The Magician’s Sleight of Hand – February 23, 2024

Wealth Management • Feb 24 2024
The Magician’s Sleight of Hand – February 23, 2024
Morgan Lewis Posted on February 24, 2024

The Magician’s Sleight of Hand

The short list of market darling stocks leading this market higher continues to dwindle. The remaining “magnificent” market leaders are now floating on unadulterated investor exuberance. The performance dispersion (in trickle down fashion) is this: Nvidia, anything within spitting distance of the artificial intelligence (AI) narrative, and then the tech sector more broadly. Frothing and frenzied fear of missing out (FOMO) has now fully turned panic of missing out (POMO) all across Wall Street for all the remaining “magnificents.” For the select Mag-few, market mania is in gear and is starting to hit top speed.

This week it was a glowing earnings report from Mag-7 leader Nvidia that sent the latest gust of wind into the sails of the stock market. Nvidia’s post-earnings surge, which added more than $277 billion to the AI chip maker’s market value—a single day record—helped power the S&P 500 to another new all-time high weekly close.

Jensen Huang, co-founder, President, and CEO of Nvidia, told investors this week that the next wave of investment into artificial intelligence will “open up a whole new world of applications not possible today.” He explained that “we now have a new type of data center that is about AI generation, an AI generation factory,” Later, he clarified, “You’ve heard me describe it as AI factories. But basically, it takes raw material, which is data, it transforms it with these AI supercomputers that Nvidia builds, and it turns them into incredibly valuable tokens.”

If Huang’s description of Nvidia’s bright shining future didn’t quite deliver the clarity hoped for, don’t worry. Here’s the money shot, and the only thing that matters: “There is no way we can reasonably keep up on demand.”

HAI takes nothing away from Nvidia, nor from the opportunity for some companies to massively benefit from the market potential of AI. But make no mistake, the magicians of Wall Street are hard at work. They know a profitable marketing opportunity when they see one, and they never let a good story go to waste. When it comes to the bright and glorious future of AI, it’s now the sun, moon, and stars being promised.

In response, the consensus is all-in. This week’s Investors Intelligence Advisors’ Survey shows that the committed bullish percentage has risen to a new rally extreme of 78%. By this measure, advisors are more bullish than at any time over the past two-and a-half years, which includes the highs in November 2021 and January 2022. At the same time, CNN’s Greed and Fear Index is at 78—the “extreme greed” quadrant of that indicator. In conjunction with these extremes, Market Vane’s Bullish Consensus is at 66, the highest reading since January 3, 2022 (67), when the S&P 500 made a closing high that preceded a 25% decline that stretched until October of 2022. Always remember, the history of markets is unambiguous when it comes to prices, sentiment, and narrative—they reverse at extremes. And we’re swiftly marching toward just those types of extremes on all three measures. Forewarned is forearmed.

Furthermore, as of now it’s only the positive potential of AI being advertised. But recall that an AI-dominated future is also an exceptionally complicated future with very uncertain implications for society, economics, and labor markets. To be clear, digging below the surface of Wall Street’s overwhelmingly positive AI investment narrative, some sobering and alarming findings emerge.

Goldman Sachs, for example, estimates that 300 million jobs could be “lost or diminished” globally by the incredibly fast-moving technology. For perspective, that number exceeds estimates for the total number of jobs temporarily lost during the forced Covid economic shutdown—perhaps the greatest labor market disruption in modern history.

Significantly adding to the complexity, according to Goldman, it’s the higher-paying full-time gigs that are the fattest target of AI-induced job losses. Jobs oriented around physical work (often lower paying and part-time), by contrast, are the least likely to be significantly affected.

In the U.S., according to Goldman, office and administrative support jobs have the highest proportion of positions that could be automated with 46%, followed by 44% for legal work, 37% for architecture- and engineering-related jobs, 36% for the life, physical and social sciences sector, and 35% for business and financial operations. For this author, that last one hits hard—and way too close for comfort.

Additionally, no doubt, AI will have truly profound ramifications extending into the realms of ethics, human agency and meaning, privacy, freedom, societal construction, and spirituality. All of this is coming. None of it has been digested yet.

Now, ultimately, the AI bubble will be what it will and go where it goes, but, in addition to the smoke and mirrors of narrative hype creation, Wall Street magicians are also famous for another maneuver—the “sleight of hand.” When the crowd is captivated by the bright and shiny object in one hand, the best question is often, what’s the crowd missing in the other hand?

In HAI‘s view, the answer is two-fold. Concealed in the other hand of our Wall Street magicians are: 1) The persistence of inflation ultimately toppling the stock market stimulative “Goldilocks” thesis. 2) The worsening U.S. fiscal situation that JPMorgan CEO Jamie Dimon just called “the most predictable crisis” in history.

As past HAIs have detailed, the stock market is counting on policymakers to restore Goldilocks economic conditions. Specifically, the market is pricing in a future in which inflation falls back to the 2% target and the Fed can aggressively cut interest rates. But, as last week’s CPI inflation data reminds us all, inflation is a very tough foe to vanquish. Historically, winning the battle over inflation has always required a painful recession. Today, either a recession or reinvigorated inflation would rudely disrupt the Goldilocks disinflation, rate cuts, and soft-landing narrative. To be sure, a disrupted narrative would be bad for financial assets currently pricing in Goldilocks perfection.

After last week’s hot inflation data, in fact, CNBC’s Charlie Gasparino reported that sources close to the Biden Administration said panic at the White House went “somewhat hyperbolic on the real possibility that Powell can’t cut rates or will be cutting them into an uptick of inflation, which could be worse.” He continued, “the vice on Jerome Powell’s head just got tighter… [as] calls to cut rates run into the reality of inflation.” Crucially, Gasparino then added that Wall Street CEOs told him that last week’s inflation print may loom as one of the biggest stories of the year. These telling signs clearly indicate that the current Goldilocks market narrative is on extremely thin ice. In other words, Goldilocks is a narrative in grave danger of reversing sharply—and quickly.

Similarly, the current mainstream media and Wall Street complacency over the U.S. fiscal situation may prove all too fleeting. As a reminder, a year ago market legend Stanley Druckenmiller described the U.S. fiscal situation as a crisis akin to “a 200-foot tsunami just 10 miles out.” That tsunami is much closer now.

According to the Congressional Budget Office’s own estimates, entitlement spending on seniors along with interest expense paid on debt will combine to reach 100% of federal tax revenues by 2040. Crucially, however, those CBO estimates are themselves also based on the assumption of Goldilocks conditions. The CBO assumes interest rates will be cut, income tax revenues won’t take a hit from any recession, and capital gains taxes won’t drop because, presumably, the financial asset bubble will never pop.

If the endangered Goldilocks narrative breaks and market “party-on” turns “party-over,” then, by extension, the current narrative calm and complacency regarding the fiscal crisis will abruptly end as well.

As market analyst Luke Groman colorfully suggested this week: “mainstream media economic reporters, economists, and analysts will likely go from ‘Debt and deficits do not matter,’ ‘the US will not have a fiscal crisis for years or decades,’ to ‘the US has an acute fiscal crisis’ every bit as fast as they went from ‘Biden is fine’ to ‘Biden has a cognitive issue.'”

If the Goldilocks narrative breaks down, what new mainstream narrative will take its place? We’ve recently been given several previews. As mentioned, JPMorgan CEO Jamie Dimon said U.S. debt is the “most predictable crisis” in history. Last month, former Treasury Secretary Robert Rubin said the U.S. is in a “terrible place” with its federal deficits. Two weeks ago, noted author and hedge fund advisor Nassim Taleb said, “So long as you have Congress keep extending the debt limit and doing deals because they’re afraid of the consequences of doing the right thing… eventually you’re going to have a debt spiral… and a debt spiral is like a death spiral.” Then there’s BlackRock Vice Chairman Philipp Hildebrand, who recently warned outright that any U.S. default could imperil the dollar’s global reserve currency status. 

Lastly, and perhaps most importantly, Bloomberg noted this week that former IMF Chief Economist Olivier Blanchard warned of a “U.S. fiscal crisis after soaring borrowing.” What makes Blanchard’s warning so telling (and chilling) is that it runs a full 180 degrees opposite to comments he made just three short years ago when he completely dismissed U.S. debt as any problem at all. Blanchard’s change of heart reflects both the undeniable reality of the 200-foot tsunami and the fact that it’s closing fast. It’s also likely an important signpost indicating that current mainstream complacency over the fiscal situation is also about to shift—on a lag—towards Blanchard’s new warning.

In other words, the new narrative waiting in the wings is that the fiscal “situation” is actually an imminent fiscal “crisis” and that our options are incredibly painful wholesale reform or a debt “death spiral.” Ominously, meaningful reform isn’t even up for discussion right now.

If the Goldilocks narrative reveals its fairy tale origins, and the narrative on the US fiscal situation shifts to one of irrecoverable crisis, then expect Western investors to aggressively increase exposure to gold as financial insurance. Recall from last week’s HAI that the Western investor is the final piece of the demand-side puzzle for gold. When Western demand returns, on top of already insatiable Eastern appetite, it will combine to run headfirst into a substantially tightened supply side picture. When those stars align, expect these dynamics to translate into a sustained major breakout higher in the price of gold.

At present, both the Goldilocks and “benign fiscal situation” narratives driving current Western investment trends are skating on the thinnest of ice. That makes the gold market, upon any narrative change, a fully loaded powder keg ready to explode.

Always remember the magician’s sleight of hand. While Wall Street magicians are busily conjuring FOMO-turned-POMO hype, prominently flaunting a bright and shiny AI object in one hand, HAI sees a lit match concealed in the other. When the script abruptly flips and the narrative shifts, expect the return of the Western investor to put the match to the gold market powder keg.

It’s a set-up eerily similar to that of the 2000 bubble. Back at the turn of the century, as now, FOMO turned POMO and bubbled-up prices were justified by the hype of a legitimately incredible “game changing” investment narrative. Back then, that hype marked a bubble top in the Nasdaq 100 that subsequently soon popped. Those year 2000 peak prices weren’t recovered for over 15 years. Interestingly enough, the events of the year 2000 also marked a generational bottom turned raging bull market in gold and gold mining stocks. Will history rhyme? Only time will tell, but always remember the Wall Street magician’s sleight of hand.

While Goldman Sachs has dubbed Nvidia “the most important stock on planet Earth” and Bank of America calls it the “picks and shovels leader in the AI gold rush,” HAI is closely watching the magician’s other hand. Given the set-up, HAI will leave the AI gold rush to others, preferring instead to be adequately positioned in real gold and in the most important companies providing the real “picks and shovels,” so vital for delivering supply in the next rapidly approaching leg of the real gold rush.

Weekly performance: The S&P 500 jumped 1.66%. Gold gained 1.25%, silver was down 2.13%, platinum was off 0.43%, and palladium gained 3.75%. The HUI gold miners index was off 0.67%. The IFRA iShares US Infrastructure ETF was up 0.20%. Energy commodities were volatile and mixed on the week. WTI crude oil lost 2.51%, while natural gas registered its first weekly gain in seemingly forever with a 5.59% jump. The CRB Commodity Index was lower by 0.65%. Copper was up 1.56%. The Dow Jones US Specialty Real Estate Investment Trust Index was up 1.45%. The Vanguard Utilities ETF was up 0.87%. The dollar index was down 0.31% to close the week at 103.86. The yield on the 10-yr U.S. Treasury lost 4 bps to close at 4.26%.

Have a wonderful weekend!

Best Regards,

Morgan Lewis
Investment Strategist & Co-Portfolio Manager

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