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AI Supernova

This is the weekly market report for the week ending February 16th, 2024.

It's been a crazy week. Hard to believe but the AI melt-up that I described last week went full on supernova this week.

Unfortunately, what most investors have been told is the beginning of a new AI-driven market rally, is far more likely to be the end of the AI rally.

This week, Nvidia surpassed both Google and Amazon in market cap. Arm doubled in one week. And Super Micro Computer which I showed in last week's market summary, tacked on an additional 50% since the Barron's follow-up article was published a week ago on Wednesday February 7th:

SMCI as of Thursday close:

On the economic side, the CPI ran hot on Tuesday which came as a total shock to markets. That print generated the first 90% down (volume) day of 2024. Investors are totally oblivious to the fact that they are now caught in a feedback loop between hyper-levitating markets and the economy. The more markets melt-up in anticipation of imminent rate cuts, the more inflation feeds back into the economy via the wealth effect, making rate cuts less likely. Which is clearly what transpired during this Q4 earnings melt-up. And then ironically, just as markets reach peak anticipation of rate cuts, that's when they disappear.

Which is why I don't trust these central bank rigged markets. Because just as investors reach consensus on a new bull market it ends, leaving the vast majority of investors hanging:

"Investor sentiment is currently at its most bullish level since January 2022, according to Bank of America's February Global Fund Manager Survey"

Here we see via the weekly equal weight chart that the average S&P 500 stock is just now returning to the January 2022 level.

The net effect of this melt-up feedback loop is that just as markets are reaching a new zenith, the Fed safety net has now been moved substantially below the market. Why? Because now the Fed must be more cautious about cutting rates in the event that they cause inflation to re-accelerate. Here below we see that when the Fed paused and then cut rates in 2007, inflation tripled. If that happened again, the CPI would be at 9%. The same thing happened to Volcker in 1980. He lowered rates in 1981 and inflation sky-rocketed.

Thursday, Feb. 16th, 2024:

"There’s no urgency for the Federal Reserve to cut interest rates and the battle with inflation is not over yet, Atlanta Fed President Raphael Bostic said late Thursday"

In other words, the market is getting ahead of itself. The market is currently pricing in a first rate cut in June, although just a month ago a March cut was seen as the most likely"

This week is monthly options expiration. When call options are being bought they drive the overall market higher because the market makers selling options are forced to buy the underlying stock/ETF to hedge their implied short position i.e. if an option is exercised they are required to deliver the stock. This effect is known as a "gamma squeeze" because gamma (second derivative delta) is the option parameter that determines how much underlying stock must be hedged relative to the strike price. Think of it as an options-generated short squeeze.

The difference however is that in a true short squeeze there is no time limit for when it ends. True shorts can remain outstanding indefinitely. Whereas in an options-driven squeeze, when the options expire the "squeeze" effect ends. On Friday, 90% of outstanding options are expiring. Which means that this rally is not owned, it's rented using RECORD call option capital.

During this Q4 earnings melt-up the market and the Fed safety level moved in opposite directions. The market moved higher and the Fed safety net moved lower.

In summary, all it takes for investors to forget the last time they got burned, is time.

"Clients, including many who traded through the dot-com boom and subsequent collapse, are more worried about being underinvested than overexposed right now"

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