Market Comment - July

The month of July usually is the strongest month of the year, measured by the seasonality of the past 98 years, with an average return of 1.13% for the S&P 500 and an average return for the Stoxx 600 of 1.10%.

While the European market held its premise, large-cap US equity indices came under pressure as the Semiconductor Index SOX dropped a stunning 27.30%, to close the month down 20.56%. The low for the month in US indices happened on the 30th of July, when Kevin Warsh, the new Fed Chair, held his press conference, which was rather confusing. In the end, it led to a sharp rise in interest rates, lifting the 10-Year Treasury Yield to a new 52-week high of 4.745%.

For 48 hours, it looked like the market showed its discontent with the Fed Chair’s communication, as a meaningful spike in interest rates is never welcomed by the market. But, behind the curtains of Wall Street, another event weighed on equities, especially on the AI trade. Leopold Aschenbrenner’s AI-focused hedge fund, Situational Awareness, collapsed from a peak value of $45 billion to around $10 billion in assets, due to margin calls, forcing a distressed sale of leveraged positions to Citadel. The latter, which was well prepared for the situation, pushed equity prices down as far as possible to get the cheapest possible price for the fund’s assets.

The mechanism of this calamity implied that after the trades were settled, the market witnessed a vacuum of selling pressure, because it simply had evaporated overnight. This led to a strong recovery towards month-end and into the beginning of August.

This latest anecdote from Wall Street should be a reminder of how much risk investors currently are willing to take. While high valuations are an expression of how upbeat market participants are, the absolute level of margin debt of $1’417’225 billion held at the New York Stock Exchange should be another confirmation of a high level of risk-taking. Surprisingly, it fell 5.65% during the month of July, after hitting a record high of $1’502’027 billion in June. It could well be that the weakness in the AI trade has led to some deleveraging not only at the Situational Awareness Fund.

On a side note, Mr. Aschenbrenner is 25 years old. Why large investors are willing to let such a young person without any previous track record manage such a huge portfolio is astonishing.

The discussions about the stock market bubble are not abating. The S&P 500 Quality Index is currently underperforming the S&P 500 by 11.50%, the exact same level we saw in 1999. By the end of the month, one of the most hyped companies called Nvidia, announced that it will raise more than $500 billion in third-party capital for the expansion of its AI infrastructure, together with six major financial institutions.

In 1999 Sun Inc. announced a five-year, $350 million agreement to supply more than 18,000 servers and associated data-storage gear and software to a broadband-data subsidiary of energy giant Enron. While Enron was the 7th biggest US company at the time, Nvidia keeps financings smaller non-profit corporations to keep up the AI spending cycle. It is not exactly the same situation, but the story certainly rhymes.

Speaking of hype, Space Exploration Technologies or SpaceX lost a stunning 36.52% in July, to close the month at $108.37, while the five biggest investment banks have price targets between $205 and $300. On top of that, the rating agency Moody’s has assigned SpaceX an investment-grade credit rating, even though it isn’t expected to be cash-flow positive for years. We don’t understand this, nor do we understand the price targets mentioned above.

By the end of the month, the Nasdaq 100 traded down 6.58%, while the S&P 500 closed with a minor loss of 0.13% thanks to the good performance of the financial sector (+6.21%) and energy (+12.06%). European markets did exceptionally well, and investors once again showed their willingness to pile into risk far above long-term trends.