Risk of US default avoided
President Biden successfully enacted the bipartisan legislation on Saturday, effectively halting the US$ 31.4tr debt ceiling and mitigating the potential risk of a default by the US federal government. The Treasury was using special accounting measures to maintain payments on all federal obligations and there were just US$ 33bn of those left available as of 31st May. It’s also been running down its cash balance, which dropped below US$ 23bn on 1st June, a dangerously low level due to the volatility in day-to-day federal revenues and payments. With this bipartisan bill signed by Biden, debt limit is suspended until 2025. Early last month, the department had pencilled in a US$ 550bn cash-balance level for the end of June.
The expected growth of debt auctions could involve a significant amount potentially exceeding US$ 1tr in new securities. This process may have unintended effects by draining liquidity in the banking sector, raising short-term funding rates and tightening the screws on an economy that analysts see headed for a recession.
Bank of America estimates this issuance could have a comparable impact to a 0.25% Fed interest rate hike.
JPMorgan strategist Nikolaos Panigirtzoglou estimates a flood of Treasuries will compound the effect of QT on stocks and bonds, knocking almost 5% off their combined performance this year. Citigroup macro strategists offer a similar calculus, showing a median drop of 5.4% in the S&P 500 over two months could follow a liquidity drawdown of such magnitude, and a 37 basis-point jolt for high-yield credit spreads.
The sales will rumble through every asset class as they claim an already shrinking supply of money: JPMorgan estimates a broad measure of liquidity will fall US$ 1.1tr from about US$ 25tr at the start of 2023. Nikolaos Panigirtzoglou:
This is a very big liquidity drain. We have rarely seen something like that. It’s only in severe crashes like the Lehman crisis where you see something like that contraction.
It’s a trend that, together with Fed tightening, will push the measure of liquidity down at an annual rate of 6%, in contrast to annualized growth for most of the last decade, JPMorgan estimates.
As a result, the focus of the market has shifted towards assessing the bond market's reaction to the influx of Treasury securities and the implications of replenishing the Treasury General Account (TGA) with US$ 500bn to US$ 600bn at the Federal Reserve (Fed), particularly in relation to liquidity within the banking system. JPMorgan estimates the flood will compound the effect of QT on stocks and bonds; Citi projects a drop of 5.4% in the S&P 500 over two months. An options bet on Equitrans on May 24 generated some US$ 7.5m in paper profits through Friday.
AI Hype
Yes, S&P 500 is up 12% this year, but it would be negative without the contribution of 7 big tech companies. That potentially leaves the index vulnerable to a steep pullback if even one or two big companies misstep (WSJ).
BCA Research on the IT sector performance. Since 1996, sales-per-share in the IT sector have increased by 45% relative to the S&P 500, but earnings-per-share have increased by 112% and price-per-share has increased by 216%. Thus, around 80% of the outperformance of IT stocks can be attributed to rising profit margins among a select group of companies, and the higher PE multiples that investors assigned to them.
Ned Davis Research on Big Techs: Mega-cap tech has drawn comparisons to the internet stocks of the late 1990s. The key difference is the group today is very profitable. However, their market-cap relative to earnings weight has gotten extremely extended and could be nearing a breaking point.
Table I/O Fund – Beth Kindig:
In an environment where margins are king, these tech stocks have the highest EBITDA margin % over the past 12 months.
And here are the top 10 tech stocks with the highest gross margins
5 AI predictions from UBS for the next 5 years: * By 2025, the use of synthetic data will reduce the volume of real data needed for machine learning by 70%. * By 2026, over 100 million humans will engage robo-colleagues (synthetic virtual co-workers) to contribute to enterprise work. * By 2025, 30% of outbound marketing messages from large organizations will be synthetically generated, up from less than 2% in 2022. Salesforce recently announced the release of its Einstein PT to generate personalized emails to customers on behalf of salespeople, specific query responses on behalf of customer service professionals, and targeted content for marketers. * By 2027, nearly 15% of new applications will be automatically generated by AI without a human in the loop, up from 0% today. And * by 2025, more than 30% of new drugs and materials will be systematically discovered using generative AI techniques.
BTIG on Tech stock rally: “ we remain skeptical on the big picture sustainability of this rally. […] We just saw the largest weekly inflow into $QQQ of the year […] typically contrarian as [it] signal investors have 'FOMO' into the tail end of a move.”
A major ETF firm provider is betting the artificial intelligence boom is just starting. Roundhill Investments launched the Generative AI & Technology ETF (CHAT) less than 20 days ago. It’s the first-ever exchange-traded fund designed to track companies involved in generative AI and other related technologies. The fund includes not just pure play AI companies like C3.ai but also large-cap tech companies such as Microsoft and AI chipmaker Nvidia. CNBC
The frenzy of activity in the options market shows how many traders are looking to turbocharge their wagers on Nvidia. The dynamic is reminiscent of the excitement surrounding Tesla shares—and its options—in 2021. Citi: "Performance chasing in tech is evident in options flows that may reflect capitulation in the space after a 30% YTD rally and 55% rally in Semis".
great take, thank you!