Markets
The second biggest question on investors’ minds, the tractory of US yields being number one, is what’s next for US equities?
At the risk of stating the obvious, much depends on what happens in rates and especially how things develop at the long end of the US Treasury curve.
Indeed, the movement in long-term interest rates, particularly 10-year Treasury yields, is a critical factor influencing various asset classes, including stocks.
As long-term real rates rise, stocks could struggle mightily. Higher reals increase the discount rate applied to future cash flows, leading to lower present values for these cash flows and potentially affecting every asset class we price, except oil, which deals in the present.
The rapidity of the rate rise and the sharpness of the recent escalation in long-term interest rates can be quite concerning for financial markets. It’s not just the level of rates that matters but also the pace at which they change. Rapid rate increases can disrupt various asset classes and market sentiment.
The concentration risk in expensively-valued growth stocks makes the current situation troublesome for equities. These stocks are susceptible to higher reals through the valuation channel. However, this was not a significant concern for the first seven months 2023. This was mainly due to the oversold state of the technology sector after the previous year, such as Meta, which had dropped by about 75% at one point. Additionally, the optimism around AI was more significant than the effects of realism. As a result, the Nasdaq 100 had its best first half in history.
The hype around AI has decreased since July, but the challenges from higher interest rates have only increased. This makes the upcoming earnings reports of major tech companies even more important. While Tesla’s earnings were disappointing, they are not necessarily an indicator for the rest of the “Magnificent 7.” Four will report their earnings in the coming days, which will be closely watched.
In the past, the top seven largest companies in the market have consistently demonstrated that their performance significantly impacts market sentiment and overall market trends. These companies now make up an even larger market share than the peak of the pandemic-driven “everything bubble.” As a result, when these heavyweight companies deliver strong financial results, it often leads to positive market reactions and can overshadow other factors influencing the market.
Will this time be different?
Oil markets (as per Asia trade)
Oil prices continued to slip amid reports of the US pressuring Irseal to delay any ground offensive.
Also, the US military presence, including sending a second aircraft carrier strike group to the eastern Mediterranean near Israel to deter Iran or Hezbollah, is providing a significant deterrent for other actors entering the fray while likely safeguarding oil interest in the region against terrorist attacks in the Gulf of Hormuz.
The biggest issue in this context is a terrorist attack on a US asset that causes the US to retaliate. That could inflate tensions and send the Geopolitical Risk Index( GPR) soaring, which, for a large part, is driving oil prices right now. But I also think the volume of headlines around oil has added a couple of dollars to the prices. In other words, media coverage is pushing the GPR index higher, so with oil headlines decreasing, perhaps some of that is coming out of the prices.
I think it is well understood that the last thing Middle East producers want to do is weaponize oil globally, as the long-term political blowback could be intense.
While I think there is a downside risk to Iran’s oil supply, I view them more as a propaganda machine rather than an actual threat.
To be clear, there is a real risk that the Israel-Hamas conflict will produce far more Iranian propaganda, and headline risk is always, as we saw with the Hospital rocket misfire. But I can confidently say that Iranian propaganda is not as sophisticated, cunning, or polished as the propaganda produced by the Kremlin or China. The theocratic regime in Tehran is generally ineffective, its geopolitical objectives are apparent, and the government is too proud of its destabilizing role to keep anything a secret.
In addition, the US remains the most critical short-term marginal oil producer. To the degree that the largest Permian Basin acquisition in 25 years helps offset any supply disruption through the Straits of Hormuz that might surprise speculators. With the improved technology and a structural rise in the average lateral well length to 10,000 feet, the Permian Basin’s new oil well production per rig has increased fivefold over the past 10 years to 1.1kb/d.
