Entering May, the most dazzling narrative in the global market belongs to $NVIDIA Corp(NVDA)$ , the leader in AI computing power, with its stellar financial report. The day after the financial report, its market cap exceeding one trillion.
Influenced by NVIDIA's strong financial report, the soap opera of the U.S. debt ceiling negotiations and the increased probability of a rate hike in the June FOMC meeting, along with other negative market news, were all set aside. The tech stocks in the U.S. stock market experienced the "melt up" that we anticipated in our Market Review| Rate Hike Pause, Stagflation Continues, Cherish the Good Times Before Recession in early May. However, global assets did not experience the same heat in May.
So, how will they evolve? Let's first review the performance of assets in May.
I. Asset Performance Review in May
1. Major asset returns
Source: Bloomberg; data period: 2023/5/1-2023/5/31
Since May, Fed has raised interest rates as scheduled, and the Nikkei Index has reached a 30-year high. U.S. tech stocks continue to perform well, leading to the rise of major indices such as the $NASDAQ 100(NDX)$ and the $S&P 500(.SPX)$ . However, the Russell 2000 index, representing small-cap stocks in the U.S., still experienced a decline.
Meanwhile, stock indices in Europe and the Greater China region have encountered varying degrees of decline.
The global bond market has experienced a general retreat.
In terms of currencies, only the U.S. dollar has shown strength, while other currencies have depreciated.
As a result, commodities, real estate, gold, and other assets have all experienced varying degrees of decline.
2. Major strategies’ gains
Source: Bloomberg; data period: 2023/5/1-2023/5/31
In terms of strategies, the long only strategy of GS VIP Hedge Fund has performed impressively, while global macro and asset allocation strategies have underperformed.
II. Market Interpretation
1. After the rapid surge of the AI concept, what can we expect next?
Institutional holdings are not high, indicating that there is still room for semiconductor growth.
During NVIDIA's epic earnings conference, founder and CEO Jensen Huang stated that the computing industry is undergoing two simultaneous transformations: accelerated computing and Artificial Intelligence for Graphics and Computing (AIGC).
With numerous companies applying AIGC to every product, service, and business process, the trillion-dollar data infrastructure already installed in global data centers will transition from general-purpose computing to accelerated computing.
Therefore, the semiconductor chip industry, which supports the demand for AI computing power, is poised to enter a new growth cycle. As shown in the graph below, as of the end of March this year, global semiconductor sales are still below the long-term upward trend line, indicating ample room for upward movement once the cycle reverses.
Global semiconductor sales moving average over 3 months
source: SIA, Bloomberg, and Tiger Trade
Despite the soaring AI trend this year, which has led to a more than 39% increase in the $Philadelphia Semiconductor Index(SOX)$ , institutional holdings in the semiconductor industry-related stocks are not high. According to UBS statistics, both mutual and hedge funds currently have allocations to semiconductor industry stocks that are significantly lower than at the end of 2021.
Regarding the top 5 weighted stocks in the semiconductor industry, compared to the end of February last year, mutual funds have only increased their holdings in $Broadcom(AVGO)$ and $NVIDIA Corp(NVDA)$ , while significantly reducing their holdings in $Taiwan Semiconductor Manufacturing(TSM)$ , $ASML Holding NV(ASML)$ , and $Samsung Electronics Co., Ltd.(SSNLF)$.
According to a report by Bespoke, a US market research and analysis firm, since 1995, in the nine instances when the Philadelphia Semiconductor Index set a new high over the past year, the strong performance of the semiconductor sector has a high probability of continuing in the following year. Moreover, during the one year after the $Philadelphia Semiconductor Index(SOX)$ breakthrough, the overall performance of the S&P 500 index in the US stock market is also expected to outperform other periods.
source: Bespoke
US stocks are expected to transition from mega cap driven gains to broad based gains
However, amid the AI frenzy, the eight major tech stocks in the US market - $Apple(AAPL)$ , $Microsoft(MSFT)$ , $NVIDIA Corp(NVDA)$ , $Amazon.com(AMZN)$ , $Meta Platforms, Inc.(META)$ , $Tesla Motors(TSLA)$ , $Alphabet(GOOG)$ , and $Broadcom(AVGO)$ - have contributed 100.56% to the year-to-date increase of the $S&P 500(.SPX)$ , as of the close on June 1st.
In other words, the remaining 492 companies in the S&P 500 index have contributed -0.56% to the index's gains this year. The lack of overall market depth has become a significant concern for investors in recent times.
To further analyze the situation, we calculated the historical percentile difference in returns between the S&P 500 index and the S&P 500 equal-weighted index since 1990. The results indicate that the current value is nearly at the 99th percentile. This strongly suggests that the performance of most stocks in the US market has not been favorable so far this year.
The historical percentile in return difference of SP500 and SP500 EW
source: Bloomberg and Tiger Trade
Based on historical data, when return difference reaches the 99th percentile, indicating a significant lack of market depth, a short-term pullback may be expected within 1-2 weeks.
However, looking at the future- 1 month or even 1 year later, the performance of US stocks is likely to be stronger, especially for the S&P 500 equal-weighted index.
In most cases, the rise of weighted stocks tends to gradually spread to other mid-cap and small-cap stocks, continuing to drive the upward momentum of the US stock market. Therefore, reflected in the data, the S&P 500 equal-weighted index is expected to outperform the S&P 500 index in terms of returns in the future.
source: Bloomberg and Tiger Trade
We believe that the AI concept, which serves as the engine driving the narrative of the rise in US stocks, still has room to grow.
Additionally, the institutional holdings in the semiconductor industry are not high, indicating that there is potential for US stocks to transition from mega cap driven gains to broad based gains.
2. Interest rate market pricing aligns with Fed guidance; US long-term bonds enter the investment range
In our Market review| Rate Hike Pause, Stagflation Continues, Cherish the Good Times Before Recession, we mentioned that the pricing of the year-end Fed benchmark rates by interest rate market traders were pricing too low, and excessive recession pricing could bring risks of interest rate increases.
By mid-May, as Fed officials began making public statements, both the 2-year and 10-year US Treasury yields started to rise again.
Although Fed Chair Powell and nominated Vice Chair Philip Jefferson at a leaning towards pausing rate hikes in June in their public speeches, other officials' hawkish comments have gradually led the market to abandon the pricing of multiple rate cuts by year-end. These comments include:
Federal Reserve Governor and voting member Waller believes that the data in the coming months is unlikely to provide clear evidence of inflation moving towards the 2% target, so he does not support pausing rate hikes.
Minneapolis Fed President and 2023 voting member Kashkari stated that skipping a rate hike in June does not mean that the tightening cycle has already ended. If inflation does not decrease, he would support continuing rate hikes.
Atlanta Fed President and 2024 voting member Bostic stated that the best-case scenario would be to consider rate cuts in 2024.
As of the close on June 1st, the interest rate market pricing for the year-end benchmark rate has increased to around 4.86%, indicating that there is an expectation for only one rate cut by the end of the year compared to the current position.
Moreover, the yields on the US 2-year and 10-year Treasuries have increased by approximately 8% and 6% respectively compared to the end of April, indicating that US long-term Treasuries have entered a relatively reasonable investment range.
source: Bloomberg and Tiger Trade
Furthermore, considering that May and June of last year were the peak months for US CPI, we anticipate that the year-on-year growth rate of CPI in the next two months will further decrease due to the high base effect. This would reduce the room for interest rates to continue rising.
The non-farm report released on Friday shows a slight year-on-year decline in hourly wages in the United States, further supporting our view that inflation will continue to decrease.
We believe that, without a recession, Fed's biggest challenge in combating inflation lies in whether the yoy growth rate of CPI can smoothly decline to below 3%.
Currently, the CPI's yoy growth rate is still around 5%, and the task of reaching below 4% in the coming months is relatively easy. Therefore, US long-term Treasuries, specifically $iShares 7-10 Year Treasury Bond ETF(IEF)$, entered the allocation range.
III. Conclusion
The current AI frenzy and macroeconomic data in the US do not support the narrative of an imminent recession. Meanwhile, pricing in the interest rate market is gradually aligning with the views of Fed officials, and there is a good chance of rapid downward movement in US inflation in the next two months.
We believe that even if there is a pullback in risk assets in the next month, the upward momentum will remain.
Allocation suggestion: 15% money market fund + 20% US long-term Treasuries + 20% US tech stocks (including AI concepts) + 20% US oil stocks + 20% stocks from the Greater China region + 5% gold.
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