A New Week 09/13

Return on capital for technology companies is at a cyclical high.

Historically, this leads to two potential outcomes:

In the semis/memory space, we’ve covered extensively why the biggest players have failed to break out of their channels since May.

The reason is simple, it is the latter outcome that is starting to take place.

From Japan, South Korea, and China, more chip production and supply is starting to come online faster than most analysts had forecasted.

At the same time, as the LSEG shows, accruals now make a large share of overall earnings per share (EPS.)

Why does this typically mark a top?

Because accruals are non-cash items, and therefore do not add real earnings power to the companies reporting these items.

In other words…

Amazon, NVIDIA, Google, and a dozen other names are misleading investors into thinking earnings are much stronger than they actually are.

As a result, their P/E multiples should be double - if not triple - what they are now.

Click here to read how Oracle showed the market how these accruals and AI debt will end up for everyone involved.

Now let’s get an update on what the market likes and dislikes:

Another big week for momentum, driving past all market forces with a 3.7% rally.

The main beneficiaries of this move were of course the AI-related names, as most of the momentum trade is centered around this narrative now.

Interestingly, the S&P 500 still closed the week with a net decline, perhaps driven by rising bond yield and oil spike fears.

No other factor reported an increase over the week besides momentum, which is 90% made up of AI-related names.

This dynamic goes to show just how concentrated the S&P 500 has become, now that most of its driving factors are down into a bear market while AI calls the shots.

If you can’t beat them, join them they say.

Which is exactly what I’m doing in the Offside Portfolio, as momentum and growth carry the biggest betas overall.

However,

There’s a smart way to join the frenzy without risking the whipsaws and potential for blowing up, and that’s usually done in two ways:

I’m leaning on the second option, as most Premium members would have seen in our September portfolio review.

Long/short options and equity positions are now going into an overall decent profit across my AI and real economy ideas, even with those in China!

Until these factors clear up, and participation returns outside of just momentum, I don’t think the portfolio approach and strategy will change much.

Click here to read my Q4 portfolio plan.

My usual read on the commitment of traders (COT) report has been extremely quiet as of late…

So I decided to create a new gauge and begin covering it until the futures market provides a reliable signal once again.

This measure represents the spread between daily VIX implied moves versus S&P 500 daily realized moves through time.

As you can see, each time we reach a 1-2 standard deviation, it creates a fantastic dip buying event, especially if you start playing options portfolios.

Right now, things are quiet and supportive of a continued breakout in the S&P especially now that we’ve reclaimed $7,700.

However,

This also means volatility spikes could show up unannounced.

Note: Whenever this spread widens, it means current market conditions and assumptions have changed enough to correct the options market, and consequently the VIX (which is priced upon these option expectations.)

No such expectation corrections coming about.

Now let’s cover some items for this coming week:

New Earnings:

As we come to the end of this earnings season, there isn’t much to talk about when it comes to market/thesis moving reports.

Other than:

These two should give us another look into the state of the consumer when it comes to discretionary experiences, and more importantly, housing.

With rising mortgage rates, more expensive construction inputs, and higher household economic uncertainty, I expect to see weaker numbers out of Lennar this week.

I do believe both the consumer and housing are two of the coiled springs in the market right now, though there is very little to support them as far as PMI data suggests.

Maybe something changes this week, we’ll see.

Retail Sales - Wednesday:

Another live take on the consumer comes through retail sales this week.

As our tracker suggests, there is barely any activity happening outside of apparel and food services for cyclical industries.

Defensive areas are taking the lead here with miscellaneous and health alike.

Combined with the Dave & Buster’s results, this update should give us something to think about on this potentially coiled spring.

Fed Rate Decision - Wednesday:

There is an 87.3% chance that the Fed enacts a 25bps rate hike this week.

I believe most markets have already priced this in at this point.

Leaving us with two potential scenarios:

I am working on a research piece centered around the recent bond yield moves and inflation prints from last week.

If the decomposition shows enough signal for you to consider, I will make sure this research is delivered well ahead of the FOMC decision.

Building Permits - Thursday:

Last time around, building permits seemed to rebound off of the long-term balance level (in purple.)

This recent expansion may have been a fluke after a long-term contraction in permit rates.

According to PMI data, and rising mortgage rates, the fluke may not yet become a trend unless the cost or mortgage factors change.

It’ll be interesting to see this new print, and see whether it justifies me looking for ideas in the housing market.

Meanwhile, here’s the latest from Goldman Sachs and their take on what a Fed hike could mean for the equity markets.

Keep in mind, most of the potential hike is most likely already priced in, so think about this in 1-3 steps ahead:

Until next time,

OFFSIDE RESEARCH

Against the Tape, Ahead of the Curve.