Ukrainian drone attacks around Moscow, so the war is no longer just defensive and has escalated well beyond Ukraine’s border.
Turning to China, the Biden Administration’s National Security Advisor, Jake Sullivan, on Tuesday called on China to be more transparent about the state of its economy. Specifically, Sullivan said, “For global confidence, predictability and the capacity of the rest of the world to make sound economic decisions, it’s important for China to maintain a level of transparency in the publication of its data.” I should add that U.S. Commerce Secretary Gina Raimondo is traveling to China for high level talks.
Meanwhile, the Biden Administration’s economic policy of aggressively onshoring semiconductor and battery manufacturing is showing signs of stress. For example, a Biden ally, namely the UAW, said that Stellantis is threatening to move production of its Ram 1500 trucks to Mexico from suburban Detroit to reduce costs; otherwise automakers have to raise prices on gas-powered vehicles to compensate for their growing EV losses. The Mustang Mach-e now has a 116-day supply and even GM’s mighty Hummer now has over a 100-day supply. Clearly, the Big 3 are struggling to sell EVs in the wake of Tesla’s price cuts.
The Wall Street Journal last week published an opinion piece titled, “The Electric-Vehicle Bubble Starts to Deflate.” Essentially, this opinion piece said that the “collapsing electric-vehicle bubble … is a lesson in how industries built by government often also fail because of government.” The Journal cited a “plethora of Chinese EV start-ups launched in the past decade” and noted that many of these start-ups are failing as Beijing reduced industry subsidies. The Journal article also said that scrapyards around China are littered with EVs with outdated technology. Other examples: Volkswagen’s joint venture in China announced up to a $8,200 discount on its new ID.6 model, while GM dealers in China are now discounting EVs by more than 25%. In the U.S., EV inventory has swelled to 103 days of supply according to Cox Automotive.
The U.S. EV incentives may continue to expand, since clearly there is much more supply than demand. Furthermore, China’s deflation in EVs should spread around the world. The WSJ concluded by saying, “Business failures are inevitable in a dynamic economy, but government will be mainly responsible for the destruction that results from its force-fed EV transition—and the damage may only just be starting.”
One casualty of China’s slowdown appears to be Germany, since the Ifo institute’s sentiment gauge declined to 85.7 in August, down from 87.4 in July. In a statement, Germany’s Economic Minister Robert Habeck said, “The restrictive interest rate environment and the weak global economy — especially the developments in China — make it difficult for us as an export nation.” Ifo’s Klaus Wohlrabe added, on Bloomberg TV, that the Ifo institute expects German output to hover around the “zero growth line.”
Looking forward, I expect that the U.S. will have to import some of China’s deflation, causing U.S. inflation rates to decline to the Fed’s 2% annual target range in the upcoming months. This will allow the Fed to begin cutting key interest rates by its December FOMC meeting. I also expect that we’ll see further Fed cuts in early 2024. Then, as the Presidential election approaches, the Fed usually likes to crawl into a hole and hide, since it does not want to be part of the Presidential debates. Overall, I expect that the breadth and power of the stock market will steadily improve, thanks to healthy consumer spending.
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