Welcome back to the Lumida Ledger. Here’s a preview of what we cover this week:

• Macro: 2024 Rate Forecast, Inflation Expectation, The Dollar’s Edge, Monetary vs Fiscal, Chinese Equities

• Markets: Liquidity, FED, Valuation, Small Caps

• Company Earnings: Costco, Oracle & Sovreigns, Lennar

• AI: LLM Wars, Current Market Leaders in AI, Interview with the CEO of Groq

• Digital Assets: Bitcoin

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Macro

The Great Gestalt Shift

The S&P marched higher for the 7th week in a row.

A major shift occurred across broad swathes of investors this past week.

And that shift is consistent with the thesis we have outlined in our newsletter: there is no recession and we’re in a strong bull market.

Global investors re-appraised their relationship with risk assets and the economic outlook.

A major capitulation in bearish sentiment took place.

You can see that in this 10-year chart of equity market sentiment as measured by the AAII bull bear survey:

The last time we saw a capitulation was in late October when ‘higher for longer’ became Consensus - and bond markets promptly turned the other way and rallied.

Looking into 2024

We believe many investors missed the ‘23 rally.

Readers know we’ve been on top of it. Not only that, we bet on the following non-consensus investment themes: digital assets, nuclear renaissance, semiconductors. 

And they’ve all had a banner year.

Most of 2023 was concerned with investors gripping tightly on to the ‘Quality Factor’. Factors explain the rise, fall, and co-movements of stocks such as Value, Momentum, Liquidity, Size - and Quality.

Quality was the optimal response for institutional investors that wanted earnings growth and exposure to AI narrative in a high real rate environment with macroeconomic uncertainty. After all, these are the best businesses in the world - the Mag 7.

There is a new trend afoot this past week, that we expect will continue.

The top-line indices are hitting new highs marginally. But Mega 7 is underperforming smaller names. You can see that in this chart from the day after the Fed meeting:

Small community banks, REITs, consumer staples, cruise stocks - you name it - they are all rallying. There is a ‘worst to first’ dynamic taking place as capital flows out of crowded Mega Cap names.

As investors gain more confidence on the economic footing, they are relaxing their clutch on Quality. 

Now they are relaxing and in search of relative value in other pastures.

We have several themes we are excited about in 2024. 

The last several weeks we’ve been talking about Small Caps.

2024 is the year for Small Caps

Small caps have had three years of lackluster performance.

Higher interest rates increase the cost of capital to these firms.

The sector is unloved - although it’s received one helluva bid as we’ve been talking about it in recent weeks.

The public mass hallucinated a pivot

Now, we do believe market enthusiasm is near peak sentiment when we see record call buying.

Also, we believe the public mass hallucinated the Fed Pivot.

We wrote this Wednesday after our own read of the Fed pressor on X.

This Friday, the Fed’s John Williams is now saying the Fed is NOT really ‘talking about rate cuts right now’.

Very few people do a careful word-by-word analysis of these FOMC.

We did.

Here’s what we heard and our evidence.

Pivot Case: Dovish Statements

1) Chair Powell acknowledged that rate hikes are likely over. "The next question is when to begin reducing"

2) "If you look at projects, expectation would be that real rate is declining as we move forward" 

But: Powell also shared his constraints and decision-making framework

Observations:

“Inflation remains above our LT goal”

“Core CPI prices rose 3.1%”

Constraints:

“We believe at or near its peak for this cycle, but reserve the right to rate hikes”

“We are prepared to tighten if appropriate”

Policy:

“Committed to 'restrictive' policy until confident inflation is 2%”

“Far too early to call victory...the economy can behave in unexpected ways”

These statements lay out the 'framework' for easing. And the conditions for easing are simply not in place according to the Fed's own framework.

Don’t blindly accept the market’s read. The interest rates markets were long thru ‘23. Last year this time they were expecting a pivot that never arrived.

Markets Expect 6 rate Cuts in ‘24, That Won’t Happen

Mark my words. There will be no rate cuts in Q1 ‘24.

Here’s the spread between market implied rates (yellow) and the Fed’s own dot plot (blue).

This difference will be reconciled by markets disappointment.

Remember in 2023 traders were betting on rate cuts? They were wrong. Here’s a table with the evidence:

That disappointment will occur via Fed officials walking back comments - already starting - and the failure to cut rates in Q1.

The Rolling Recession Thesis

There is certainly something to the idea that there are sectors of the economy that are weaker than others.

We always love to find the data points and narrative that are below the public’s consciousness.

Here’s one.

The New York State December Empire Manufacturing Index sank to -14.5 vs. +2.1 est. & +9.1 in prior month.

Prices paid softened. New orders plunged further into contraction. Employment fell to lowest since March 2021. New York State manufacturing is in a recession.

New orders are a leading indicator.

What’s the point? We laid out last week how we don’t see evidence of a recession and we’ll stand by that.

The broader point is that a new narrative will eventually rise to capture the public zeitgeist. 

Whatever it is - it will be something other than Jay Powell as Santa Claus. It could be very well Jay Powell as Grinch.

Chasing securities that are already over-extended is not a wise move.

Markets are an emotional ball of wax in the short-run. Different sectors expand or contract with the narrative du jour.

Our task is to identify excellent investments like sea shells on the beach when Mr. Market takes the tide out. When the water comes back in we sell them back to Mr. Market at higher prices and hang on to the best ones forever.

FOMO is Dangerous

We see record call option buying and low put buying.

Many people right now are experiencing FOMO. The time to buy securities was in mid-October, when it didn’t feel comfortable to do so. We wrote about that, and we did that.

FOMO is when you are long, but want to be levered long

You are in cash, but want long.

Take note of that feeling. Give it a label. 

I call that ‘the fever’.

It’s dangerous to act on it.

Your own emotional signals can give insight into the public.

If you want to find a thoughtful way to gain exposure and pick-up value, we recommend reaching out to a trained investment advisor that will help you thru these periods and keep you on the right track.

Stay Bullish, but Expect Volatility

Note we have strong positive seasonality remaining thru year-end. At the same time, many equity market sectors are overbought. This presents a challenge if you aren’t already in the market. That said, we have an idea fo you later…

We also have the Presidential Election cycle ahead which we discussed last week.

Here are some stats to keep you bullish.

Fed Cycle Stat #1

Of the 8 Fed Easing Cycles in the Last 40 Years, 5 of 8 generated positive equity performance.

The three that did not were recessionary periods like 2008. There’s no recession in sight, so that’s bullish.

Fed Cycle Stat #2

Historically, the S&P 500 has shown positive returns of 6.9%, 13.2%, and 18.9% at the three, six, and twelve-month marks after the final rate hike.

The last rate hike was last summer, so this study is active until the summer.

Small Cap Stat #3

The Russeell 2000 has never sustained 3 consecutive calendar years in a bear market territory, since inception.

Small Cap Stat #4

This is the 24th time the Russell 2000 closed at a 52-week low, then surged to its best 4-day rally in at least 3 months.

A year later, the small-cap index was higher 100% of the time with a whopping median return of 25.6%.

Small Cap Stat #5

Small cap valuations have only been this inexpensive 3 other times since the Great Financial Crisis, including 2022’s bear market.

How will the mismatch between Fed and market rate expectations play out?

We mentioned earlier the Fed will stay ‘higher for longer’ - certainly over the next quarter and likely more.

So what happens if there are no rate cuts?

Will markets tank on the disappointment?

It depends. 

If rate cuts are not delivered because GDP growth proved stronger than the Fed’s 1.4% GDP projection, then that’s fine for stocks. In fact, that’s exactly what happened last year when we made the same observation that markets were getting Fed Pivot ahead of themselves.

However, if Core PCE doesn’t get to 2.4% next year, then that’s bad for equities, especially the the lowest quality parts of the market (e.g., the stocks that rallied the last two weeks).

China

China is nearly universally reviled. Stocks are cheap.

Across the world central banks are easing on average.

Each week, we take a peak at what’s going on in China.

Our intuition is saying ‘focus here, the public has written it off.’

Something happened this week.

We saw the largest inflow to China in 11 weeks. No one is talking about that. We like that.

Chinese equities experienced their most significant capital influx in nearly three months, attracting a robust $1.7 billion in investments.

We believe there is a lot of bad news priced in China. And we’ve been a vocal critic of China this entire year. Here’s our thread critiquing China which received 6.4 MM views on X - typo and all:

Still, we have to be mentally flexible.

If there is a resumption in global growth, China will benefit.

The global grip on the quality factor will relax. And other sectors that have remained unloved will get a bid. 

Guess what?

China reports fastest industrial output growth in nearly two years

China’s industrial output grew 6.6% in November from a year earlier, outpacing expectations for 5.6% in a Reuters poll and follows a 4.6% rise in October.

Retail sales missed estimates. Still, they climbed 10.1% in November from a year ago, the fastest pace of growth since May.

Recall, China consumers had a whopping 50% savings rate not too long ago. They are in a turtle position. But, as fear lessens and savings normalizes to 30% or lower, spending goes up.

The way to approach this conservatively is to wait for a bid. Check each day and week for relative strength. Then get on the train. Here’s a 10-year chart on China. 

Notice how prices are about to test multi-year lows. We expect the re-test will succeed and bounce hard.

Whether you are a China bull or bear, we strongly recommend listening to this interview with Tim who is a Portfolio Manager specializing in China. 

CVA Funds has 15 managers on the ground in China.

We discuss China macro - but more interestingly, we get into consumer trends in China.

The interview includes videos of China’s luxury electric calls, social media shopping, A/B ecommerce testing, and other trends worth staying on top of.

China is increasingly dominating EV production globally…and they are manufacturing cars that run and look like the Porsche Cayenne or Rolls Royce.

The issue with China is its storytelling (and crushing American policy as the US refactors its supply chain).

Markets

Liquidity Boost Fuels Market Strength: MMFs Favor T-Bills Over RRP Amid Fed Policy Shift

One big factor in the market’s strength these days is improving liquidity, despite contraction in the Fed’s balance sheet.

We believe this trend is driven by the choice of money market funds (MMFs) to invest in T-Bills rather than utilizing the Fed's reverse repo program (RRP).

As MMFs anticipate a shift in the Federal Reserve's monetary policy, the RRP program is shrinking fast. It’s as if the Fed is not doing any Quantitative Tightening (QT) at all.

The Market Compass

We pointed out Energy was oversold last week - it’s bouncing back.

Rest of the US Sectors are overbought. In a strong bull market, overbought sectors can remain overbought - and there is compelling evidence this is a strong bull market.

Let’s cycle through our three-prong market compass.

1. 10-Year: The 10-year tightened to 3.91%. Lower 10-year yields are constructive for long duration risk assets like equities. This is a great sign longer-term.

Bonds and equities continue to exhibit positive correlation.

Bonds no longer provide the diversification they used to. Diversification requires negative correlation.

Bonds are approaching a key technical level, so the support they provided to equity markets may be subsiding.

Also, the violent rally indicates there is a ton of liquidity out there.

There’s a trillions of dollars in money market funds that have missed the rally.

2. USD. The dollar continues to decline. That’s bullish. However, there are signs that the USD is due for a bounce.

3. Semiconductors

These took off like a rocket in early November and continued the upward trajectory after stalling a bit in early December. 

Semiconductors are up 25% since the start of November. 

Nvidia, the bellwether, went up 2.9% last week.

It’s Getting Hot in Here

Sentiment has warmed sharply since October.

Not only is the AAII bull-bear gauge back to balmy levels, so are various market indicators.

The best indicators to gauge markets the last two years have been the AAII bull bear ratio and the 10-year.

The fundamental bid in equities is a strong bull case thesis for ‘24.

However, near-term we are getting near peak sentiment. This can certainly go on for a few more weeks, especially with positive Christmas seasonality.

Be thoughtful about what you are buying. Mega Cap tech and unprofitable tech especially is overbought. Don’t chase green candles.

Equities: Valuation Dispersion is Elevated

The spread between the top quintile and bottom quintile valuations is elevated. 

This plays out in a few ways:

1) In a recession, high multiple growth stocks will get whacked like ‘21 and ‘08.

> Low probability

2) In a broadening recovery or easing cycle, small caps should do well. 

> High probability

What is the bull case for high multiple? 

1) Continued demand for ‘Quality Factor’ and 2) AI narrative and 4) Mag 7 leading earnings growth vs expectations. 

The wider the spread the higher the bar. This is the story to watch in 2024.

Hedge Funds Are Crowding in Mega Cap Tech (Quality) 

Hedge Fund Ownership of Mega Cap Tech is at 94% percentile

That means HFs have less dry powder to buy Mega Cap Tech.

Recap: HFs are near peak crowding into Mega Cap Tech at high valuations

Investment Idea of the Week: Tactical Buy Setup

Last week, 60% more Consumer Staples stocks were above their 50-day moving averages than their 200-day averages.

This happened five other times:

1. The bottom in 1962

2. The bottom in 1974

3. The bottom in 1987

4. The bottom in 2000

5. The bottom in 2009

Let’s take a look at Staples over 1 year. You can see staples hit their 200-day moving average and promptly tanked. The ideal entry would be as Staples get back to the 50-day. That would coincide with the 2023 lows.

What’s best expression for Consumer Staples? There are several. We like Hershey’s, Johnson & Johnson, Walgreens and others.

Don’t think Consumers Staples can’t make big moves. Hershey’s had a 50% return the last time its valuations were at current levels…

Take a look at Hershey’s stock. We just had a volume spike at long-term support levels.

We’re buying it now.

Broadcom Inc.

We liked Broadcom. We wrote about Broadcom in earlier newsletter dated Oct 15th and reiterated a buy call on the stock. The price of the stock then was $883.18 (on Friday Oct. 13)

Broadcom is undergoing several significant advancements, notably powering Google's TPUs—specialized processors designed for optimal AI model execution. 

Broadcom is also engaged in developing custom silicon products in collaboration with firms like Meta. 

Their leading networking business, ranking as the second-largest expenditure in AI infrastructure after accelerators, underscores its pivotal role. 

The continued success in wireless chips and the anticipated integration with VMWare further contribute to Broadcom's positive trajectory.

Small Cap Swing

Equities are hitting fresh highs.

The choppy sideways trending Russell 2000 has bounced sharply. 

The Russel 2000 has underperformed the S&P 500 over the past few years.

The strength this week has brought small caps up to a fresh 52-week high; the first one since November 2021 - when equity markets peaked. There’s no overhang anymore. 

What is even more impressive is that the new high only comes a mere 48 calendar days after its 52-week low. 

In the history of the index, there has never been a faster of a turnaround from a 52-week low to a 52-week high.

We are overbought short-term, but significantly bullish longer-term folks.

We have put together and are investing in a small cap portfolio - reach out to learn more. We would not be surprised if small caps were up 30 to 50% in 2024 as they play catch up.

Small cap community banks ripping

Small cap banks are back from the dead. The anticipation of lower rates is causing a ‘worst to first’ rally.

Example 1-Month Returns:

Axos Bank (AX) 35%; Live Oak Bank (LOB) 33% return

YTD Axos gained 46%. LOB even more 52%.

Enphase Energy and Solar Edge, once solar darlings, were left for dead.

They are roaring coming back strong. Enphase is up 33% in one month.

SNAP, a social media company also left for dead, is also up 85% in 3 months.

Consumer discretionary stocks are also up strongly since there is no recession in sight.

What’s the point? Capital is flowing to neglected sectors. Investors are relaxing their grip on Quality stocks.

Energy Check-In

We talked about how energy was testing lows, offered relative value, and was preparing for a bounce.

Well, it bounced. Guess who bought the dip? Warren Buffett. (The synchronicity warms my heart.)

Here's OXY. You can look at XLE or many other names.

See that volume spike down at resistance?

That's the climax you want to look for.

Energy stocks have shown a remarkable total return of +131% in the last three years, outperforming the S&P 500, but they underperformed by 25% in 2023. 

The XLE is presently trading around $81, and the implied level from covered stocks is approximately $95, close to levels experienced earlier in the year.

Uranium

One of our other big investment themes this year - Uranium.

The damn thing has gone parabolic.

As we said earlier, our big investment themes: digital assets, semiconductors, nuclear renaissance all hit in ‘23.

We also had sub-themes - buying financials after the ‘banking crisis’ - notably JPM and UBS and MS (wealth managers) and buying cybersecurity in an AI world (e.g., Palo Alto Networks, Crowdstrike, Z Scalar).

New 2024 Theme Biotech

Biotech stocks are quietly making a move. And no one is talking about them. (Except me :) 

When no one is talking about an asset class, that’s a good sign. Biotech is long duration. 

Rates peaked. We are offering access to a Biotech Long/Short fund with limited capacity. We love niche, capacity constrained strategies. That’s a marker.

The HF has generated 20%+ avg annual returns - that looks promising. Reach out if you want to learn more.

We’ve written about Biotech on X if you want a recap on the thesis. 

We’ll do an interview with RTW, a NYC hedge fund specializing in biotech, in Q1 - stay tuned.

Company Earnings

• Overall, earnings for the week showed revenue and earnings beats and absolute revenue growth that exceeded inflation.

• Costco’s primary growth is now international. US sales grew 2% - below inflation.

• Oracle is activating cloud services for Sovereigns. The cloud business is growing 70% YOY. However, it’s a small part of the overall business thus far. Oracle’s stock dropped 8% on the release despite a compelling AI story because the headline growth is only 5%.

• Homebuilder Lennar is showing strong 25% QoQ growth. Mortgage rates are now a tailwind rather than a headwind.

AI

Latency is a Big Driver in LLM Wars. 

Be skeptical of the current leaders such as OpenAI. This is the Search Engine wars all over again.

Remember, Google didn’t show up on the scene until years later. And they won with Page Rank.

Have a listen to my 1:1 interview with the CEO of Groq here. We talk AGI, philosophy, and semiconductors - much fund.

We wrote about two semiconductor stocks in October’s newsletter - Broadcom and ASML. 

Let’s see how they are doing.

Broadcom

ASML

Both up sharply.

Note: We do not list every single idea we like here. We like dozens of stocks. 

There are over a dozen other semiconductor stocks we like not listed here.

If you want a quality portfolio of semiconductor stocks, reach out to learn more.

Ten years from now, we’re going to look back and say ‘Investing in semiconductors was obvious given the rise of AI, Robotics, and Decentralized Compute’.

Digital Assets

Ram was interviewed in a fun talk with Quinn Thompson from Maple Finance.

The thesis for tokenization, blockers, and how to enable it are covered here.

https://twitter.com/maplefinance/status/1734656868771914078

Disclosure: Long Maple Finance (MPL)

"We should be able to summarize a bank's risk exposure to commercial real estate in a pivot table, drawing data from an all-to-all blockchain."

How’s Bitcoin doing?

Bitcoin is a momentum asset. The trend is up.

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