Charts of the Week

Happy Monday, my friends. I hope you had a great weekend. We have a lot of very interesting charts to look at this week, from housing through semis and much more.

Let’s dive in!

The Affordability Crisis

American families, particularly younger generations, are facing an affordability crisis. In most key spending categories not only have costs risen, but they’re staying higher than most can afford.

Housing affordability in the US is at historic lows as mortgage rates hit the highest levels since 2000 and mortgage applications slump to levels not seen since 1995.

The pain isn’t isolated to housing, however, as monthly car payments are also the highest that they’ve ever been for new cars, and not far from all-time highs on used cars.

Family formation has become so cost intensive that we’re seeing the most young adults living with their parent(s) since 1940.

That’s not a good sign, as it tells us that Gen-Z is even more locked out than the Millennial generation. If the housing market does not experience a reset in the cost of ownership, many will remain locked out, and that will have a negative impact on the US economy longer-term.

A Growing Disconnection

Home builders and retail often enjoy a strong positive correlation. Not anymore. Home builders are pricing in a much more buoyant market and economy than retail. Who’s right? I’m leaning towards the latter for the reasons discussed above.

Hedge funds certainly seem to see the same potential for downside in the US housing industry, as they’ve been increasing short interest considerably over the last two months.

There’s another intriguing correlation breaking down, and that’s between banks and broker-dealers. This time I favor the former, as I believe banks are more accurately pricing in what we may expect from the economy and financial markets.

Then there’s Wall Street vs Main Street, which plots the correlation of the S&P 500 vs US job openings month-over-month. While it varies as to whether the market or job openings lead, as they tend to take turns, the amount of growing divergences suggests that job openings may lead this time.

Is the AI Bubble Deflating?

The largest catalyst for this year’s rally has been the AI bubble, and while there’s certainly merit to some of the technological innovation that has taken place, I believe that it’s gotten ahead of itself.

There’s a lot of froth in the leading mega cap techs, where valuations are rather excessive. Particularly for some of the companies that aren’t growing and yet are continuing to see multiple expansion drive higher stock prices.

With AI stories falling and retail net buying of AI stocks collapsing, it does suggest that the peak euphoria phase may be behind us.

One of the key beneficiaries of the AI bubble were semiconductor stocks. They may be putting in a double top here, and if that’s the case it suggests that a lot of the move from late last year to the present could be retraced.

Hedge funds are looking at this situation and positioning accordingly. Were they early? Absolutely. But they probably aren’t wrong.

Microsoft, Apple, Amazon, Alphabet and Facebook make up about 24% of the weighting in the S&P 500, a level of concentration that prompts concern.

Volatility’s Disappearing Act

Volatility in the tech-laden NASDAQ is at some of the lowest levels we’ve seen in over three decades. Is that sustainable with rising rates, extended valuations, inflation re-accelerating, and a Fed that seems adamant.

Open interest within VIX calls is near the highest levels that we’ve ever seen, much of it long. That suggests that there’s so much long volatility positioning that volatility is oversupplied and that can actually have a suppressive effect. One reason why volatility has been so low perhaps, and another, of course, being the impact of so much market participation being expressed via 0DTEs.

Short exposure also grew significantly last week, led by fundamental long short funds. A lot of this short exposure is concentrated within single stocks of the consumer discretionaries and cyclicals.

Contextualizing this data beyond week-over-week flows shows just how significant the increase in gross leverage and net leverage (short) is for these funds. Net short exposure is the highest it’s been since early 2023 and gross leverage is close to 2023 highs.

This tells me some of the most shorted stocks may see a bit of a squeeze with any meaningful positive catalyst for the market.

Dollars, Bullion, and Rates

The US dollar recently hit a 6-month high, and the rally may not be over yet as rates continue to drag the greenback higher.

Which makes the resilience in gold, within an environment of both rising rates and a strengthening dollar, ever more impressive. It also, however, suggests that risks to the downside may be growing should rates and the dollar continue to rise without a catalyst for gold, the “uncertainty hedge”, to see a more meaningful bid.

Meanwhile, US bond yields are breaking to new highs. For the 5s and 10s, these are yields not seen since 2007, and for the 2s, we have to go back to 2006.

These losses are setting us up for the third year of losses within the US bond market, which would be the first there’s been three consecutive years of losses in US history. Does that mean bonds are an opportunity here?

Not so fast. Buying longer duration US debt when it is yielding less than the shorter end of the curve seems unattractive. I continue to favor exposure to bills over bonds until that paradigm shifts meaningfully. After all, would you want to lend to the US government for 30 years at a lower rate than 1-month of the same risk?

The Japanese Economic Miracle Could Become a Nightmare

Inflation is becoming more firmly entrenched in Japan at a time when the BoJ appears to be relatively complacent and the government is engaging in even more stimulus, with the goal of raising wages (and as a result prices of goods and services).

Adding to that, the BoJ has engaged in such aggressive stimulus that its balance sheet to Japan’s GDP is the highest such ratio of any central bank on Earth. Where the central bank owns over half of the country’s debt, and the government of Japan owns over half of the central bank.

The problem here is all the NIRP (negative interest rate policy) and YCC (yield curve control) led to significant debasement of the yen.

Because Japan is an island nation that imports much of its energy and agriculture, those imports are likely to become more expensive, which could be another catalyst for inflation becoming more persistent and even accelerating.

In Closing

We’re entering a period of renewed turbulence and I believe that markets have been irrationally optimistic for much of this year, with the majority of upward price revisions led by a small cadre of stocks, many of which aren’t growing their earnings or revenue.

This multiple expansion, as inflation re-accelerates, has prompted rates to continue to move higher and the Fed to become even more adamant about “high(er) for longer”.

I believe that after such an incredible run in so few stocks leading the market higher, we’re likely to see risk re-rated, and sobriety come back to price discovery in the months to come.