A PAIR WITH SOX AND FRANCE
EDU DDA Nov. 15, 2024
Summary: It’s always dangerous to wade too far into equities looking for useful macro or money signals. There is far too much noise in share especially indexes. However, at certain times substantial and critical divergences invite some careful scrutiny. We have those here with two of them, a curious pair each with compelling stories. The one a big-cap index, the other related to a widely-recognized cyclical industry. And both breakdown coincident to a number of other real economy developments.
It’s always dangerous to wade into the morass known as equity markets. I have little time or patience for them given how little useful information they most often contain. “We” spend so much attention focusing on them collectively simply due to the fact that’s where most Americans’ savings reside.
That doesn’t mean the NYSE or equities in general are completely devoid of useful information. The challenge is trying to find useful signals from inside all that noise. Keynes was right in that you have to first understand what it is you’re looking at.
It isn’t fundamentals, that’s for sure. He said shares present a strange kind of beauty contest where as a judge you aren’t judging the contestants, rather how the other judges will. Or, if we’re being honest, how other judges with judge how other judges will judge. So, if you believe, for example, that everyone else believes everyone believes share prices suffer during periods of higher interest rates, the prophecy easily becomes self-fulfilling.
I discussed this topic in great detail especially the “liquidity” or monetary aspects of stocks, lack of, in this previous DDA. It goes into the history of why so many people still to this day associate shares with money and depression, owing to the Great Collapse after 1929. But even that wasn’t what most imagine or are led to. This is why, for example, there was no Great Depression 2 after the Crash of ’87 (considering the hundreds of bank failures also happening at the same time) or concurrent to the slow-motion dot-com bust at the start of the 21st century, and why it was monetary breakdown that crashed stocks in 2007 rather than the other way around.
What about times when there may be disagreements among the various judges?
That’s where we are right now, spotting a few potentially significant divergences among the constellation of global equities. One right off the bat at least in the short run is Amazon. The company reported solid earnings and results not long ago, yet today the stock suffered a better-than-four-percent drop, the same day retail sales came out and…were a total mess.
For the story on retail sales – both the US and, oh boy, China – here’s today’s Daily Briefing.
We can never know for certain or even with much confidence what moves shares or markets in the ultra-short run, but that one might be worth considering. Consumer spending, in my view, continues to look weak, a view that is corroborated by Industrial Production, jobs, incomes, etc. Retail sales were under the 3% annual threshold which is the main concern.
However, Amazon could also just be reacting much like the rest of the market overly focused on Fed Chair Powell’s recent comments that I went over yesterday; that thing about potentially higher interest rates. In this case, though, it’s not higher interest rates, rather rates that aren’t falling as quickly as they might have before. There’s likely a lot more noise here than anything useful, but worth paying some modest attention to.
One divergence that goes beyond the short run is Germany vs. France; and I don’t mean soccer or one of last century’s world wars. The DAX versus CAC. As you can see, both main European big cap indexes were lockstep up until mid-May.
That’s right around the time we began seeing more definitive macro signals in bonds and the like. The Treasury curve rally had started two weeks before and it would extend into European and Japanese trading two weeks after. Since Germany’s economy is an utter and complete mess and has been for the past two-plus years, we can immediately throw out any macro explanation for the DAX in any direction.
Like most stocks around the world, it had suffered in 2022 on that rate hike beauty thing. While Germany’s economy sank into recession around October of that year, Germany’s biggest-name equities could not have cared less. Part of that dismissal owes to the fact German corporations are more global than perhaps local, therefore we see that the DAX correlates strongly with the S&P 500 despite those two having little else in common other than, again, the beauty contest.
In other words, S&P and DAX are judging the same one for once.
So, too, had France and the CAC. Why, then, the sudden divergence right at that critical juncture?
One quite plausible explanation is the French election, series of them. At that time, it was heating up with increasingly worrisome results (at least from the mainstream, Establishment perspective). The more it looked like the electorate was going to lash out in some fashion, which it would, that was judged to raise the chances for a more radical government moving forward, making business more difficult for French companies.
Remember, however, there were German elections results around the same time, for the same European “parliament”, and they went just as in France. Though the French would quickly hold a snap Presidential election right after, the trend was already there in Germany just like France. Not only that, just a few months further on we just saw the dissolution of the German government last week meaning the same political “instability” as France only slightly under the surface.
The DAX is like the S&P for reasons of the S&P not the CAC, meaning Germany’s index gets treated with the same beauty as the S&P which is considered near-invulnerable to any macro fundamentals. France, therefore, maybe has a touch more of that macro ugliness, or at least is judged that global judges believe so.
And if that’s the case, the divergence is the French market’s participants picking up on the same thing as bonds.
Of all the divergences in stocks, I think the one with clearest signal is SOX. The Philadelphia Exchange’s semiconductor index had traded as if a member of the S&P 500 for years; I mean, as close as you can get with having different constituents. Then, all of a sudden, mid-July semiconductors fall out of favor.
That’s the same exact timing as Japan’s Nikkei so you can see where this going – US macro risk that is really global risk in this case viewed from different sides. Nikkei was a victim of carry trading byproducts whereas SOX appears to be more the object in the stock market, the thing the carry traders focused on causing them to unwind in the first place.
It isn’t just the possible burst of the AI bubble as it would need to be much broader than that to get carry traders thinking exit. Instead, again, macro risk and the SOX not only diverged from the S&P at that moment, they’ve remained on separate trajectories, too, just like CAC.
If you go back a few cycles to the middle 2000s, you’ll see the same thing leading up to the 2007 recession and crisis. This is by no means a timing signal, nor is it foolproof. In that earlier episode, SOX does begin to soften relative to the S&P 500 around mid-2006 right when bonds began to really stir about the possible looming macro and money crunch.
Even in 2007 itself, SOX was up modestly through mid-July then plunged in the weeks before the monetary crisis fully erupted in early August. The drop in semiconductors was also three months before the S&P would eventually follow after setting a record high first. In short, there is precedence for semiconductors.
Since this also makes intuitive sense, it just adds to the beauty. Chip stocks are widely considered a leading cyclical indicator because of how much that business is tied to those same oftentimes fickle parts of the economy. Even as the goods economy had fallen into the negative inventory cycle starting in 2022, including the semi business itself, contracting at a slow yet painfully sustained pace for over two years since, chip stocks had stayed ignored all that to remain hitched to the S&P, NASDAQ and DJIA.
Why now? Or, why July to now?
The timing also corresponds nicely with commodities especially crude oil. WTI has been sliding, with some variability, dating back to late April just like bonds. The more noticeable and determined downward trend developed in mid-July.
Oil went lower, gasoline, too, the yen carry trade began to more forcefully show up and SOX were knocked free from the foot of the S&P 500.
Crude is also down big again today, verging on its September lows despite the whole “stimulus” effect not to mention Trump trading.
Where it comes to the former, Beijing’s bazooka, any sentimental boost from it is already waning, too, which is another signal to consider even as “stimulus” only ever adds so much more noise to the background. The signal comes from how much various markets, like oil or stocks, might be tuning it out.
Hong Kong’s Hang Seng, for one, has been steadily (and predictably) retreating since October 7 following the, frankly, plainly stupid buying craze. Then again, the Hang Seng like China’s Shanghai SSE have done this several times before and it always ends the same way – in so doing, proving yet again Keynes had indeed had it right this whole time.
Upon whichever announcement for “stimulus”, the entire market piles right into shares not because anyone believes it will work, solely for the beauty: they buy believing everyone else believes everyone will buy first. It is literally a self-fulfilling prophecy especially since it keeps happening with so much regularity - and turning out the same way every time.
With Hong Kong’s key market (for signal) on the downswing now, back under 19,500 today, that means less of a “stimulus” noise in varying degrees to also have to filter from various markets like the CAC or DAX. Perhaps even the SOX, too, since the chip business and China are heavily intertwined.
Metals like copper are doing the same as the Hang Seng and for the same reason. Despite the sharp decline in gold since late October, copper has been down roughly the same meaning the copper-to-gold ratio has been steady very close to its recent multi-year low in that near-term period. Fundamentally, that’s closer to the CAC and SOX; or, more precisely, those stock indexes are more influenced by the same ugliness as CtG.
Sure enough, the ugliness in the ratio got a big boost around the middle of July.
The S&P 500 like the DJIA, NASDAQ, or DAX are all examples of indices whose only job is to invite investments regardless of any fundamental consideration. There isn’t a whole lot those can tell us about real factors in the economy or financially. The same is true for any other index that simply follows those, such as CAC or SOX up until more recently.
Thus, when we find these kinds of divergences it’s worth taking a closer look. In this case, the two I’ve highlighted closely associate with a lot of other indications. Semiconductors in the real economy are highly cyclical but now all of a sudden, this summer stock investors in the SOX choose to be pessimistic. Why?
Same for France. Maybe elections and government uncertainty, perhaps something else.
The French and semiconductor “judges” appear to be judging those a more questionable bet because they also believe it is increasingly more likely everyone else will come to see it the same way.
While these are arguable signals, they do stand out slightly above the usual noise. Not only is the pair interesting, if they are what they seem to be, also compelling. A few more to add to a growing list not seeing soft landing, only the further emergence of more downside to the supply shock era. Perhaps even a new stage to it.
