A new market melt-up? Semiconductor Bull Takes the Software Throne

Economic Outlook: Solid Growth and Moderating Inflation

The economic indicators scheduled for release during the shortened week ahead are expected to reinforce the narrative of robust economic growth and a continued moderation in inflation rates. Here's what I'll be keeping an eye on:

1. Personal Consumption Expenditures (PCE) Data

According to the Cleveland Fed's Inflation Nowcasting model, the headline and core PCE figures for the previous month are projected to have risen by 2.68% and 2.74% year-over-year (0.27% and 0.23% month-over-month), respectively. If these projections hold, the core PCE reading would mark the lowest year-over-year increase since March 2021.

Financial markets will likely welcome the anticipated progress in taming inflation, particularly the core measure. This development comes after markets were initially spooked by the hawkish undertones in the recently released Federal Open Market Committee (FOMC) minutes. It's worth noting that the FOMC meeting occurred approximately two weeks before the release of the more moderate-than-expected Consumer Price Index (CPI) and Producer Price Index (PPI) data for April.

Digging Deeper into Inflation Measures

While lagging rent disinflation continued to boost April's Consumer Price Index (CPI), it's important to note that the rent component accounts for roughly one-third of the CPI index. In contrast, shelter costs carry a lower weight of around 16% in the Personal Consumption Expenditures (PCE) deflator.

Another area of divergence is the health insurance premiums component. The CPI's health insurance premiums component tends to be highly volatile compared to its more subdued counterpart in the PCE deflator.

Additionally, auto insurance has been one of the biggest contributors to CPI inflation this year, but it has been disinflating in the PCE deflator recently (chart). This discrepancy arises from the fact that the PCE deflator nets out insurance claims from premiums and assigns a weight of around one-fifth to auto insurance, compared to the CPI's higher weighting.

These differences in weighting and methodology between the CPI and PCE deflator can lead to varying inflation readings, particularly in categories like rent, health insurance, and auto insurance. The PCE deflator's broader coverage and methodological adjustments may provide a more accurate representation of underlying inflation trends.

Positive Outlook

The combination of solid economic growth and moderating inflation rates should reassure market participants and policymakers alike. As inflation continues its trajectory toward the Federal Reserve's 2.0% target, it could alleviate some of the pressure on the central bank to maintain an aggressive monetary tightening stance.

Overall, the upcoming economic data releases are expected to paint a picture of a resilient economy that is gradually overcoming inflationary pressures, potentially setting the stage for a more balanced policy approach in the months ahead.

Technical analysis of the Nasdaq 100 index

We are firmly in wave 9 of the move up, which started in the autumn of 2022. Right now, I cannot see any topping formation. Most negative divergences that were present last week have gone at the Nasdaq level, but they persist at the Dow Jones level.

I expect the usual hesitation this week before the critical PCE numbers on Friday.

Positive PCE numbers may provide a catalyst for the stock market and the bond market to go substantially higher.

In my opinion, a pretty large move in bond yields is imminent. Depending on the next set of inflation data outcomes, I expect the TLT ETF to trade between 94 and 96 USD shortly (maybe even going up to 100 USD) or between 88 and 83 USD.

I favor the lower yield and rising prices scenario and give it a probability of 70 %.

Growth software is the big loser, and semiconductors are the big winner

Semis are an extremely popular spot for hedge funds. The weight in hedge fund long US equity portfolios today is more than 3 times what it was 10 years ago.

On the other hand, the exposure to growth software stocks has gone dramatically from 2021 until today.

Nvidia CEO: Software Is Eating the World, but AI Is Going to Eat Software

Jensen Huang got it right - the quote is from 2017.

The Narrowing Bull Market

Stock market analysts have been expressing concerns over the concentrated nature of the ongoing bull market, which began on October 12, 2022. Initially propelled by the "Magnificent-7" group of stocks, the rally has now become increasingly reliant on Nvidia's remarkable performance.

Nvidia's Dominance

Nvidia's stock has surged an astonishing 115.0% year-to-date, significantly outpacing the S&P 500 index, which has gained a modest 11.2% over the same period. This divergence has sparked apprehensions among pundits, who fear that the market's upward trajectory is becoming overly dependent on the success of a single company.

The Magnificent-6 Left Behind

Not only has Nvidia outperformed the broader market, but it has also eclipsed the performance of the "Magnificent-6"—the remaining stocks that initially fueled the bull market's momentum. As Nvidia continues its meteoric rise, analysts are growing uneasy about the potential risks associated with such narrow market leadership.

The concentration of market gains in a single stock raises questions about the rally's sustainability and potential vulnerabilities should Nvidia's fortunes take a turn. Diversification and broader participation from various sectors are often viewed as hallmarks of a healthy bull market, and the current dynamics have sparked debates among market watchers.

I will provide a framework for my AI trading strategy in the next newsletter article. It is based on the 4-stage Goldman Sachs model.

I will name a few of my favorite stocks and those I avoid.

According to Goldman Sachs Research, Nvidia represents the first phase of the AI trade. Phase 2 will involve other companies helping build AI-related infrastructure. Phase 3 involves companies incorporating AI into their products to boost revenue, while Phase 4 concerns the AI-related productivity gains that should be possible across many businesses.

And what about the forthcoming recession and the inevitable bear market?

I will not listen until the Sahm Rule, the best leading indicator of a recession, provides an alarm signal. The link below provides further information.

https://www.investopedia.com/what-is-the-sahm-rule-8637564#:~:text=According%20to%20the%20rule%2C%20the%20beginning%20of%20a%20recession%20is,over%20the%20last%2012%20months.