Panic at the Disco

Preface: This story was written before the Israeli attack last night. We have kept it intact despite the fact we wrote this in anticipation of a conflict. The biggest explosion of the night appears to have been the reaction to the Netflix earnings announcement where they reported they will stop providing quarterly subscriber numbers and disappointed on their revenue forecast. ?

Edge

Investors are operating in a one-dimensional world right now. The world is on edge because of certain factors that have nothing to do with monetary policy, fiscal policy, or company earnings forecasts, which typically determine price action.

The potential for a wider war in the Middle East is dominating the price action across equities, currency, fixed income, and commodity markets. In general, when trading markets, you always want an edge, meaning a consistent trading approach based on quantitative models, fundamental research, or what we favor, a combination of both.

Markets are normally influenced by a vast array of factors that determine investor perceptions about growth and inflation. Lately, these perceptions have centered around three things:

1. The impact on productivity that artificial intelligence promises
2. Strong labor demand keeping services inflation high
3. The recent spike in crude oil prices driving consumers’ inflation expectations

Market environments change as these factors vary over time, shaping capital flows from one stock to another, one sector to another, one asset class to another, and one country to another.

By their nature, one-dimensional markets ignore market news that would otherwise have a major impact. Fed Chairman Jerome Powell stated last Tuesday that high inflation has delayed the potential for Fed interest rate cuts. These comments would normally have created an enormous downdraft in stock prices, but barely caused a ripple.

One-dimensional markets in recent memory occurred during the COVID-19 pandemic in March 2020, and the Silicon Valley Bank (SVB) closure in March 2023. During these times, the VIX, which is the favored indicator of volatility amongst equity traders, always spikes. Some of our indicators show that the VIX peaked last Tuesday, April 16. Under normal circumstances, that means the worst may be behind us.

Will investors celebrate and buy the dip, or are we headed for a further selloff? The problem with markets driven by just one factor is that controlling risk becomes entirely dependent on one unforeseeable outcome. In these environments, one would need to be a fortune teller to accurately measure risk.

So how can we tell that the market has returned to normalcy? One indication would be when a typical market driver such as good company earnings generates a stock market rally that is not met with heavy selling. We should get our answer next week when mega-cap tech earnings are released.

This Week’s Developing Storylines

1. AI-related company earnings. NVIDIA Monday, April 22, Tesla Tuesday, Meta Wednesday, with Google and Microsoft capping the mega-cap earnings week on Thursday, April 25. We will, of course, be looking at mentions of AI during earnings calls, but specifically, we are on the lookout for discussions that echo Amazon CEO’s annual letter where Andy Jassy warned of insufficient electrical capacity to support generative AI buildout plans. Markets are hoping for good news to reverse the recent equity selloff. Good news that does not cause an improvement in prices would be an extremely negative event for stocks.
2. Bitcoin mining rewards are cut in half every four years. One of those occurrences happens this week, which will cause investors to watch price action. The consensus is that higher interest rates plus the March move to record highs supported by flows into Bitcoin ETFs will mute any positive impact. We believe that Bitcoin is correlated with the Nasdaq, so the direction mega-cap tech stocks take after this week’s earnings will decide Bitcoin’s direction.
3. Tuesday’s 2-year and Thursday’s 5-year and 7-year note auctions on April 22 and 24, respectively, normally are not market-moving events because they occur every month. However, since the last auction, inflation data has moved yields on these Treasury notes by over 50 basis points. We will see if that is sufficient to generate strong demand. If the results are poor, it could push rates to multi-year highs, which would further depress equity valuations and stock