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Flip Flops
The Day the Music Died?
Soundbite: Last week, something major may have occurred...twice. We have been warning of the possibility of poor stock tone in one or more Magnificent Seven stocks following either: 1) a positive earnings release or 2) a positive news release that results in heavy selling. AI vendor financing deals were unambiguously positive news until last week. On Tuesday, news broke that Anthropic, NVIDIA, and Microsoft were entering into a strategic alliance, but instead of a major spike higher, NVDA and MSFT not only fell but also underperformed both the NASDAQ and the S&P 500 index. Secondly, on Thursday following record earnings, NVDA opened up 5% but then fell almost 12% before seeing tepid demand surface Friday. Both events are what we have been warning about, and Google’s successful Gemini 3 release could be the driver. Comparing GOOG to MAGS, the Mag 7 ETF, GOOG outperformed by 11% last week (even with MAGS price flattered by its 6% weight in Google). This is a significant shift. Stocks can still make a new high but similar watershed events in the past teach us the reversal process may already be in motion.
As we have maintained repeatedly, tops are a process; although we may not have reached bubble territory, we are on the doorstep of change.
Gemini 3 marks what could be called a DeepSeek moment, as it was trained entirely on Google’s own Tensor Processing Units (TPUs), not on NVDA GPUs. Differentiating itself from compute-constrained competitors, Gemini 3 rolled out worldwide thanks to its TensorFlow machine learning and AI software library. This is a significant advance that poses real concerns for the circular-financed sphere involving NVIDIA, Open AI, and Anthropic, among other major players such as Microsoft and Oracle.
Google’s TPU training allows the company to lower marginal costs because they can scale training around its own chips, showing that hyperscalers can complete work on in-house semiconductors. A move away from NVIDIA GPUs will not happen overnight for hyperscalers, but it marks the start of the breakup of NVIDIA’s monopoly.
This is a watershed moment because Gemini 3, although only 72 percent accurate, is now the AI industry leader, and it has bypassed the need for Blackwell processors. Google is now in a great position to take market share from Open AI, Anthropic, etc., making the revenue projections necessary to cover multi-trillion-dollar data center capex that much more difficult to meet. This raises fundamental questions that will weigh on the entire AI investment landscape, and we are witnessing the beginning stages of an unwind.
Michele Bowman, Vice Chair of Undersight
Soundbite: A Fed memo outlined a new regulatory policy for the banking sector that significantly scales back financial risk oversight. This is happening just as subprime delinquencies are rising, not to mention recent anxiety over $1.7 trillion in private credit loan visibility. The change in direction was conducted by the newly minted Vice Chair for Supervision, Michele Bowman, inspired by her desire to cut red tape facing banks. Additionally, the day after the memo was sent internally, she announced Washington staff cuts of 30%, diluting supervisory oversight. This marks a fundamental change in how the central bank will respond to risks. The Vice Chair established a threshold to focus only on “material financial risk” in determining a lender’s safety and soundness, not on emerging risks. This is an easy one to analyze: handcuffing supervisors makes them less able to flag potential crises just as we enter a period when the chance of adverse events is rising.
Great, let us not track down potential risks until they get so bad that we cannot ignore them. From our perspective, the point of regulation is to identify problems before they become material.
Biden appointee Michael Barr, whom Bowman succeeded in this role, shot back last Tuesday that the new direction creates “a dangerous environment” not only for the banks, but for the economy.
If bank examiners and supervisors identify a deficiency, but it does not constitute a “material financial risk to a regulated firm’s safe and sound operation,” they are prohibited from further review. If an evaluation uncovers a nonmaterial problem, the regulators can make “nonbinding supervisory observations.” A nonbinding observation takes the teeth out of a regulatory bite.
The true danger to this regulatory change is the message it sends to banks, and it could lead some financial institutions to lower lending standards without fear of Fed oversight to avoid losing market share to private credit competitors.
The memo tells Fed regulators to ignore “smaller, less complex and less systemic organizations.”
Therefore, the new message to a soon-to-be overburdened staff: do not follow any threads that could lead to substantial risk until they begin to metastasize. Also, ignore the smaller banks (where risks often begin), just focus on the stronger institutions.
Vice Chair Bowman firmly believes that these changes represent a “significant shift in direction [and] a sharpening, not a narrowing” of focus toward more effective regulation. This sharpening includes plans to cut the headcount in her division to 350 by December 2026 from 500.
Removing the number of staff monitoring the financial system and restraining remaining regulators to catch banking irregularities only after they pose a material risk is begging for trouble. Bowman’s revisions will result in the loss of the ability to identify early signs of unsound lending practices. That is a less-than-optimal response to avoid the next Silicon Valley Bank blowup.
No Yen for Yen After Fiscal Revisions
Soundbite: New Prime Minister Sanae Takaichi introduced a new $112 billion spending package representing a return to Abenomics: a policy of structural reform, monetary expansion, and forceful fiscal spending. Unfortunately, Japan’s public finances are already excessively leveraged. The result has been a revolt in fixed income and currency markets. Dollar Yen is threatening the 160 level that marks its 40-year high. Japan’s lack of fiscal restraint shares a common thread with the 2022 Gilts and Sterling crisis caused by an ill-fated introduction of the second-largest UK tax cut as a percent of GDP on record. While this fiscal stimulus could be a positive for Japanese growth, it injects worrisome instability into global risk assets and must be a focus for U.S. investors.
This drastic acceleration in fiscal policy carries the following implications:
· Such enormous capital injections increase velocity, but against a fragile global backdrop, the equity rally that has unfolded can also reverse quickly.
· Bond yields have moved so high to be attractive to Japanese institutions. The fact that there is no repatriation yet shows that yields will need to move further before capital moves back to Japan.
· This policy is intentionally inflationary, and if it causes the BoJ to raise rates again from 50 basis points, it could trigger a yen carry trade unwind. In 2007, the move from 40 to 80 basis points started to cut global liquidity, contributing to the eventual global asset melt-down.
Takaichi rose to power after her Liberal Democratic Party (LDP) lost its political lock on the country that existed since 1955. The LDP lost the Lower House for the first time since 2009, the Upper House in July, and their 25-year coalition partner Komeito, broke the alliance last month. That forced an unstable forced partnership with the right-wing Japan Innovation Party (JIP).
Japanese citizens voted for this populist platform, but aggressive fiscal stimulus when Japan’s Debt-to-GDP ratio is more than double the U.S. at 240 percent, has investors drawing parallels to the UK in 2022. In what has become known as the infamous “Liz Truss moment,” the newly elected UK Prime Minister’s aggressive fiscal policies caused a loss of confidence in UK assets and an 11% drop in the British Pound. Her term lasted all of 49 days in office before the 2022 market turmoil pushed her out.
We do not know how closely the situation in Japan will track England in 2022.
Certainly, there has been an analogous knee-jerk market reaction of higher rates and a 5% drop in the Yen. Furthermore, despite three percent inflation, the Bank of Japan has not raised rates since Trump took office. This passive stance has fueled inflationary expectations.
However, the flip in fiscal stance caused a bull, not a bear market in the Nikkei, which has been outperforming globally since Takaichi’s election, thanks to a weaker Yen. Therefore, there has not been a complete loss of confidence in domestic assets.
Japan will introduce a host of tax incentives mirroring those in the U.S., including immediate depreciation for capital expenditures. Therefore, GDP growth could respond positively. Additionally, Takaichi will stop short of a Modern Monetary Theory fiscal expansion because that risks a free fall in the Yen. So, there are limits to the fiscal expansion that is terrifying investors.
As a caveat, a troubling sign for U.S. investors would be if Japanese Government Bonds and the Nikkei begin to drop together. That could push already rising global equity volatility even higher. Like the second Point above, the timing of this policy change is coming at the wrong time. We think Japan’s impact on our markets is a matter of how measured the new administration handles its policy rollout.
What to Look for This Week
(All times E.S.T.)
1. Tuesday, November 25 at 8:30 a.m. Producer Price Index and Retail Sales delayed data for September. It is stale but worth a look, certainly true for PPI, given the parade of Fed speakers who have been concerned about sticky inflation . At 10:00 a.m. a more current release is the November Conference Board Consumer Confidence Survey. It could give a better look for employment with their labor differential that has been deteriorating. October Pending Home Sales is also out at the same time.
2. Wednesday, November 26: at 8:30 a.m. the Preliminary Q3 Gross Domestic Product is released. It is often ignored because it is old data, but given the absence of government data, it will get a closer look than normal. We will look at Q3 Corporate Profits and Export/Import data as well as Inventories.
3. Wednesday, November 26, at 2:00 p.m. the Beige Book is released for the December 9-10 FOMC meeting. Again, given the dearth of data to analyze, it will carry greater weight than normal by the voters on the Committee in making what could be a contentious decision. We will be looking for comments from all twelve Regional Banks on Prices and Labor Markets.
FOMC Voters Speaking: Aside from Wednesday’s Beige Book release, there are no Fed Speakers this week that ends with the blackout period. This leaves the last comments on Friday were from FOMC voters, NY and Boston Fed Presidents John Williams and Susan Collins, respectively. Williams signaled he would vote for a cut, Collins was hesitant. However, investors listened to Williams, and the prediction site Polymarket doubled the chances of a rate cut, and futures traders now place a 70% chance on a 25-basis point cut.
Earnings: Wind down for Q3 starts. Tuesday, November 25 before market open, Alibaba (BABA) and Analog Devices (ADI), and after market, Dell (DELL), and Best Buy (BBY) the latter for any sense of holiday demand. Wednesday, November 26, before market, we have Deere & Company (DE).
By Peter Corey
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