AI Hype Wears Off and Magnificent 7 Returns Suffer 🤖

🐺 Hi pack-mates,

This is Howling Markets, the magnificent newsletter that covers all the market hype in a thorough and interesting way!

Today we will be covering:

• Education: Why is Deflation Bad? 📉

• Bank of Japan Hints at First Rate Hike Since 2007 📈

• AI Hype Wears Off and Magnificnet 7 Returns Suffer 🤖

• Equity and Debt Markets Daily Update ⚖️

• And more!

Market Watch 👀

Why Is Deflation Bad?

Especially over the past two years, we have been talking a lot about inflation and how it strains households and families by increasing the cost of living. If prices increase more than wages, then the consumers will be able to afford less goods and services.

Deflation, instead, is the phenomenon of negative inflation, which would actually bring an increase of consumer purchasing power as prices begin to decrease. So, why is deflation so bad?

Deflationary periods are often characterized by a significant slowdown of the economy, which leads to a recession. The first cause of this slowdown is that falling prices will induce companies to increase the layoffs, causing a surge of unemployment.

Secondly, the decrease in prices will cause debt deflation, which is a situation where the value of your debt increases in real terms because you have to pay dollars that are worth more than the ones you borrowed.

Additionally, at the same time, due to the decrease in prices, the value of the assets in the balance sheet will decrease, causing a situation where companies have less assets and more expensive debts.

Because of this, during deflationary periods companies are exposed to bankruptcy risks and, as a consequence, they decrease their borrowings, slowing down the economy, potentially even causing a recession.

As a matter of fact, all the central banks around the world do not have an inflation target of 0%, but rather something slightly higher, usually 2%, to ensure an operating buffer to avoid deflation.

Bank of Japan Hints at First Rate Hike Since 2007

Fighting deflation is a whole different story than taking down inflation. During inflationary periods, the central banks can simply increase interest rates and wait for an economic slowdown. However, what if there is already an economic slowdown and the rates are at their minimum?

When fighting deflation, ordinary monetary policy is often not enough. Even if central banks have recently discovered that they can lower interest rates to negative territory to spool up the economy, they cannot lower them enough to spark a prompt recovery, causing decade long policies to control deflation.

This is the case of Japan, which has been struggling with deflation since the 80s and whose central bank has maintained a negative interest rate since 2007.

However, the Bank of Japan (BoJ) has recently communicated in their quarterly statement that the likelihood of achieving their 2% inflation target was gradually rising, even though they still need additional information before pulling the trigger on a rate hike.

The current central bank interest rate has been sitting at -0.1% since 2007, when do you think the BoJ will be able to push it into positive territory?

Today’s Howling Question

And now, it is time for our howling question!

We have talked a lot about the deflation issue that the Bank of Japan has been trying to contrast with negative interest rates since 2007, but do you know the country’s current level of inflation?

a)  -+2.6%

b)  0%

c)  -0.5%

d)  -0.8%

e)  -1.2%

Note: negative inflation signifies deflation.

Try to answer the question by yourself, and then check the correct answer after the last interesting news!

AI Hype Wears Off and Magnificent 7 Returns Suffer

In one of our first newsletters of 2024, we have discussed what the magnificent 7 are and their extraordinary performance. These 7 stocks managed to achieve 4.5 times the S&P 500 returns in 2023, registering an annual gain of more than +115%.

Such an extraordinary performance was motivated by the billion dollar investments in AI which pushed the share prices of these companies through the roof. However, now that the hype is wearing off and the AI revolution has been priced in, the performance of these seven stocks has become much more varied and closely based on their earnings.

For example, Meta has recently reported record breaking earnings in the last quarter, causing an overnight jump in price of +20% and a YTD gain of almost +35%.

Likewise, Nvidia has achieved very similar returns, almost +34% YTD, as the revenues estimates have been recently boosted in view of their release on the 21^st of February.

On the other hand, Apple has lost -3.5% since the beginning of the year, falling as low as -6.5% YTD during the last trading session before recovering to the current price level.

However, the worst Magnificent 7 performer YTD has been Tesla, which has fallen more than -25% YTD partially caused by the announcement of suboptimal earnings, prompting the price to fall by -12% overnight.

Equity and Debt Markets Update

And now, our daily markets update!

Friday’s daily market update has a lot to cover. During last week there was the FOMC meeting and the job opening announcement, two extremely relevant events regarding possible rate cuts expectations.

Despite Powell being very clear about the likelihood of keeping interest rates higher for longer, it was the job opening announcement that really sealed the deal. This announcement showed a job opening figure that blew past expectations, indicating everything but the economic slowdown that the Feds were looking for.

This caused the expected March rate cut probability to drop from 80% to just 20%, and as a result, the 10 year US government bond yield to surge by almost +3.66% back above the 4% level, and to continue to climb during the first trading hours of Monday morning.

On the other hand, not only was the stock market completely unbothered by this event, but also it helped push prices higher due to the expectation of increased productivity. Additionally, thanks to the higher than expected quarterly earnings reported by many growth tech companies, the S&P 500 index has pushed +1.07% higher, setting a new all-time high.

Answer

The correct answer is a) 2.6%

I know that this might have possibly been a trick question, but the current level of Japan’s inflation is actually positive and above their target level.

What the central bank is worried about is a drop in inflation after a rate hike, so they must be able to transform this short-term 2.6% into a long-term 2% inflation rate.

Howl-Worthy Memes 😂

🐺 See you next time!

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