This edition of Market Factors starts with an extremely bullish strategist from HSBC who believes most of the bad market news is behind us. We move on to takeaways from a recent technology lovefest in San Francisco hosted by Morgan Stanley and then I lament the new trend where chunks of satellite randomly rain from the sky.
Views
Buy the losers, says HSBC
HSBC chief multi-asset strategist Max Kettner is now “maximum overweight” global equities with the belief that the peaks in investor fear are now in the rearview mirror.
Mr. Kettner firmly believes that the outlook is as bad as it’s going to get right now and indicators are set to improve. In his words, “For us to turn bearish on risk assets now, we’d have to expect things to get even worse from here, not just stay the same ... we are now maximum overweight and fade the [negative] moves from the last few days.” The market is poised to climb, requiring only news that is slightly less bad than last week’s, he said in a Tuesday report.
The strategist points to the CBOE Volatility (VIX) index futures as a sign of peak fear. He notes that backwardation, the extent that future date derivative prices point to lower levels for the index, is as severe as the onset of the COVID-19 pandemic. Futures markets, in predicting lower levels for this primary gauge of equity market volatility in the near future, clearly expect that investor sentiment is set to improve.
Mr. Kettner expects flare-ups in military activity in the Middle East but believes that U.S. President Donald Trump’s comments about the imminent end of the conflict signal a change in tone, even if the U.S. has trouble extracting their defence assets from the region in the near term.
The regional markets that have held up best since the initial bombing of Iran at the end of last month are set to underperform, according to HSBC, and this is not great news for the TSX. Canadian equities, along with Brazil and the U.S., have “outperformed a little too much,” according to Mr. Kettner, and can expect less of a rebound if the conflict ends. (The TSX has had the benefit of a heavy weighting in energy stocks. The Brazilian benchmark no doubt benefited from the outsized influence of oil and gas giant Petrobras SA).
The markets that were hit hardest since late February were Korea, Japan and Taiwan and the strategist expects these market to recover most quickly as the Middle East situation cools. The Korean and Taiwanese markets are dominated by technology stocks - Samsung and SK Hynix in Korea and Taiwan Semiconductor in Taiwan - so this is also very much a call on the resumption of the AI rally, at least initially.
In terms of global equity sectors, materials stocks sold off hardest in the past two weeks and Mr. Kettner expects them to bounce higher. Canadian investors will have to be careful with this information. Domestically the materials index is basically a precious metals benchmark thanks to Barrick, Agnico Eagle and other gold producers, but in the U.S., for example, the materials index includes industrial gases, paint, construction aggregates, water management and food processing.
The strategy report also contained recommendations on foreign exchange levels but I doubt Canadian investors will be too interested to buy the Egyptian pound as it suggests.
Mr. Kettner is not expecting the breakout of broader world peace - bad news from the Middle East is still likely in the cards - but he expects that the market outlook will trend positive from this point and that the stocks hit hardest since the bombing are the ones to acquire in the coming days.
“Maximum overweight” is a bold prediction and shows a level of conviction rarely seen at major investment firms.
Tech
TMT conference highlights hardware’s bright outlook
Morgan Stanley’s recent TMT conference in San Francisco was a festival of bullish forecasts on technology, with speakers including Nvidia CEO Jensen Huang. I will attempt to sort through the utopian perspectives in the summary report from analysts Stephen Byrd and Michelle Weaver in search of objective and helpful details for investors.
The main conclusion of the summary report is, in the words of Mr. Huang, “compute equals revenue.” The word compute in this sense is a noun meaning computing power. I’m not disputing this premise in the short and medium terms but it is worthwhile to note that Mr. Huang’s GPUs are central to the trend.
Mr. Huang also stated that OpenClaw is the most important software ever released. I am chagrined to note that I had never herd of OpenClaw before but thankfully Copilot led me to a description from popular tech blog OfficeChai.
Openclaw is open source code written by independent developer Peter Steinberger. It is designed to take AI from response-oriented to multi-stage task-oriented. It apparently can “read, summarize, triage, and send email replies … manage calendar events, create reminders, and handle scheduling.” It runs constantly in the background and remembers user preferences and habits. Every technophobe’s nightmare, in other words.
The Morgan Stanley report mentions papers written by Emil Michael, chief technical officer of the U.S. Department of War, and Owen West from the Defence Department. These papers outline a surge of government spending to apply AI to military conflicts, ensure supply lines to important minerals, the use of quantum computing on battlefields and, terrifyingly, “scaled directed energy” weapons. The analysts believe that investors will be able to benefit from this spending but the beneficiaries are not clear yet.
The analysts expect political opposition to data centre power supplies to result in hyperscaler technology companies to adopt off grid renewable power for data centres and push excess power to residential utility grids through one-way connections. Selected renewable power providers, and potential natural gas producers, will be the related profitable investments but again the leaders of the trend are not apparent two far.
Mr. Byrd and Ms. Weaver already see sign of AI-driven deflation in cases where AI can replicate the work of humans at much lower costs. They did not mention specific cases but call centres and insurance brokerages are two areas that have been mentioned in previous research.
My personal investment-oriented takeaway from the report is that that data centres will continue to be built, enriching Nvidia, Broadcom, Sandisk, Western Digital, Corning and all the other producers of related hardware. Software is still a dangerous proposition for investors as AI continues to get more powerful and capable of replicating the functions of current software. (I believe this despite the recent reports about Amazon.com’s struggle with AI-written code).
I need to make a personal admission as context for readers. Working through this report, I was increasingly aware of my cynicism regarding the outlined technological dream world. I got a headache from rolling my eyes at phrases like “the market is not prepared for the non-linear increase in LLM capabilities”, “2026 is gonna be insane and likely the busiest (and most consequential) year for the future of our species” and “recursive self improvement loops likely do live in the next 12mo.” (The latter two are from OpenAI CEO Sam Altman and Jimmy Ba, co-founder of xAI).
I am willing to be proven wrong eventually and leave it to readers to decide whether to accept the Morgan Stanley conference takeaways with more of an open mind.
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Diversions
It’s raining satellites
As if we didn’t have enough to worry about, a NASA satellite is set to re-enter the earth’s atmosphere late Wednesday and the space agency predicts that portions of the 600 kilogram machine will not melt in the process and could possibly crash through anyone’s roof while they’re sleeping.
NASA puts the odds of anyone on earth being harmed at 4,200-to-one but I would have put longer odds on Donald Trump winning the presidency as late as August 2015. The government standard for safety in the event of a falling satellite is a one in 10,000 chance of a fatality so someone clearly screwed up.
This is unlikely to be an isolated incident going forward as the problem of orbiting traffic jams is becoming severe. A January article in The Space Times highlighted programs called megaconstellations by, for instance, SpaceX’s Starlink, Amazon’s Kuiper and China’s Guowang, are putting thousands of new vehicles into low earth orbit and raising the odds of a crash or system failure.
I doubt an umbrella will help. Watching the skies for falling satellite feels like yet another dystopian trend that would have sounded absurd 20 years ago.
The essentials
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Globe Investor highlights
CIBC’s Mokhtari on how investors should deal with the surge in geopolitical volatility and the stocks he’s most bullish on
The U.S. dollar’s quiet decline: Sam Sivarajan on what investors should do now
Private credit alarm bells are echoing 2007 subprime warnings, comments Jamie McGeever
Quick hits
BofA Securities keeps sending me reports on what active fund managers are buying and holding when nothing could interest me less. At extremes, manager holdings are an inverse indicator - the most popular holdings are set to plunge - but the point at which this happens is only apparent in hindsight.
Morgan Stanley is pushing a bullish outlook on optical equipment really hard and they almost have me convinced to buy a small position in Corning. Fibre optics are apparently necessary for connectivity everywhere but particularly data centres.
I have been using Morgan Stanley research a lot lately but I promise you it’s not by design, just a coincidence of focus. I mention this as preamble to point out the establishment of The Morgan Stanley Institute as of Tuesday to provide cross asset thought leadership and almost certainly a lot more cliches and jargon along with useful analysis.
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