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SP500: The Bounce Is Stalling, Nvidia To Trigger The Next Leg Down (SP500)
Ultimately, the S&P500 is facing a recessionary bear market, and the recent volatility is in the process of topping. The bounce has stalled The V-shaped bounce from the early August selloff in the S&P500 (SP500) has extended nearly to the all-time highs. However, it seems like the bounce has now stalled, and the next leg lower is likely approaching. The specific trigger for the next leg lower could be the NVIDIA Corporation (NVDA) earnings to be released on August 28th. Here is the chart for S&P500: An imminent recession trigger Let's review the current macro situation and explain the bear case, which is why the next leg lower might be imminent as the current bounce fades. The early August selloff was triggered by the release of the July labor report, which showed that the unemployment rate increased to 4.3% - above expectations. The increase in the unemployment rate triggered the Sahm Recession indicator, which suggests that the recession is imminent once the unemployment rate increases by 0.5% from the low point, based on three-month averages. The unemployment rate bottomed out at 3.4%, and now it's at 4.3%. Once the Sahm rule was triggered, the traders increased their bets on an imminent and aggressive monetary policy easing - which is what happens when the recession starts. This is a chart of 2Y Treasury Note futures. The expected monetary policy is embedded in the 2Y yields. When traders expect Fed cuts, the price of 2Y Treasury Note futures rises (that's what the graph below shows), which means the yields are falling. The graph below shows the sharp spike in 2Y Treasury Note futures after the July labor market report, which priced even an emergency Fed cut. However, the bets for aggressive easing subsided as the recent labor market data (the initial claims) eased the imminent recession worries. Yet, the traders are still pricing a substantial and imminent monetary policy easing - and that's consistent with a recession. The VIX and the Yen The July labor report triggering an imminent recession worry caused a very sharp spike in the VIX Index, which is based on the option prices, in this case specifically the S&P500 (SPX) put prices. Traders hedged the expected drop in the S&P500 due to 1) an imminent recession, and 2) the GenAI bubble burst (explained later) by rushing to buy put options, which boosted the VIX index nearly to the Lehman Brothers highs. Given the more assuring labor market data since, and the stabilization in the 2T Treasury Note futures (as discussed earlier), the VIX fell back to the pre-spike levels. The expectations of the Fed's aggressive monetary policy easing, together with a more hawkish Bank of Japan monetary policy triggered the Yen Carry Trade blowup and a sharp rise in the Japanese Yen (FXY) - after the July labor market report. Since the Yen also stabilized, but it continues to trade above the key technical levels, and it's approaching the early August highs. The Nvidia bubble burst and the bounce The sudden pricing of a recession, given the rise in 2Y Treasury Note futures, and the rise in the Japanese Yen, forced traders to exit the speculative trades related to the Gen AI theme, specifically Nvidia. As the chart below shows, Nvidia peaked on June 20th at 140 intraday prices, and fell to a 90-intraday low on August 5th - that's a 36% drop based on intraday levels. For all purposes, the Nvidia bubble busted already. However, as 1) 2Y Treasury Note futures stabilized, 2) VIX fell from the peak, and 3) the Japanese Yen stabilized, Nvidia bounced back sharply to 130, that's a 44% bounce from the intraday lows of 90. It is important to note that Nvidia accounts for 7% of the S&P500, so the bounce in Nvidia is the primary cause of the bounce in the S&P500. More importantly, the bounce in Nvidia caused the bounce in the AI-related tech mega-caps, which account for over 33% of the S&P500. In addition, the bounce in Nvidia pushed up other semiconductors (SMH), which caused the bounce in the Nasdaq 100 (QQQ). Thus, the bounce in Nvidia was significant in explaining the broad market bounce since the early August selloff. The chart above shows that Nvidia bounce has also stalled, which explains the stall in the SP500 bounce. The next leg lower in the S&P500 is likely to be driven by the next leg lower in Nvidia - and Nvidia is about to report earnings on August 28th. My expectations are that Nvidia could beat the earnings estimates because the GenAI capex has been strong, but the problem could emerge with the guidance. There are several issues, such as Blackwell's delay and increased competition. But most importantly, the expected growth in revenue doesn't support the PS multiple of 40. Even if everything is perfect at the Nvidia earnings call, the valuation is still a concern, especially if the economy is about to slip into a recession. In fact, that is why Nvidia declined by 36%, before the bounce. I expect that Nvidia's downturn will resume after the earnings, which is likely to cause the resumption of the downtrend in the S&P500 as well. Implications The early August selloff in the S&P500 was due to expectations of an imminent recession. The recent bounce in the S&P500 was likely due to the general stabilization in the macro environment after the selloff (falling VIX, falling Yen, expectations of less aggressive Fed cuts), and the bounce in Nvidia. However, the Yen has been rising again, and the VIX has increased from just above 14 to over 16 currently. Thus, the environment is deteriorating. The Nvidia earnings will be the next trigger - and in my opinion, it will be a negative trigger that causes the next leg lower in the S&P500. The bottom line is that the S&P500 is facing a recessionary bear market (irrespective of Nvidia earnings) and the recent volatility is just a process of topping. Commodity Trading Adviser (CTA), member of National Futures Association. Managing the Macrotheme TTF Trading Program, currently in a launch stage. Professor of Finance, research on Global-macro issues. Editor-in-Chief, Journal of Corporate Accounting and Finance. Analyst's Disclosure: I/we have a beneficial short position in the shares of SPX either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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SPX: AI Fantasy Is About To Meet Economic Reality (SPX)
While interest rate cuts and Nvidia's upcoming earnings may offer short-term optimism, the long-term risk-reward outlook for equities remains extremely poor. While the S&P500 is back to within a percent of its July 16 all-time high, there has been a stark change in leadership in the market since this peak, with mega cap tech stocks beginning to lead on the way down, as the chart below shows. This is a significant development and while Nvidia's upcoming earnings release may breathe fresh air into the bubble, it appears to be starting to deflate. I continue to see market valuations as detached from long-term earnings potential as they have ever been, and expect at least a 50% market decline over the coming years as sentiment towards AI sours amid harsh economic realities. Every single reliable valuation metric for the US market puts it within a few percent of its most extreme level in history. Using a simple growth plus dividend yield approach, the current yield of 1.3% means that if dividends grow at the pace of nominal GDP of say 4%, investors can expect 5.3% annual returns relative to around 10% over the long term. For the S&P500 to be considered fair value from a historical returns' perspective, the dividend yield would have to rise to 6%, requiring a 78% decline. To many investors, US equity valuations are justified by the strong outlook for earnings growth, driven primarily by the productivity enhancements of Artificial Intelligence. The S&P500 has seen its PE ratio rise 10 points since the release of ChatGPT in November 2022 ignited a frenzy of interest in AI investments, and over half of this increase has been due to the multiple expansion among the magnificent 7 stocks. The earnings of these 7 stocks have grown to a spectacular 24% of total S&P500 earnings, and their market cap has grown to 31% of the market. Their combined market cap is now 9x total S&P500 earnings compared to 6.5x at the tech bubble peak in 1999. Little Sign Of Significant Real-World Impact While the AI boom has done a lot for equity valuations, in the almost two years since the release of ChatGPT, there has been very little in the way of results. S&P500 earnings including extraordinary items are actually down over the past two years, as are free cash flows. Even operating cash flows have gone nowhere over this period. It is looking increasingly likely that a great deal of AI related capex over this period will turn out to be malinvestment as it becomes clear that while the technology is impressive, it may not always be economically viable. When a particularly impressive technological development gets the attention of Wall Street, demand from investors to see this technology adopted by businesses causes a surge in investment. Regardless of the investment case, companies have been encouraged to roll out AI infrastructure to avoid being left behind in the short-sighted race for speculative capital. The most underappreciated threat facing the AI boom comes from the physical and human resource constraints. Regarding the former, according to this article a ChatGPT text search consumes 10 times the power of a Google search, while other research finds that generating an image using a GenAI model could take as much energy as half a smartphone charge. Regarding human resources, as far as I can tell, while the output of LLM models is often breathtakingly impressive and creative, it still needs to be proofed and fact-checked by capable humans. As these machines have no way of knowing the difference between fact and fiction, this problem is unlikely to go away, regardless of the amount of expensive inputs that are thrown at them. While it is true that chatbots are increasingly being used by businesses and individuals as a smarter alternative to Google for answering a basic query, in my opinion, they are only marginally better at answering most queries and much worse at answering some. The Global Chatbot Market Size was valued at USD5.4bn in 2023 and is expected to reach USD42.8bn by 2033, according to a research report published by Spherical Insights & Consulting. This 2033 figure is barely higher than Netflix's annual revenues, and pales in comparison to the tens of billions already invested in the technology. The Bubble Is Reflected In Economic Imbalances The inflation of the AI bubble has in part been driven by the fiscal deficit which, as I explain here, has created the illusion of abundant savings in the economy. By keeping tax rates low and spending high, consumers have been able to spend more of their wages than they otherwise would have, raising corporate profit margins. Even with the impact of the budget deficit, however, the consumer savings rate is close to the record lows seen at the peak of the housing bubble in 2006. There is a significant risk that we see a combined rise in the US personal savings rate and a rise in corporate tax rates, acting as a double negative on corporate profits and exposing the extent to which these profits were partly the result of huge and unsustainable economic imbalances. Indeed, presidential front-runner Kamala Harris has proposed raising the corporate tax rate to 28% from 21% currently, while any economic weakness could cause precautionary savings to surge. What Could Go Right? The main risk to my bearish view comes from renewed optimism over the impact of upcoming interest rate cuts. The Fed appears ready to delivery at least 100bps of cuts by year-end which seems aggressive given CPI is still at 2.9%, but 2-year breakeven inflation expectations sit at 1.7% and 5 year break evens are back on target at 2.0%, so there is no reason to think that the Fed is embarking on activist monetary policy that should force investors further out onto the risk curve. Monetary policy is objectively tight right now as it was at the 1999 and 2007 market peaks, and it is likely to get progressively looser over the coming years as it did follow these peaks. There is no reason to expect this to ease to have any beneficial impact on stock valuations. Another upside risk comes from the upcoming Nvidia earnings release, which could reignite speculative sentiment, but even a strong beat would shed little light on whether this demand is sustainable beyond the next few quarters. While the direction of the stock market in the short term is anyone's guess, the risk-reward outlook continues to deteriorate. For investors to generate even modest returns over the coming years, equity multiples will have to remain at current extremes or even continue to expand if earnings growth does not accelerate. I am often asked, what if I am wrong in my short conviction. My answer is: I will lose money, but I am safe in the knowledge that I am receiving net positive cash flows as interest on cash far exceeds the dividend on stocks and likely will continue to unless there is a sharp fall in valuations. I am a full-time investor and owner of Icon Economics - a macro research company focussed on providing contrarian investment ideas across FX, Equities, and Fixed Income based on Austrian economic theory. Formerly Head of Financial Markets at Fitch Solutions, I have 15 years of experience investing and analysing Asian and Global markets. Analyst's Disclosure: I/we have a beneficial short position in the shares of SPX either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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The recent bounce in the S&P 500 is showing signs of stalling, with Nvidia's upcoming earnings report potentially triggering a downturn. Meanwhile, the AI-driven market enthusiasm may be confronted by economic realities.
The recent rally in the S&P 500 appears to be losing momentum, raising concerns among investors about the sustainability of the current market trajectory. According to market analysts, the index has shown signs of stalling, with technical indicators suggesting a potential reversal in the near future
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.All eyes are on Nvidia's upcoming earnings report, which could serve as a significant catalyst for the market's next move. As a leading player in the AI chip market, Nvidia's performance is seen as a barometer for the broader AI-driven tech sector. Analysts speculate that if Nvidia's results or guidance fall short of the market's lofty expectations, it could trigger a downturn in the S&P 500
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.The market's recent enthusiasm, largely fueled by AI-related stocks, may be on a collision course with economic realities. While AI has captured investors' imaginations and driven significant gains in tech stocks, there are growing concerns that this optimism may be overextended
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.Several economic factors are casting shadows on the market's AI-driven rally:
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.The current market valuation, particularly in the tech sector, has raised eyebrows among some analysts. The concentration of gains in a handful of large-cap tech stocks, often referred to as the "Magnificent Seven," has led to questions about the broader market's health and the sustainability of these valuations
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Investor sentiment appears to be at a crossroads, with bullish AI narratives competing against bearish economic indicators. The market's near-term direction may hinge on how these conflicting forces play out. Some analysts argue that a reality check is imminent, potentially leading to a correction in overvalued AI-related stocks
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.Technical analysts point to various indicators suggesting the S&P 500's rally may be running out of steam. These include overbought conditions, resistance levels, and potential trend reversals. The coming weeks are seen as crucial in determining whether the index can maintain its upward trajectory or if a pullback is on the horizon
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