Weekly Recap:

by Eric Criscuolo & Michael P. Reinking, CFA

The Intelligence Formerly Known As Artificial (“TIFKAA”) has still not destroyed humanity. Weak sauce, man. Weak sauce. 

Last week the S&P 500 gained just over 1% and hit a new all-time high. Breadth was solid however and the equal-weight version outperformed, up ~1.5%. That broke its 7-week losing streak. There was a defensive tilt to performance as Consumer Staples, Utilities and Healthcare among the leaders. Small caps were a negative outlier as the Russell 2000 fell about 1%. 

While the human race continued onward, the Yankees season sadly does not. You don’t need Super Intelligence to calculate the odds of winning when your team’s strikeouts almost triple its base hits. With no more local playoff games, we turned our focus to the beginning of Q3 earnings season this week. Monday was quiet with bond markets closed. The big financial stocks then took their positions in the earnings leadoff spot Tuesday. Unlike the Yanks, they made contact but didn’t exactly hit lines drives all over the place.

Citigroup, JP Morgan, Wells Fargo, and Bank of America all reported that overall economic dynamics are solid, consumer spending remains healthy and credit performance is stable, if not strong. More idiosyncratic to them, equity trading was much more robust than FICC across the group. However, of the roughly 20 large banks and financial companies that reported this week, about half fell after their results. 

While Financials kicked off the earnings cycle, tech wobbled to start the week, especially the semiconductor and memory stocks. Concerns about Chinese competition (CXMT technological advancements), AI capital needs and rising credit spreads weighed more on the sector. Broadcom’s CEO generated headlines after commenting that AI investors were “gambling” with little understanding of what they’re betting on. 

The kindling ignited on Wednesday, triggered by a hot core CPI print (more below). The long-end of the Trearsury curve ripped 15-20bp and expectations for rate hikes shot up,  immediately putting equities under pressure. The S&P 500 wound up down over 1%, breaking a streak of 53 trading days without a 1% decline. Small caps saw larger losses and the overall AI trade was under a barrage of fire. Meanwhile, Anthropic hosted a pre-IPO investor day in the middle of it all. Details trickled out, including Q3 revenue of ~$17B which grew 45% sequentially. That sounds incredible, but that growth is a slowdown from Q2’s 143%, fueling the Bear narrative. 

The latest Tech Wreck this week wasn’t the only story, however. It was intimately linked with a huge reversal in treasury yields. Even though yields shot higher on the CPI print, by the time equities opened that day, they had peaked and were already turning back. As the NYSE Closing Bell rang on Wednesday, 10 and 30y yields were down 2-3 basis points on the day and the 2y was flat. It was very notable that the complete U-turn did nothing to help equities. PPI followed up with an even hotter inflation print the next day. This time, yields skipped the upside feign and basically just went lower. There was also a miss in core Retail sales, adding more weight onto yields.

After a big run up in Q3, a narrative shift occurred. Inflation remains high, keeping the near-term priced for higher rate levels, if not further hikes. However, demand concerns are rising. If AI spending slows, equity markets will likely come under pressure and overall demand in the economy could slow, as AI is such a huge driver. That raises questions about longer-term growth, triggering flight to safety and defensive adjustments.  

A relative reprieve for Tech on Thursday was short-lived, as Friday saw the pressure return. A lot of the concern is centered on data centers, especially the neoclouds that have been providing a lot of the (potential) compute capacity needed beyond the hyperscalers. CDS spreads for CoreWeave and others have been a hot topic as the need for new capital- largely debt- to fund ever growing capacity for AI needs to reliably bridge the gap to significant cash flows from these buildouts. Questions around the demand, ability to power up these buildings, and the impact of a higher rate environment have hit the entire capital stack.  

The SOXX semiconductor ETF fell over 10% this week, the 2nd worst decline over the past five years. The NYSE Semiconductor index is back at the Situational Awareness blow-up lows in late July, and the there was significant discussion across social media of another large AI-focused fund collapsing.

The S&P fell 2% and broke below the 50d ma. A month ago we saw a similar move, and the index fell further to test the 100d ma. That level held and the S&P went on to make another record high. Small caps lagged, with the Russell 2000 down 3%.

Despite the headline weakness, the S&P equal-weight is in the green for the week, much like last week, as solid breadth continued to overcome mega cap (NYSE 100 down 6%) and tech weakness. 7 of 11 sectors ended the week higher as investors rotated into defensive and non-tech sectors.

Outside of Energy, the defensive rotation was apparent as Consumer Staples and Healthcare had solid gains and were strong across-the-board. JNJ got hit on earnings but managed to cut into a lot of the loss the rest of the week. Initially, UNH was up sharply after its earnings but eventually gave back all of it that day. The next days it reversed back to reclaim those early gains. Materials were another strong sector with most components up on the week. The lack of direct AI exposure was likely a factor. Comm Services and Consumer Discretionary were laggards, weighed down by mega cap tech weakness (GOOG, META, AMZN, TSLA all lower). The VIX finally cracked 20 on Friday, a level not seen since the Situational Awareness…situation…at the end of July.

With rates hovering around YTD highs coming into this week the focus shifted to the inflation data. If Paris Hilton was describing the data she would say, “That’s Hot”. Headline CPI was inline with expectations, up 0.6% m.m while the annual reading accelerated to 3.7% from 3.4%. As widely expected, energy drove much of the move higher with the increase in gasoline accounting for >50% of the total increase. Interestingly, food away from home was up 0.2% while food at home fell 0.1% (not based on my grocery bill).

The problem was core, which came in a tenth ahead of estimates, up 0.3% versus last month and 2.6% on an annual basis. With signs of broad-based inflationary pressure. Shelter ticked up to 0.4% while used cars, apparel, transportation and medical care services all accelerated. Bloomberg’s Chief Economist Anna Wong tried to provide a little bit of an optimistic take. She looked at the diffusion index of CPI inflation, similar to the PCE metric Chair Warsh highlighted at Jackson Hole. She highlighted that while over 50% of components are tracking >3% on an annual basis it has ticked down from the high. However, if you look at this on a 6mo annualized basis this has improved more significantly, falling below 40%.  

PPI looked worse. Headline rose 1.3% m/m (0.5% expected) while Core rose 0.7% (vs 0.3%). Ex-Food, Energy and Trade also accelerated from last month (0.5% vs. 0.3%). On the positive side, Final Demand Goods ex-food and energy rose 0.3%, falling from last month’s 0.4% increase. Final Demand Services jumped, rising 0.8% versus last month’s 0.2%. Trade Services, or seller margins, drove almost half the increase, indicating producers may be passing on higher costs to customers.

Retail sales increased 0.8% m/m, above estimates but below last month. However, the control group missed, up 0.1% below the 0.3% estimate and down from 1.2% last month. We also got two regional fed reports. Empire Manufacturing came in much higher than expected. New Orders and Shipments growth jumped, while Prices Paid fell and Prices Received was slightly higher. The 6-month outlook wasn't as robust, however- though still positive (see Chart). The Philly Fed manufacturing survey painted a slightly different picture, no wonder given how things playing out with the Eagles. The survey missed expectations and moderated from last month, pulling back again from the recent high but still expanding. New Order growth fell while the prices components were consistent with the Empire readings. 

No major changes in the claims data…….boring!

This morning, monthly import and export prices both came above estimates and accelerated from last month. On an annual basis import prices were up 8.1% (prior 6.7%) while export prices were up 11.6% (prior 9.3%). Industrial production was ahead of estimates at 0.7% (vs. 0.4%), manufacturing production was inline at 0.3% while capacity utilization ticked up to 76.9% from 76.4%. 

Despite the hot inflation data, yields have moved lower this week driven by a flight to safety and concerns that a slow down in AI spending could ultimately trickle down through the economy and slow growth. Fed officials have been active throughout the week with officials supporting further tightening but suggesting there is no rush. NY Fed Williams has been at the forefront of this cohort and the most dovish suggesting that beyond one additional hike this year and that he didn’t currently see the need for additional tightening next year. Chair Warsh spoke overnight saying he doesn’t prejudge meetings and that the Fed was not in the forward guidance business anymore, clearly his message hasn’t made it through the ranks. The fact that he didn’t push back on the patience camp has helped the probability for a hike later this month to move lower, now <20% probability. 

Credit Spreads - Have been widening significantly over the last month particularly non-investment grade. 

Global Equities -  mirrored the rotational activity in the US with tech heavy indices in Asia pulling back sharply while European indices which have less exposure ended the week higher. India’s Sensex rallied as this market has been hit hard by the AI disruption fears with heavy exposure to software and IT services. 

Earnings will continue to pour in. Given all the AI angst, Meta will be a very important update, along with IBM, SAP, Tesla and Blackstone, among many others. The data calendar will be light, headlined by flash PMIs and China data. Most importantly, the NBA champion NY Knicks will begin their title defense and raise their championship banner on Tuesday night. Enjoy your weekend.

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