For the past month, the number of risks to the bond and stock markets has risen, with some pundits wondering just how the market can trade so confidently higher when it appears that there is the clear and present potential of one or more large-scale events unfolding that pose a systemic risk to the U.S. and global financial markets.
Let’s start with an easy one that caught everyone off guard. At last week’s 30-year Treasury auction, where $26 billion in debt was being bid for, the Industrial and Commercial Bank of China (ICBC), the world’s largest lender by assets, said its financial services experienced a ransomware attack that reportedly disrupted the trading of Treasuries. The attack prevented ICBC from settling trades and rendered the bank unable to clear commitments, forcing it to send the settlement details to its counterparties by a messenger carrying a thumb drive in an effort to limit the damage.
The attack was orchestrated by suspected perpetrator Lockbit, a prolific cyber-criminal organization with ties to Russia. Bloomberg reported “The incident spotlights a danger that bank leaders concede keeps them up at night — the prospect of a cyberattack that could someday cripple a key piece of the financial system’s wiring, setting off a cascade of disruptions. Even brief episodes prompt bank leaders and their government overseers to call for more vigilance.”
“This is a true shock to large banks around the world,” said Marcus Murray, the founder of Swedish cybersecurity firm Trusec. “The ICBC hack will make large banks around the globe race to improve their defenses, starting today.” This particular hack affected about $9 billion in transactions — no small amount. But imagine if the hackers were able to force the auction to seize up and sever trading altogether.
Not good. But hey, the auction was rated a D- by CNBC’s Rick Santelli after primary dealers had to take in 25% of the auctioned paper that didn’t sell, and both the bond and equity markets rallied sharply the next trading session, led by mega-cap technology stocks on lower-than-forecast consumer sentiment data and more AI euphoria in the software sector that spread like wildfire.
Here is where it gets a bit weird. On Friday, the University of Michigan Consumer Sentiment report for October crossed the tape at 60.4 versus consensus of 63.7, marking the fourth straight month of declines. The Current Economic Conditions Index dropped to 65.7 from 70.6, year-ahead inflation expectations increased to 4.4% from 4.2%, hitting their highest level since November 2022 and five-year inflation expectations rose to 3.2% from 3.0%, which is the highest reading since 2011. And the market rallies 1.6% in response, with the Nasdaq bolting higher by 2.0%, led by none other than the Teflon tech sector.
Despite new restrictions on chip exports to China, semiconductor and semiconductor equipment stocks raced higher in front of this week’s meeting between President Biden and China’s Xi Jinping at the Asia-Pacific Economic Cooperation summit in San Francisco. The two leaders have only met once since Biden was elected, and I do not expect this meeting to go well at all. Xi wants Biden to reject Taiwanese independence and to reiterate America’s commitment to doing “business as usual” and the United States won’t decouple from China anytime soon.
For its part, the U.S. contingent will want to weigh in on China’s ongoing support for Russia in Ukraine, among other items that are set to produce nothing in the way of any form of concessions on the part of China. As it is, the chip and chip equipment companies are doing workaround technology to offer products that comply with export provisions, not wanting to be cut off from the lucrative Chinese market.
On a completely different note, and one that I find pretty stunning, on Nov. 5, before the tech sector scored a big week led by none other than Mr. Softie and its “all the rage” ChatGPT open generative AI tool, Elon Musk revealed his own artificial intelligence bot to challenge ChatGPT, claiming the prototype is already superior to ChatGPT 3.5 across several benchmarks.
“Dubbed Grok, it’s the first product of Musk’s xAI company and is now in testing with a limited group of U.S. users. Grok is being developed with data from Musk’s X, formerly Twitter, and is thus better informed on the latest developments than alternative bots with static datasets, the company’s website said. It’s also designed to answer ‘with a bit of wit and has a rebellious streak,’ according to the announcement.” xAI launched in July with a team stacked with former employees of OpenAI, DeepMind and more. It is still hiring for several roles.
Here’s the crazy thing: even after the Musk announcement that Grok can run laps around ChatGPT 3.5, shares of Mr. Softie traded to a new all-time high. Why? My guess is that it is considered the quintessential underinvested fund manager year-end performance pressure safety trade. Fortress balance sheet, company running on all cylinders and first-to-market AI leadership that is now in question.
Let’s not forget that Musk was part of OpenAI in the founding days and stopped backing the company after a disagreement with senior management over the speed and nature of the technological advancement, suggesting that OpenAI wasn’t doing enough to ensure safe development. So now, X (formerly Twitter) is rumored to offer Grok at $17 per month. One of the standout features of Grok is its access to real-time data from X, a unique advantage that allows it to provide the latest information on current events and happenings not available on ChatGPT and other chatbots.
My point here is that on any other day, the news of the Grok release would have had a wrecking-ball-like impact on the leading AI player. But with no way to invest in Grok, the market took the news as if the AI race to become the superior Large Language Model (LLM) is a catalyst to bid up shares of leading AI stocks and the rest of the tech sector against what was largely just an okay earnings reporting season for the broader sector. The lack of earnings robustness was forgiven when the bond market rallied, implying lower rates would fix all things.
In any event, investors are in a lopsided market. Last week’s impressive rally for the major averages showed only the tech sector as a true standout. The rally in tech masks a lot of other areas of the market that are under stress. The one-year charts of the consumer staples, financials, healthcare, materials, real estate and utilities sectors are downright ugly. Charts of the other sectors, save for tech and communication services, are lagging as well.
In terms of investing in the world outside of big-cap tech, it takes intense stock picking to buck what is a very challenging investing landscape for small caps. The Russell 2000 tried to make a stab at breaking its primary downtrend but failed. Maybe this next retest will provide the proverbial double-bottom, higher-low technical formation chartists get all excited about.
Investors are in a super top-heavy market, where dips in tech are very likely going to continue to be bought into. With the China summit, the Israel-Hamas war, the Nov. 17 deadline for a Congressional continuing resolution and the data pointing to a consumer that is dialing it back, be thankful there is a winning sector that is the biggest, the fastest growing, the most liquid and the most trusted to pad portfolio gains in an otherwise chaotic world.