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The US stock market’s self-defense mechanism is running full blast

5/31/24 11:39AM

One of the oldest — and truest — market axioms is that in a crisis, correlations go to one.

That means when conditions take a meaningful turn for the worse, everything in the stock market goes down together.

Right now, we’re in the midst of one of the longer streaks in history without a 2% decline for the S&P 500: 321 sessions and counting. Amid this streak, the VIX Index — a gauge of the how volatile the S&P 500 is expected to be over the next month — recently hit its lowest levels since 2019.

Meanwhile, these days tech stocks are still doing relatively well when bond yields are rising — because no matter whether the risk-free rate is 4% or 5%, that’s a rounding error compared to the return potential associated with AI, in the minds of corporate executives. That kind of spending does not appear to be that rate-sensitive — especially because the companies with some of the biggest AI capex outlays are sitting on piles of cash in the form of retained earnings.

Back in 2017, the narrative was more about high yields being a headwind for expensively-valued tech stocks, because so much of their earnings potential was in the future not the present (and would need to be discounted by this higher interest rate).

Another key way in which this story only rhymes with but doesn’t quite match the excruciatingly low-volatility world of 2017 is that these individual groups are, on their own, moving much much more. Their moves are just offsetting one another.

“The difference between now and 2017 is when bond yields were so much lower we didn’t even have these under surface swings like we do now,” said Dave Roberts, independent trader. “Indexes are fine now, but names and sectors are still moving a lot more than 2017.”

It’s like a duck: the illusion of calm on the surface of the water belies the furious paddling going on underneath.

The KBW Bank Index and the Invesco QQQ Trust Series 1 ETF (which tracks the Nasdaq 100) have had a daily gain or loss in excess of 1% on 74 occasions so far this year. Compare that to 88 instances for 2017 as a whole.

Putting this together, this suggests that if indeed we do get more of a “correlations to one” moment for the equity market, it could be quite a bit more disruptive than the down days were in 2017 — as the likes of tech and banks have already demonstrated they’re primed to move.

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Matt Phillips1h

Insurance against Oracle default becomes favorite AI-bust hedge, Bloomberg reports

Volume in the market for credit default swaps — essentially a kind of insurance against a company defaulting on its debts — on Oracle is surging as the company has supercharged its borrowing to finance its AI ambitions, Bloomberg’s Caleb Mutua reports:

“The price to protect against the company defaulting on its debt for five years tripled in recent months to as high as about 1.11 percentage point a year on Wednesday, or around $111,000 for every $10 million of principal protected, according to ICE Data Services.

As AI skeptics rushed in, trading volume on the company’s CDS ballooned to about $5 billion over the seven weeks ended Nov. 14, according to Barclays Plc credit strategist Jigar Patel. That’s up from a little more than $200 million in the same period last year.”

A Hedge Against AI Crash Emerges as Oracle CDS Market Explodes

“The price to protect against the company defaulting on its debt for five years tripled in recent months to as high as about 1.11 percentage point a year on Wednesday, or around $111,000 for every $10 million of principal protected, according to ICE Data Services.

As AI skeptics rushed in, trading volume on the company’s CDS ballooned to about $5 billion over the seven weeks ended Nov. 14, according to Barclays Plc credit strategist Jigar Patel. That’s up from a little more than $200 million in the same period last year.”

Nvidia dunks on the doubters

CEO Jensen Huang and CFO Colette Kress dismantled most of the recent arguments and bear cases put forward by their naysayers.

Luke Kawa2h

Matt Phillips3h

Cipher Mining surges on additional AI hosting deal

Bitcoin miner turned AI compute power provider Cipher Mining jumped early Thursday after announcing a deal that fully leases its Barber Lake data center in Colorado City, Texas.

The deal — which is also giving a lift to IREN, another miner turned compute provider — is an expansion of a previous agreement with Fluidstack, a UK-based provider of GPU-based cloud networks. The new deal amounts to roughly $830 million in additional revenue over 10 years, Cipher says.

The market clearly loves it. But it’s worth pointing out that this agreement is a pretty good example of the byzantine financial structures that are increasingly accompanying plans for many billions of dollars of spending on the AI boom.

For example, Cipher also announced Thursday that it would be borrowing $333 million to finance an expansion of that Barber Lake data center through a private placement of debt.

That offering will be secured, in part, by the warrants Google received to purchase Cipher common stock worth roughly 5.4% of the company. (Those warrants, by the way, look a lot more valuable today, with Cipher mining up double digits.) Google is also backstopping Fluidstack’s borrowing plans to finance its build-out to the tune of $1.4 billion.

For now, this makes financial sense. Alphabet — one of the most successful companies on the planet — needs the computing power to compete in the AI race. And the quickest way to get that capacity is to essentially cosign leases for the smaller companies taking the lead in that build-out, thereby lowering development costs and helping to bring projects into existence.

But in this deal alone, things get awfully complicated awfully quickly, as Alphabet is essentially the prime customer of, an important debt guarantor for, and potentially a significant owner in Cipher Mining, once it transfers the warrants into an ownership stake of more than 5%.

This isn’t, on its face, a terrible thing. There are precedents for circular funding relationships in industries like aerospace, as it developed from the 1920s to the 1950s.

But financial complexity does have a history of essentially hiding the level and locus of financial risks a system is building up, essentially during periods of heady optimism.

Cipher Mining Signs Additional 56 MW, 10-Year AI Hosting Agreement with Fluidstack

This isn’t, on its face, a terrible thing. There are precedents for circular funding relationships in industries like aerospace, as it developed from the 1920s to the 1950s.

But financial complexity does have a history of essentially hiding the level and locus of financial risks a system is building up, essentially during periods of heady optimism.

Luke Kawa5h

Odds of December Fed cut creep higher after unemployment rate unexpectedly rises in September

The September jobs report was a mixed bag: much better job growth than anticipated, but the unemployment rate unexpectedly edged higher.

The release of this data, which was delayed by the government shutdown, showed that nonfarm payrolls grew 119,000 (compared to the expected 51,000), but the unemployment rate crept up to 4.4%, while economists thought it would remain steady at 4.3%.

Event contracts show that the likelihood of the US central bank standing pat in December moderated to about 65% from around 75% prior to the release.

(Event contracts are offered through Robinhood Derivatives, LLC — probabilities referenced or sourced from KalshiEx LLC or ForecastEx LLC.)

Job growth for the prior two months was revised lower by 33,000.

The market-implied odds of a Fed cut in December tanked on Wednesday after the Bureau of Labor Statistics said that the updated employment statistics through November wouldn’t be published until December 16 — that is, the week after the US central bank’s last meeting of the year.

During the press conference that followed the October decision to lower rates by 25 basis points, Fed Chair Jerome Powell said that a dearth of fresh data “could be an argument in favor of caution about moving,” adding that a rate cut in December was “far from” a foregone conclusion.

Fedspeak since that October rate cut has generally tilted hawkish. Some voting members like Boston Fed President Susan Collins and Kansas City President Jeffrey Schmid (who dissented from the last cut) have signaled that they are unlikely to support an interest rate cut in December. Fed Governors Chris Waller and Stephen Miran have publicly endorsed another rate reduction, while other officials have yet to take a definitive stance. The minutes from the October meeting said that “many participants” thought “it would likely be appropriate to keep the target rate unchanged for the rest of the year.”

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Main Street bought after weakness at three distinct moments early in the year.

Luke Kawa6h

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