Ladies and gentlemen, the weekend! In this space each week, Greg and I share some of our favorite articles, notes, and graphics from the past week along with our commentary. Please feel free to provide feedback and forward along to others if you enjoy. We appreciate you taking the time to read. 

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Was the June FOMC Meeting a Fed Pause or a Hawkish Skip?

“For the first time since January 2022, the Federal Open Market Committee (FOMC) voted to leave the Federal funds rate unchanged at a target range of 5.00%-5.25% at its June meeting. While this “pause” had been telegraphed by Federal Reserve (Fed) officials in recent weeks, the statement language and press conference commentary were decisively hawkish. The statement was essentially unchanged except for a slight adjustment from “to which” to “of” in “determining the extent of additional policy firming that may be appropriate”, suggesting another increase is to be expected. Moreover, in his remarks Chair of the U.S. Fed, Jerome Powell, confirmed the committee used the June meeting to assess the impact of the cumulative tightening since the Fed began hiking in March of last year though hinted that while the trends in inflation and labor markets were encouraging, they are still at levels that warrant further tightening…

Perhaps more notable was the updated “dot” plot. Of the 18 FOMC members, nine see rates ending the year between 5.5-5.75%, while three see rates above 5.75%. This now suggests the median FOMC member anticipates two more rate increases, indicating the mid-year meeting will serve as hawkish skip and not a pause in the current tightening cycle.

To be clear, we do not think further tightening is appropriate at this stage given growth is slowing and labor markets are already loosening. Moreover, we anticipate another soft inflation print for June driven by base effects, normalizing rent inflation and used car prices. That said, today’s announcement made it clear that the committee still needs more compelling evidence that inflation is under control and could very well tighten at least once more this summer.”

There were both good and bad takeaways from the latest Fed meeting which concluded on Wednesday.

The good: The pause. There was no interest rate hike for the first time since March 2022.

The bad: The dot plot. The median projection for the year-end federal funds rate was 0.5% higher than the current and projected rate (at least for the last 6 months).

It may just be a case of hawkish posturing with dovish action. However, Chair Powell inadvertently referred to it as a “skip” rather than a “pause” in the press conference. Market-based futures pricing implies a 75% probability of a 0.25% hike in July then a pause, rather than two more hikes per the dot plot.

On Mega-Cap Stocks

“It’s been another one of those years when US equity markets are dominated by mega-cap stocks. The average [year-to-date] return on Amazon, Apple, Google, Meta, Microsoft, NVIDIA and Tesla: 84%. The average YTD return for the rest of the S&P 500: just 3.7%. Apple’s market cap is now the same as the entire Russell 2000 Small Cap Index, the largest 7 companies represent the highest share of market cap on record (25%), and the percentage of stocks beating the S&P 500 on a trailing 3-month basis is just 11%, surpassing the March 2000 low of 20%.

What’s driving this? A lot of mega-cap [price-to-earnings] multiple expansion, although there’s a difference between NVIDIA, Apple and Microsoft which are priced at the high end of their historical ranges and the other four which are not. For NVIDIA and Meta, sharply increased earnings expectations also explain their rise this year. For the other five stocks, earnings expectations are either flat, or in the case of Tesla down substantially due to $2k-$10k price cuts for Model Y, S and X vehicles (which hasn’t prevented Tesla from rising by ~110% YTD).

On a related note, investors are paying a sizable premium for AI exposure. One example: the 32 stocks in the $CHAT Generative AI ETF have returned 77% this year. The 22 $CHAT ETF stocks that have positive earnings projected for the next 12 months trade at an average P/E of 31x. The other 10 $CHAT ETF stocks have infinite P/Es, either due to negative earnings or trivially positive earnings that create nonsense P/E ratios over 100x. The large language model revolution is going to have to live up to the high end of expectations to justify this. I have seen estimates that AI will eventually add ~10% to the fair value of the S&P 500 due to some combination of augmented employee productivity and staff reductions, but I’m not sure how one would measure that.”

We touched on the divergence of mega-cap and technology stocks from the broader market a couple of weeks ago. This blurb had a few more data points.

While there are a couple of stocks (NVIDIA and Meta) that have pressed higher due to a ramp-up in projected earnings, there are others that have merely gotten more expensive due to the prospect of artificial intelligence. It’s difficult to value AI productivity or profit margin improvements, although at least Microsoft has a stake in OpenAI (Chat-GPT)’s profits to value.

There are other areas of capital markets that have much more reasonable valuations.

BlackRock is applying for a spot Bitcoin ETF. Here's why it matters to the crypto industry.

“BlackRock, the world's largest asset manager, has filed an application for a spot bitcoin exchange-traded fund.

There are currently no such products in the U.S. The SEC approved several bitcoin futures-based ETFs in the past, but has yet to greenlight anything that is backed by bitcoin itself.

BlackRock (BLK) will tap Coinbase Global Inc. (COIN) to provide custody for the ETF, according to a filing with the U.S. Securities and Exchange Commission on Thursday.

BlackRock filed the application as regulators are increasing their oversight of the crypto industry. The SEC recently sued crypto exchanges Binance and Coinbase, charging they operated unlicensed securities exchanges.

The move is especially impactful for the U.S. crypto industry now, participants said.

If an asset manager as big as BlackRock is making such a move at a time when crypto regulation is being tightened, 'they probably have done sufficient due diligence to know there is a decent chance for the ETF to get approved by the regulators,' according to Matt Zhang, founder and managing partner at Hivemind…

[SEC] Chairman Gary Gensler has repeatedly said that bitcoin was the only cryptocurrency he was prepared to publicly label a commodity, rather than a security.

The SEC's recent actions are 'actually not bad for bitcoin,' said Peter Eberle, chief investment officer at Castle Funds. 'Perhaps BlackRock saw that and has decided that they want to make a move in that direction,' noted Eberle in a call.

Bitcoin was trading at around $25,625 on Thursday, up 2% over the past 24 hours, according to CoinDesk data. The largest cryptocurrency has gained 50% year to date, but is still down over 60% from its record high in 2021.”

BlackRock and its iShares ETFs are asset behemoths. If they are applying to the SEC, it is likely to be approved. Asset and investment flows into cryptocurrencies and their infrastructure crashed back down to Earth in the fallout of the FTX scandal. However, there was also some fortification around Bitcoin and Ethereum as crypto “blue chips”. An ETF could provide further legitimization.

I'm not sure who makes up these rules, but the U.S. stock market (as measured by the S&P 500) is now up more than 20% from its bear market low, which technically marks the start of a new bull market.

Historically, what does that mean going forward?

In the modern market era, it is positive 12 out of 13 times over the following year at an average return of +17.7%.

Thanks for reading. Have a great weekend!

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