Overcoming Fear, Embracing AI, and Navigating Central Bank Dynamics for Higher Returns
Abraham George Market Musings
We are well into the second half of this year, and we've certainly come a long way since I called a bottom in the S&P 500 back in October 2022. If you're a regular reader, you're already aware of this. For your reference, I've attached a link to one of my previous articles.
2022 was undoubtedly a challenging year. Stocks plummeted by approximately 20%, marking a definitive bear market. Of course, there have been even more severe bear markets in the past, and if you've been in the markets long enough, you've probably experienced them.
What made last year truly unique was that most people lost all perspective. When the market hit its lows in October, many predicted a further decline of 20% to 30%.
To experience a drawdown of 50% or more, we would have needed a debt crisis of some magnitude, similar to the Global Financial Crisis. However, that wasn't the case. The central banks had already positioned themselves to do "whatever it takes." What we witnessed was purely a contraction in valuations due to a sudden rise in interest rates. If investors had recognized this for what it was and trusted their analysis, they could have stayed invested or even bought more at lower levels. Unfortunately, many investors fell victim to the unhelpful commentary from the talking heads on various channels.
While the markets are currently stalling below the 4500 mark in the S&P 500, allow me to present my case as to why they could still rise higher.
Most regular equity investors follow a strategy known as modified dollar-cost averaging. They make automatic contributions during bull markets but withdraw during bear markets. Then, when the market rallies again, they jump back in. Similarly, most hedge fund managers who track an index are still shorting the markets.
Additionally, we've witnessed the removal of several key risks over the past couple of months. These include the elimination of the immediate banking crisis risk (although it could potentially resurface to haunt the Fed and Treasury), the removal of the risk of a US government debt default, and the eradication of the constant threat from the Fed to destroy jobs and suppress wages.
So far, only $600 billion of the $4 trillion approved under the Biden administration has been deployed, which means a massive influx of money is yet to hit the economy. And let's not forget about the increased productivity growth resulting from generative AI.
We've already seen a significant revision of Q1 GDP, with growth estimates rising from 1.3% to 2%. Currently, the Atlanta Fed's GDP model predicts an almost 2% annualized real growth rate for Q2, which is double the consensus view among economists.
The prevailing thesis in the market is that the yield curve is still inverted, with both manufacturing and services activity PMIs below 50, indicating economic contraction. The Fed remains hawkish, and everyone is on the lookout for a recession.
As I've discussed before, the inverted yield curves can be attributed to bond market manipulation by central banks. Over the past 15 years, various degrees of central bank intervention in bond markets have nullified most of the conventional signals that the bond market historically relied upon to assess the economy.
I encourage you to watch the attached clip from the major central bank gathering in Portugal last month. Notably, we now have a new BOJ Governor, Kazuo Ueda, who speaks fluent English. Christine Lagarde, the head of the ECB, speaks English even better than Fed Chairman Jerome Powell and BOE Governor Andrew Bailey. This linguistic fluency enables them to communicate more effectively. The crucial aspect I want to highlight is the questioning by Sara Eisen, CNBC's news anchor. While the central bank chiefs attempted to dodge her inquiries about the persistence of central bank cooperation, they eventually admitted to it. This once again underscores my point that major central banks are all in this together.
It's possible that the Fed may raise interest rates again, and my arguments against further hikes are irrelevant. Whatever the Fed's intentions may be, they're already factored into the market. Sentiment trading revolves around thinking and acting opposite to the consensus.
Now, you may wonder about AI. Hasn't its impact already been priced in? Shouldn't we be doing the opposite of what everyone else is doing? The answer is no. AI represents a revolutionary change, even more significant than the invention of the internet or the wheel. Therefore, it's unwise to go against the trend. Unfortunately, most AI stocks are currently overvalued. So, our best hope is for some correction to occur, providing an opportunity to enter the market.
If you're considering purchasing an AI stock right now, I suggest looking at AMD. I believe AMD will compete on equal footing with NVIDIA. I'll delve deeper into this topic in another report.
Back in 2007, when AMD faced numerous challenges, Abu Dhabi made substantial investments in the company, eventually owning about 8.1% of it. They largely divested from AMD in 2019. It was a position worth holding, and I believe AMD will continue to be an excellent stock moving forward.
Just recently, the ADP report came in much stronger than expected, and for the first time in over three months, the 10-year yield has surpassed 4%.
Historically, whenever the yield breached the 4% mark, it didn't remain there for long and was forced by central banks to retreat back into the three-handle territory.
Several unfortunate events unfolded when the yield was above 4%. The collapse of Silicon Valley Bank occurred at 4.10%, FTX suffered a blow-up when the 10-year reached 4.22%, and in October last year, the BOJ had to intervene to stabilize the weakness in the yen when the ten-year traded at 4.34%. Furthermore, the UK bond market experienced a meltdown when the ten-year yield was at 4.02%. While rates rising above 4% in ten-year US yields might not be ideal, I believe the central banks currently have the situation under control. Keep an eye out for the CPI numbers on July 12th; my hunch is that they will surprise us with a lower inflation figure, mainly due to "base effects" as we've discussed before.
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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office, and a hedge fund.