This newsletter is a synopsis of a continual series of updates by a market analyst Mark Meldrum. Mark Meldrum is a CFA that provides weekly updates on the market, but they tend to be an hour long. Here is a synopsis of his video found here.
Interest Rates & the Fed
Most of the data and predictions will fluctuate as the debt ceiling deal is reached and completed. Market was clearly expecting a deal to be reached, evidenced by the overall positive uptick. However the deal proceeds, the Market will likely follow suit: a failed deal will probably constitute a downturn and a successful deal will likely result in a big upswing.
Highly probable rate hike in June—that’s a change from previous predictions. Last week, the likelihood of another rate hike was 17%; this week it’s at 64%. But Meldrum believes any rate hike will be downplayed a bit among a strong economy and the relief of raising the debt ceiling. Money market rates will probably start to be more behaved, capital market rates continue to increase, and there’s a fair bit of Fed speak this week.
Two stories were guiding the Market a week ago: the debt ceiling issue, and the Fed. Now, AI is starting to pop up as another influencing factor, and it’s feeling a lot like 1999 again—I’m sure many of you remember the dread leading up to Y2K of “What’s going to happen with technology!?” The emergence (or rather explosion) of AI tools has had a clear effect on business valuations and the Market.
Credit Default Swaps (CDS) have receded a bit: the 5-year down 7 basis points (bps) to 58 bps, and the 1-year down 9 bps to 149 bps. Given the news of the impending debt ceiling deal, these are likely to crash in the next week.
Real Rates, Federal Funds Rate, and TLT
Real yields have all increased for the third week in a row.
TLT, a major index made of up of long-term bond ETFs, was virtually unchanged, indicating some stability taking hold.
As a reminder, federal funds futures (FFF) are securities based on the rate set by banks to borrow money from each other for overnight loans. The new projections for the curve on the FFFs are pricing in some gradual rate increases as we project to the end of 2023, but we should see some rate cuts in early 2024.
Housing
The Primary Mortgage Market Survey shows 30-yr. Fixed Rate Mortgages (FRM) are at 6.57% (up 18 bps from last week) and 15-yr. FRM are at 5.97% (up 22 bps from last week).
Homebuilders are finally showing some pull back, but it’s not clear if this is because of rising mortgage rates or because they were so far extended over the moving average.
As a reminder, month-over-month (MoM) refers to changes on a monthly basis, so new home sales are up 4.1% compared to April 2023. But year-over-year (YoY) refers to a comparison of one time period compared to the same time period in a previous year. So the pending home sales numbers demonstrate a steep drop in comparison to the same period in 2022, but on a monthly basis, there’s virtually no change.
PCE
Personal Consumption Expenditures (PCE) shows no progress and came in higher than last month. Rents are increasing. This kind of volatility means we haven’t even begun the period of stability that the Fed is requiring to signal rate cuts. They’d require at least 6 to 8 months of stability to even consider lowering rates.
Generative AI “Pre-Bubble”
Businesses are finding that mentioning AI as a resource has a positive effect on their valuation, not to mention the social implications of saying “Yeah, we use AI in our business!” Meldrum believes this creates a sort of bubble that inflates our valuation of businesses beyond their book value or true value. Below is a chart that tracks the S&P’s year-to-date growth, represented as a white line. The contrasting brown line shows the S&P minus the AI-boom stocks:
The chart tells a story that can’t be ignored. Over time, the inflationary effect of AI has been accelerating. The AI-boom stocks represent 7 companies—that’s it! 7 companies alone make up 25% of the index, which is made up of 505 company stocks. Year-to-date, the S&P is up 10%. If you reverse the 10%, you arrive at the brown line represented on the chart, meaning these 7 companies alone are chiefly responsible for 100% of the growth in the S&P this year. Those 7 companies and their year-to-date growth are:
Without the growth from these 7 companies, the S&P would reflect a marginal decrease for the year. That’s a rather alarming and sobering truth. But the momentum they’re carrying can’t be denied and, as Meldrum says, “You should never short momentum!”