The Breakdown - The Worst Day in Stonks Since 2024

Episode Date: July 26, 2024

NLW goes macro and looks at the fluttering in markets plus a variety of other signals which suggest rougher times on the horizon. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Thursday, July 25th. And today, we are talking a big stock route yesterday. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to Bit.L.Y. Hello, friends, today we are taking a break from our Bitcoin politics, crypto politics conversations to go to the macro side, where the markets had a rough day yesterday.

In fact, it was their worst day since 2022 as fears of a growth slowdown set in. The S&P 500 was down by 2.3%, but the real pain was in the NASDAQ, which fell by 3.6%. The tech heavy index is more than two weeks into a correction, which has seen a 7% drawdown from all-time highs. Yesterday's move was the sharpest so far, with more than a trillion dollars in market cap wiped off in a single day. In terms of nominal value, this was the third worst day in the history of the index. Analysts are viewing this as a confirmation of a trend change after a historic hot streak for U.S. stocks. The S&P 500 had lasted almost a year without a 2% daily loss, the longest streak since 2008. Jay Woods, chief global strategist at Freedom Capital Market said,

all good things must come to an end, but this isn't the end of the world for the U.S. stock market. The rotation trade into small caps and value is still on, with volatility picking up as weak seasonal factors come into play ahead of U.S. election season. End quote. The volatility index has reached its highest mark since April. Small caps have been putting together a nice run recently with the Russell 2000 Small Cap Index up more than 8% over the past three weeks. That move was largely driven by a large narrative boost in early July, when market breadth narrowed to extreme levels. Yesterday's move was slightly less punishing on small-capped stocks, but the Russell 2000s still closed down 2.1% collapsing in the afternoon session. Analysts Michael

Gaiad tweeted, reminder that the last time the NASDAQ crashed, small caps outperform large caps by being down less. A relative rotation is not the same as an absolute trend. One trigger for the collapse in mega-cap tech is a spate of rough earnings reports. On Tuesday night, Tesla reported an underperformance in Q2 profit. The stock plunged by 12% in the following session, its largest single-day decline since September 2020. Google's earnings were a little better, reporting $24 billion in quarterly profit, including a billion dollars in interest income from simply sitting on their gigantic cash reserves. Revenue outperformed estimates posting a 14% year-on-year increase, however, a slight downtick in ad revenue made it difficult to price and continued growth.

The big story that seems to be taking hold are questions about rapidly increasing capital expenditure on the AI buildout. Google spent $13.2 billion in the second quarter and guided a further $12 billion per quarter through to the end of the year. That's roughly a doubling in capital expenditure compared to last year. Google CEO Sundar Pichai defended the choice to spend big on the emerging technology strongly, stating, when you go through a curve like this, the risk of underinvesting is dramatically greater than the risk of overinvesting. I think we are in this place where we have to deeply work and make sure that these use cases in these workflows we are driving deeper progress in unlocking value, which I'm bullish will happen. But these things take time. Google's stock was down around 6%

following the earnings call. Apple, Microsoft, Amazon, and Meta are all set to report next week. The hardware side of the AI boom also struggled, with Nvidia down 6.8% on the day. S.K. Heinex, a key Nvidia supplier, reported a doubling of quarterly revenue, but still posted an 8.7% loss in Korean markets. Morgan Stanley has now cut chipmakers from their focus list, suggesting that it's time for the sector to cool off. Analysts wrote, We are not calling for the end of the cycle, but with all the focus on shortages and talk of a new AI paradigm, it is important not to lose sight of the normal cyclical nature of the semiconductor market. The big question now is whether this is just a mid-cycle correction or the beginning of the end

for big tech outperformance. Alec Young, chief investment strategist at MAPSignals said, The overarching concern is where is the ROI on all the AI infrastructure spending? There's a pretty insane amount of money being spent. Maybe it'll pay off in a few years, but I think investors realize that the payoff is going to take time to materialize, and the hyperscaler's earnings are being hurt in the short term by how much they're spending on it. This is broadly the read in the market, that AI investment will show profits eventually, but that a growth slowdown is a more immediate concern. There is, of course, no shortage of people pounding on the table that the bubble is breaking.

Mark Spitznagle of Universal Investments is one of the most prominent, having gathered huge returns during the 2008 crisis. He's been framing this period of high public debt and even higher asset valuations as the, quote, greatest bubble in human history. During an interview last week, he said, I think we're on the way to something really, really bad, but of course I'd say that. Bob Elliott of unlimited funds encouraged traders to zoom out just a little tweeting, Even with all this pain, the S&P 500 is still up for July, shows just how crazy the first few

weeks of the month were to the upside, and just how crazy it would be for the Fed to succumb to all the chatter about needing to cut in July because of this market reaction. Now, obviously, as you guys know, I spend a lot of time on the AI space as well. I've been tracking these narrative changes around Wall Street's assessment of whether this is a bubble or not for some time. There's no doubt that the AI trade has been holding the entire market afloat basically since the rate cutting cycle began. And so naturally, there's going to be a tendency to re-evaluate it at some point.

I think part of the challenge here is that in this particular circumstance, big tech companies are acting much more like VCs and startups that operate in private markets than they are public companies who have to think about quarterly returns. They are all sold on the big bet that this is the most significant technology change in a very long time. They are willing to spend what it takes to be in the lead on the other side. They are convinced that doing so will ultimately be worth everything it costs now. However, that's an uncomfortable assessment for Wall Street. In fact, it's one that Wall Street is simply structurally incapable of making. It's a totally different category of investment that comes with a totally different

category of mindset. And so it doesn't surprise me at all that we're seeing some friction there. I think the market figuring out what it's comfortable with from a repricing scenario is not a bad thing in this circumstance. But whether that actually happens, we'll just have to wait and see. Now, over in monetary policy circles, the fear is beginning to show through. Yesterday, former New York Fed President Bill Dudley reversed his position that rates need to stay higher for longer. He published an op-ed in Bloomberg under the fairly stark headline, I changed my mind. The Fed needs to cut rates now. Until now, Dudley has been of the opinion that the Fed needs to hold rates at high levels to ensure we don't get a repeat of the 1970s with a repeated

burst of inflation. Now he writes, the facts have changed so I've changed my mind. The Fed should cut, preferably at next week's policymaking meeting. Markets are currently pricing only a 6% chance of a surprise rate cut at next Wednesday's meeting, with the current consensus being that the first cut will come in September, followed by two additional cuts by the end of the year. Portfolio manager Brett Bererudji thinks there's basically no chance of a surprise cut tweeting, it's an interesting take from Mr. Dudley. The Powell Fed is not a shock-in-aw committee. The only way they cut is a last-minute interviewer media leak, clearly outlining it, and given market positioning, think that's nearly impossible now. Two weeks ago, I thought July was possible. If Powell does a shock-in-aw cut,

it's going to smack of panic. The last thing he wants. I've been on record for months to cut in July and pause September. I was corrected by others, and July is off the table. He added that Doveish San Francisco Fed President Mary Daley had basically ruled out a July cut during an appearance last week, commenting, when the doves say no dice, there isn't a cut in the works. Now, Dudley's argument for an emergency cut basically comes down to rapidly cooling growth. He noted persistent strength in the U.S. economy driven at first by transfer payments and infrastructure spending, then later by the wealth effect from a booming stock market. For most households, cash reserves have now been spent and pressure is starting to show up in credit card and auto loan delinquencies. Dudley added

that housing construction has slowed right down, and the momentum built by the infrastructure spending is stalling out. For the labor market, an increase in unemployment over the past quarter suggests that a recession is already on the way. Average hourly earnings are currently rising by 3.9% annualized, a huge collapse from the peak of almost 6% in March of 2022. Meanwhile, inflation is at 2.6% according to the Fed's preferred metric core PCE. That's still above the 2% target, but well within the range that Fed officials say they were comfortable with to end this year with rate cuts. So why then isn't the Fed in a rush to cut rates? According to Dudley, there are three factors. First, the Fed doesn't want to be fooled again. He points out that last year

also featured an inflation slowdown that ended up re-accelerating. Second, Dudley thinks that Powell needs to play politics behind the scenes. A one-meeting delay is likely something the doves can stomach and would help to build the consensus with the Hawks. Finally, there is some suggestion that the data has been scrambled by high immigration. Dudley points out that the rise in unemployment could simply be driven by growth in the labor force rather than by job loss. In conclusion, he argues that this path is needlessly risky, writing, historically, deteriorating labor markets generate a self-reinforcing feedback loop. When jobs are harder to find, households, trim spending, the economy weakens, and businesses reduce investment, which leads to layoffs in

further spending cuts. Although it might already be too late to fend off a recession by cutting rates, dawdling now unnecessarily increases the risk. Hello friends, before we get back to the rest of the show, I want to implore you to join me at Permissionless. Permissionless is the conference for crypto-natives by crypto-natives, and the reason it's so important this year is that despite regulators' best attempts to push industry founders, devs, and executives out of the U.S., the United States remains the beating heart of crypto. Today, the tide is turning, policymakers have pivoted from fighting crypto to embracing it. Literally now we are in a major political parties platform, which will lead ultimately to the creation of new financial products, new applications,

and ultimately new adoption. Permissionless is the conference for those using and building on-chain products. It's home to the power users, the devs, and the builders. And perhaps more importantly, I will be there. The location is Salt Lake City, the dates are October 9th to the 11th, and tickets are just $499. If you want to get 10% off, use code breakdown 10. Go to the block website, blockworks.co. There will be links to register for the conference, and again, you can use Code Breakdown 10 to get 10% off. This article certainly grabbed attention across FinTwit. Dudley leaned slightly dovish when he was a Fed official, but his opinion is taken very seriously. Nick Timmeros remarked on how dramatic the shift was, tweeting,

this is quite a turnabout considering that just two months ago, Dudley argued a much higher neutral rate might mean a 5.3% Fed funds rate wasn't high enough to restrain growth. Andy Constan of Damned Spring Capital thinks a surprise cut would shock the market, writing, a Fed cut in July is not what stongs want. But don't worry, they won't cut. The market has already priced a relatively fast cutting cycle, and that's already easing. The Fed just needs to validate that path by cutting is priced. If we are soft landing or already landed, that's what they will do. Mark Dow agreed, tweeting, if the Fed cuts next week, the market will react negatively. In other words, the Fed might be a little stuck at this moment. There's minimal time to signal a cut,

so the market would need to rapidly reprice. This seems to already be happening to an extent, with big moves and increased volatility across a host of asset classes yesterday. If Dudley has the correct read on where the economy is heading, then he's right that dawdling now will force the Fed to play catch-up. James E. Thorne, the chief market strategist at Wellington Altus, tweeted, if the Fed does not cut in July, 50 basis points in September would not surprise. Don't ignore Mr. Dudley's pivot. In fact, the bond market is pricing in the chance that rate cuts begin earlier than expected. Two-year yields fell sharply on Wednesday and continued into the overnight session, declining by nearly 100 basis points. 10-year yield spiked higher in the morning, but moderated as the trading day continued.

This movement brought the yield differential as low as 14 basis points, the smallest margin since October 2023. This section of the yield curve is viewed as a critical recession signal. When the yield converts with the two-year yield higher than 10-year yields, economists believe a recession is inevitable. The signal historically has a 100% success rate. Timing, though, is another question. Typically, the recession begins once the yield curve has as uninverted, which usually occurs when the Fed begins cutting rates, pushing down the two-year yield. This yield curve inversion has been the longest on record, first beginning in July of 2022. With no recession materializing, some economists have begun to think the signal is no longer

valid. Joseph Lovorna, chief economist at SMBC NICO Securities said, it's been such a long time you have to start to wonder about its usefulness. I just don't see how a curve can be wrong for this long. I'm leaning towards it being broken, but I haven't fully capitulated yet. Mark Zandi, chief economist at Moody's Analytics said, So far, yeah, it's been a bald-faced liar. It's the first time it's inverted and a recession didn't follow. But having said that, I don't think we can feel very comfortable with the continued inversion. It's been wrong so far, but that doesn't mean it's going to be wrong forever. In other words, just because a recession hasn't happened so far doesn't mean that it won't.

With Zandi adding, it could very well be the case that the curve's been lying to us up until now, but it could decide to start telling the truth here pretty soon. It makes me really uncomfortable that the curve is inverted. This is one more reason why the Fed should be lowering interest rates. They're taking a chance here. It seems as though the curve will uninvert by the end of the year. Until recently, many analysts have been leaning into the idea that this time is different. Reasons from abnormal treasury issuance to high deficits have been used to explain why the usual signal might be distorted. This week, though, it seems as though a consensus is forming. Tabi Costa of Crescat Capital wrote, The gold standard of recession indicators is issuing a

clear warning. While the yield curve is starting to uninvert significantly, it still has a long way to go. Currently, 76% of all treasury yield spreads are negative, and it's worth noting that the shift from widespread inversions to a steeper curve typically happens very abruptly. We expect the same phenomenon to occur this time around. Adam Taggart of thoughtful money agrees that the warning lights are on, adding, the yield curve has been inverted so long we've become numb to it. Well, now it's starting to uninvert. History shows that's when repercussions hit. Odds aren't low that yield curve and credit yield spreads might be a lot more prominent in headlines over the coming year. John DeArco, Ovali wealth managers, thinks this is part of the cause of stock market weakness, tweeting,

the yield curve on inverting this fast is very bad, almost always results in a crash, markets sniffing it out appropriately. Ultimately, signs of a growth slowdown are evident anywhere you look. This morning's GDP figures were expected to show 2% annualized growth in the second quarter. Combined with a 1.4% rate of growth in the first quarter, this would be the slowest half year since 2022. The housing market struggled through a week spring selling season, with inventory building rapidly and previously hot markets. Mortgage rates have lowered somewhat over the past month, but are still north of 6.5%. That's almost double where they were three years ago during the post-pandemic housing boom. Mortgage originations are now at their lowest level since

2012 when the Fed began tracking the statistic. Single-family housing starts have fallen sharply since the beginning of this year and have shown no signs of a seasonal bounceback so far this summer. Mortgage delinquencies are also on the rise among the lower income population. FHA loans, which were available to families with lower credit scores, have hit a 10% delinquency share, which is the highest since 2021, and approaching its 2009 peak. One in 10, FHA delinquencies are citing unemployment as the reason. Earlier this week, the Wall Street Journal declared that the, quote, hottest job market in a generation is over. The rapid pace of hiring has slowed down, and unemployment is relentlessly ticking up. Economists seem to think this is a

transition from red-hot to toasty warm. Claudia Somm, chief economist at New Century Advisors, said, the labor market cooled back to a strong place. This is a good labor market, but it's not clear if the cooling is done. Sam did acknowledge a lack of open positions, adding, it's a good time to have a job. It's a harder time to find one. Karen Jones, an unemployed HR professional in the Philadelphia area, had a firsthand example, explaining, as soon as a position is open on LinkedIn within an hour over 100 people have applied. One HR professional who was trying to help me land my next opportunity, she wound up getting laid off. It seems as though companies are still rattled by the recent labor shortage and it become reluctant to reduce headcount. Gregory Deco, chief economist at E. Y, said he's

concerned that this could change quickly, commenting, it's an unusual slowdown. Could this turn into something worse, that's certainly a risk. We're navigating uncharted waters when it comes to the post-pandemic labor market. Meanwhile, consumer confidence is coming down fast as well. In June, economic activity in the services sector contracted at the fastest pace in four years. The University of Michigan Consumer Sentiment Index is now at its lowest level in eight months. To be clear, this is still a much larger level than the 2022 slowdown, but the trend change at the beginning of last quarter is stark. Cost cutting is evident across all segments of society. Earlier this year, the spending habits of low-income earners took a hit with discount stores reporting a reduction in sales.

During their May earnings call, Walmart reported that sales were back up, but this sales growth was driven by high-income shoppers forced to trim their budgets in the face of mounting inflation pressure. The inverse effect is now showing up in luxury goods. LVMH, which owns brands from Louis Vuitton to Hennessy reported a 42% drop in profits in their Q2 earnings. They said the decline reflected, quote, sluggish aspirational consumer demand in the U.S., and sales decline among Chinese consumers. So the question is, with Fed rate cuts on the way? Will they be enough to save a deteriorating economy? Not according to Eurodollar University's Jeff Snyder, who tweeted, what happens now that Fed rate cutting is on the deck? To hear basically

everyone tell it, not much. The economy is already a little weak. The FOMC cuts a couple times, presto gentle glide into joint Goldilocks. It's a nice story, but like the three bears, it's a fairy tale. Rate cuts have a perfect 100% failure rate, yet everyone remains convinced they are powerful and effective. Why? Superstition. Seriously, that's the answer. So friends, lots and lots to watch, lots of interesting signals changing. The next time we will have context to talk more about this, I think will be the middle of next week around the FOMC meeting. For now, though, that is going to do it for today's breakdown. Appreciate you listening, as always, and until next time, be safe and take care of each other.

Peace.