Runnin' on Empty

Another year, another successful drive to Florida! We hit the weather window perfectly and the drive was stress-free and smooth. But I did notice something that piqued my interest. I saw a grand total of two Teslas on I95 during my 2400+ km of driving. And I did not see even one roadside charging station. I'm sure they were there somewhere if you pulled off the road every 300km or so. But every time I filled my gas tank and noted the range estimate on my Q7 jumping to 950km, it reinforced that, for many Americans, there remains little incentive to buy an EV just yet.

That illustrates the problem that I'm having with one of the Magnificent Seven stocks, Tesla. The low-hanging fruit of early adoption is firmly in the rearview mirror for the company. Earnings will be reported this week and the market is bracing for impact, with the stock at a six-month low. Even gushing praise from ARKK's poster child for techno-investing, Cathie Wood can't seem to rally the stock. She had better give up on pushing last year's shiny-coin trick of EV mania soon. Just as Crypto and Cannabis fads before it, the Electric Vehicle hype is now taking a back seat to the newer, popular AI trade.

But this is symptomatic of a market driven by too much money chasing too few stocks. The massive liquidity generated from the Fed's micro-managing of the financial system over the past 15 years is to blame for that. Who thought setting the cost of money at zero could produce massive distortions to the financial system? Certainly not the wonks beavering away in the Eccles Building. So the market lurches from fad to fad mindlessly chasing the headlines of the day.

The problem is, just like the Dot-comTech and China bubbles and so many others in history, the party eventually ends usually with a whimper, not a bang. The upward surge in a bull phase creates a self-correcting mechanism. Valuation risks rise commensurately with rising markets. As the chart below demonstrates, we are heading into the mid-twenties PE for the S&P 500. The combination of rising earnings estimates and lower expected discount rates is the culprit, as it is in every cyclical bull market. But valuation itself isn't a timing tool. This expansion phase of the price of risk assets can persist as long as the underlying narrative that promulgated it persists.

S&P 500 PE Ratio

More importantly, the Magnificent Seven is now under threat of losing one of its most popular constituents - TSLA. The replacement is likely to come from the AI space. And just like any gold rush, the 'arms dealer' effect is at work here. The ones making all the money are selling picks and shovels, not the poor bastards digging up the ground. That points us to the AI Chip makers like NVDA and AMD for the momentum players out there.

So when do we get the rest of the market to take leadership? Simple...once the data starts to indicate enough deterioration and the Fed cuts rates to defend the soft landing. And the market is sniffing that out now. Yesterday's late rally in Small Caps and Financials again showed the willingness of investors to "look over the valley" for a second-half economic re-acceleration promoted by the expected rate cuts from a supportive Fed.

Sounds easy, doesn't it? The problem is, in the U.S., the data are getting stronger, not weaker. The highest level in two years was just logged for the key consumer confidence measure from the University of Michigan. Maybe it had something to do with their winning the college football national title, but the Wall St narrative of lower rates and a soft landing economy is now being embraced on Main St.

University of Michigan Consumer Sentiment

So that explains the market perfectly. The gradual weaning of investors off the Mag 7 fixation has begun in earnest now that Elon Musk's intelligence is increasingly being seen as artificial. And unlike most Teslas, AI has a fully charged battery. Some of the EV money is heading to NVDA and the like. More importantly, some of that money will head to the cheaper, left-behind stocks that populate the small-cap and value sectors. After a brief pullback, the 'tape' is broadening once again

Last year was a case of 'no Banks, no thanks' for me. But with the inverted yield curve and deposit crisis in the rear-view mirror, and bank lending set to rise later this year, I believe the Jamie Dimon bottom of October has been successfully tested this week. Buy the dip in Financials.

This year I now say - "Banks... Thanks"!

S&P 500 Financials vs. Technology

Risk Model: 3/5 - Risk On

The pullback in sentiment is a healthy development in the short term. As we head into the month-end, investors who 'missed the move' from the October low are being forced to nibble away and draw down their cash balances. Hence the tug-of-war feel to this pullback. The AAII indicator of the Model has notionally dropped below the signal line, but that is in the context of a broader improvement in risk appetite.

AAII Bull/Bear