Duet Protocol Global Market Recap and Outlook — 20231120

13 min readNov 20, 2023

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US stocks rallied for a third straight week, largely recovering the past three months’ declines. The recent market reaction is reminiscent of this summer’s initial reaction to cooling inflation. The narrative is markets rebounding on confirmation the Fed is done hiking for this cycle, evidenced by the Fed hinting smaller hikes and faster-than-expected inflation decline alongside the jobs data. The shift in policy expectations and actual market rates benefited equities, bonds, non-USD currencies, and crypto alike. On Friday, President Biden is expected to sign a stopgap spending bill, formally averting a government shutdown this weekend, greeted calmly by markets.

The US 10-year yield briefly broke below 4.38% on Friday while the 2-year yield dropped under 4.80%, both hitting 2-month intraday lows. UK 10Y yields fell to May lows.

In the near term, market expectations around the timing and magnitude of rate cuts will likely keep swinging but not too wildly. The timing is seen fluctuating between May-July (currently May pricing) while the magnitude is seen ranging 75–150bps (currently 100bps, up from 70bps a month ago which is already exaggerated since the Fed itself only forecasts 20bps). The economy would have to be quite gloomy for cuts to start earlier than May or exceed 100bps initially. So short-end pricing looks largely done for now, while the long-end remains uncertain given still-present supply, deficit, and political chaos issues if anything worsening. The futures positioning data also shows shorts have barely eased the past two weeks and have risen.

The USD weakened recently alongside cooling rate hike expectations, seeing its largest weekly drop in 4 months via the DXY index. Non-USD currencies including CNY rallied strongly last week, with the yuan quickly advancing from the 7.30 line towards 7.25. Seasonal factors also favor yuan strength in the final two months of the year, related to corporate conversion trends (selling foreign currency to buy yuan). Fundamentally, the return outlook for USD competitors also remains poor, limiting how much the greenback’s appeal can be eroded at the current juncture.

From a positioning standpoint, dollar net longs are not at low relative levels, so some unwinding impetus exists:

Benefiting from the weaker dollar and yields, gold and silver rallied hard as the SEC looks set to delay the physical ETF decision again absent surprises. Cryptos bounced and consolidated with altcoins outperforming relatively:

US equity short covering pressure continued releasing with diverging tech performance — unprofitable tech surged while megacaps were relatively muted. Regional banks and highest short interest names saw above-average gains while consumer staples got dumped.

Last week’s outstanding performers shared key traits of benefiting from lower rates/oil and weak prior performance, suggesting the rebound is largely an unwind of recent shocks. The 10% August-October correction had three distinct stages/drivers — August’s normal pullback, September’s rate volatility shock, October’s geopolitical crisis. For now, the equity bounce is erasing the rate volatility and geopolitical impact but performance does not yet reflect cyclical upside growth expectations.

We can’t simplistically call the market as pricing growth or value, since significant internal bifurcations exist. For instance, consumption cyclicals, financials, transports still price a typical recession while various tech and energy names have little to no recession priced in:

[OpenAI Board Ousts CEO Sam Altman]

There were two sources of contention:

Safety vs commercialization debate: There has always been debate within OpenAI about safety and commercialization of AI tech since its founding. (Altman and the other departing co-founder Greg Brockman leaned aggressive while the board members ousting Altman, led by OpenAI Chief Scientist Ilya Sutskever, were more conservative.) These disputes led to Elon Musk cutting ties with OpenAI in 2018 and a batch of employees leaving in 2020 to start competitor Anthropic.
Altman’s entrepreneurial ambitions: Altman had sought to raise billions from Middle East sovereign wealth funds to start an AI chip startup rivaling Nvidia, intensifying board tensions.
This sent Microsoft shares tumbling over 2% at midday before closing down nearly 1.7%, despite hitting all-time intraday highs in recent days. An OpenAI shift to conservative anti-commercialization control would clearly be a negative for Microsoft. Microsoft CEO Nadella was reportedly “furious” over the ouster since it further weakens Microsoft’s grip on OpenAI. It was already odd they invested $10B without a board seat, and Microsoft has been eager to commercialize OpenAI’s work. For now, Ilya Sutskever’s side seems poor at external communications with zero extra explanation after the incident. This will be hard to win over public opinion without changes, and current board members may face pressure to resign as well.

Additionally, Google parent Alphabet which delayed the launch of its proclaimed “most powerful AI model” LaMDA to Q1 2023 fell nearly 1.2%, breaking its October 24 highs reached this week (though OpenAI turmoil should be positive for Google’s AI efforts).

Other related names affected were Sam’s crypto project WorldCoin down, and AI leaders in crypto Bittensor (TAO) up 25%, Render (RNDR) up 8%. (Feeling they have a chance now?)

[Biden-Xi Achieved Some Rapprochement But Not Economically]

Xi came to San Francisco last week with the twin missions of stabilizing US-China relations and restoring investor confidence in China’s economy. Expectations were low for the meetings, but the outcomes met them. Biden called it real progress, with deals reportedly struck on military communications, fentanyl, and AI.

The usually aloof Xi showed a warmer, gracious side in San Francisco. He reminisced with Biden about his first US visit 38 years ago, openly accepted a NBA team jersey gifted by California’s governor, and even said he’d send pandas to American zoos.

The Wall Street Journal’s headline cast it as “Xi Fails to Reassure U.S. Business Leaders on China Investment Climate: Foreign capital is fleeing China as the country’s leader makes first visit in six years” noting Xi did not discuss any initiatives on future trade and investment ties with the US, calling the remarks “general”. But others saw the speech as conciliatory, saying “He could have given a much more radical, nationalistic speech, defending China.”

In fact, Xi did state China will create a “first class business environment” and improve mechanisms protecting international investor rights. He also said “We’ll take more ‘heart-warming’ measures, such as improving visa and residency policies for foreigners,” adding access will become smoother for financial, healthcare, and digital payment services. “All of this is to make it easier for foreign companies to invest in and operate in China.” However, the issue is those access improvements have long been underway so are not news. Foreign investors now care more about safeguarding legal rights and fair competition, hence views Xi sidestepped the crux.

[Chinese Market Response to Biden-Xi Talks]

Global stocks were still rising last week, but China’s CSI 300 index posted one of its worst weeks in about a month. Foreigners dumped 5 billion yuan of Chinese stocks, exacerbating the selloff. China faces unprecedented 3 straight years of losses for A-shares.

Of course this wasn’t all due to the Biden-Xi meeting. The property sector remains the core of persistent weakness in China, flaring worries again last week. Data Thursday showed October new home prices posted the biggest 8-year drop while the resale market saw the largest 9-year decline.

[Inflection Point in Global Fight Against Inflation]

Latest data last week showed UK consumer price growth slowed to 4.6% (4.8% expected), Eurozone October final HICP decelerated sharply from September’s 4.3% to 2.9%, and adding the earlier 3.2% US CPI print, this bolsters expectations that central banks may ease off the brakes and cut rates next year. Markets predominantly expect the Bank of England to start cutting rates from May 2023, followed by the Fed and ECB in June.

For most people, housing and medical costs are fixed for periods via contracts. Stripping those out, monthly inflation US households face has fallen to 2.6%:

[Walmart Worried About Looming Deflation]

Speaking at an investor conference, Walmart’s CFO described the current US pricing situation with the word “deflation”, noting we may be headed for months of falling prices. “General merchandise prices have been declining and the rate of deflation has accelerated over the past several weeks or months…We could see some deflation/price decreases in dry grocery consumables in the coming weeks and months.” No one knows fluctuations in everyday good prices better than large superstore management. When they use the term “deflation”, it at least indicates parts of the market are currently seeing declining price indices. The CFO also said they saw some concerning signs in sales and volume the last 2 weeks of October trailing the rest of Q3.

Walmart, McDonalds, etc are typical consumer stocks and in the essentials part of consumption. The past 2 years of high inflation allowed consumer companies to aggressively raise prices under cover of input costs and supply chain disruptions, successfully passing higher costs to consumers. So most industries actually expanded profit margins despite higher costs, especially large companies with pricing power.

US PPI for October came in cooler than expected at +1.3% YoY and fell -0.5% MoM, the biggest monthly drop in 3.5 years since April 2020.

Warren Buffett’s Berkshire dumped consumer stocks including GM, Johnson & Johnson, P&G, and Kraft Heinz last quarter. Consumer share is now just 12%, not matching his proclaimed preferences for stable, brand-name companies resilient to economic fluctuations.

[Deflation Doesn’t Necessarily Benefit Stocks]

If prices fall faster prompting the Fed to cut rates from current high levels -

Impact on USD (likely negative):

Easing implies more accommodative policy which tends to reduce foreign demand for USD assets, leading to potential currency depreciation. Unless a major crisis triggers safe haven flows, which would briefly aid the dollar.

Impact on US Treasuries (typically positive):

Rate cuts almost assure declining bond yields, boosting Treasury prices. Thus US bonds, including most higher grade fixed income, tend to perform well during easing cycles.

Impact on Stocks (uncertain):

Equity reaction depends on the reasons and context for easing. If responding to risks of slowing growth or recession, initial stock response may not be positive since markets would focus more on deteriorating fundamentals. However, over time rate cuts typically reduce corporate borrowing costs and stimulate growth, which can eventually support stocks.

Impact on Commodities (uncertain):

Commodities response is also complex. On one hand, a weaker dollar may lift dollar-denominated commodities. On the other hand, easing due to growth concerns may imply weaker demand and thus pressure prices.

BofA Fund Manager Survey

Investors cut cash, add bonds, first overweight stocks since April 2022:

Cash allocations dropped from 5.3% to 4.7%, lowest since November 2021 and biggest 1-month reduction this year. 4.7% cash is still mildly above the historical average in neutral territory. Below 5% is when BofA considers their cash signal triggered. If cash continues falling under 4%, their model would flash a “sell” signal reflecting investors getting too aggressive adding risk assets amid over-optimism on the economy:

Retail investors are clearly more bullish on stocks than institutions now, but the gap has narrowed this year amid some improvement in institutional bearishness. AAII shows retail allocation 64% bullish at the moment, while FMS has institutions net 2% overweight:

Adding a BofA Private Bank client survey, equity allocation is now 59% of AUM, above the 56% average since 2005 but below every year of the past decade except 2020:

Investors overweight tech, healthcare stocks while underweight Europe, utilities

Biggest 1-month changes are adding to bonds, tech, telecom and sticking with materials, cash, industrials:

Most crowded trades are long mega cap tech, short China, and long short-term Treasuries.

Positioning and Fund Flows

Goldman noted that “over the past 10 days CTAs have purchased close to $70bn of US equities…the largest 10-day buy in our records.”

Goldman estimates ~$140 billion of global short covering since early November. Buy flows expected to persist at least another week absent surprises. Some markets have greater positioning unwind needs still, like small caps requiring more buy-to-covers.

Of course, the cost is CTAs are now more balanced after this massive buying frenzy, limiting future repositioning momentum:

However, we’re in a period of concentrated corporate buyback activity expected through mid-December, which will be very strong supplementary buy flows. Estimated $40 billion in buybacks last week:

Deutsche Bank’s measure shows overall US equity positioning surged sharply since late October but still only at 49th percentile presently. Discretionary positioning rebounded more strongly to mildly overweight (69th percentile) while systematic remains low at 34th percentile.

Some CTA fund exposure bounceback:

Equity funds took in strongest inflows in 2 months at $23.5 billion, mainly from the US ($25.8 billion) while other regions saw outflows. Money market funds got a 4th week of inflows but slower than recently.

CFTC data (through Nov 14th), overall US equity net longs rose a second straight week, increasing across main indices.

On bonds, aggregate net shorts rose on higher 10Y shorts offsetting other tenors.

FX total positioning remains close to neutral. Euro net longs surged but offset by other currency longs dropping.

On commodities, investors further reduced oil net longs to historic lows. Copper shorts edged up slightly this week while gold longs fell sharply from elevated levels.

Sentiment

Goldman: Extreme greed

BofA: Little changed, Buy signal

AAII: Little changed, Bullish

CNN: Surged, Greed

Week Ahead

Thursday Nov 23, US markets closed for Thanksgiving holiday and only open half day Friday, usually one of the lowest volume days of the year for stocks. Absent surprises, expect markets to churn narrowly around last week’s closing levels.

Earnings season wraps up with AI leader Nvidia reporting this week. Street expects Q3 revenue at $16.079B, up 171% YoY. Adjusted net income at $8.419B, up 478% YoY. Average price target $628.68.

$16B 20Y Treasury auction this week seen as another test of bond market’s appetite for supply. If poor auction results spike yields again, it could even prompt Fed reaction to soften over the medium-term.