The Overnight Report: Slaughterhouse Friday

This story features CAPSTONE COPPER CORP., and other companies. For more info SHARE ANALYSIS: CSC

World Overnight
SPI Overnight	7925.00	– 144.00	– 1.78%
S&P ASX 200	8114.70	+ 22.40	0.28%
S&P500	5446.68	– 75.62	– 1.37%
Nasdaq Comp	17194.15	– 405.26	– 2.30%
DJIA	40347.97	– 494.82	– 1.21%
S&P500 VIX	18.59	+ 2.23	13.63%
US 10-year yield	3.98	– 0.13	– 3.24%
USD Index	104.34	+ 0.28	0.27%
FTSE100	8283.36	– 84.62	– 1.01%
DAX30	18083.05	– 425.60	– 2.30%

By Chris Weston, Head of Research, Pepperstone

Good morning.

-A poor ISM manufacturing report triggers broad de-risking
-Cyclical plays shunned – Growth fears resonate through broad markets
-US swaps price a 25% chance of a 50bp cut in September
-Rotation into ultra-defensive equity plays
-CHF and JPY find the love in FX markets
-All eyes on US nonfarm payrolls

Those involved in the US session have had to navigate a real old-fashioned anti-cyclical risk aversion day, and it has got a little moody out there in the markets.

One could argue the Federal Reserve planted a seed yesterday, by moving its focus so much more to the labour market, which screams out – and has all but confirmed – that their models see the US economy in the late stages of the business cycle. As such, market players, and algos are positioned far more sensitively to the marquee growth economic data points and labour market readings and will react more intently to the macro over earnings.

The signal to de-risk was opened with the weekly jobless claims coming in at a higher-than-expected 249k, although the punchy cross-asset moves really came alive once the US ISM manufacturing report came in 30 minutes after US equity trade was underway. The numbers were grim, with the headline index in at 46.8 vs 48.8, and well into contractionary territory, with the employment sub-component at a lowly 43.4 and new orders falling to 47.3. It’s not great reading, especially with prices paid increasing from the prior month.

From here, we saw a move that would last right through the session and that sets Asia up on a dark and sinister footing.

US 2yr Treasury yields fell from 4.28% to 4.13%, and settled at 4.14% -11bp on the day, with eyes now on the YTD yield low of 4.11%. US Swaps now price 31bp of cuts for the September FOMC meeting, essentially a 25% chance of a -50bp cut at this meeting, and we see over -3 25bp cuts priced by December.

With 9x -25bp cuts priced into swaps over the coming two years – this pricing suggests the market is moving away from a soft-landing scenario to one where the Fed will need to take the fed funds rate below a neutral setting and to stimulate. Perhaps even an element of front-loading upcoming rate cuts, which is a far more worrying sign.

Any goodwill towards US tech in the prior session has been unwound, with cyclical names taken down hard, although it wasn’t a blanket liquidation, and we have seen rotation into the ultra-safe haven equity sectors utilities, staples and healthcare, and the plays with low volatility in their cash flow generation. Nvidia, once again, trading like a penny stock with shares closing at -6.7% and names like Qualcomm -at 9.4% and AMD -at 8.3% respectively.

We can see high yield corporate credit spread widening out, with the HYG ETF -0.7% and looking dangerously like it wants to break the recent consolidation lows of $78 put this on the radar, because while corporate credit is still at multi-year tights, if we do see a deterioration in the credit markets then equity will not be happy.

Smalls caps have been taken to the woodshed, with the Russell 2k -3%, and the close in the large-cap indices was hardly much better, with the NAS100 -2.4%.

Volatility has been a major factor, and while we’ve seen the S&P500 trade a massive 166-point high-low range on the session, we’re seeing the VIX index into 18.5%, with traders holding a strong preference for put options over calls. Flow once again exacerbating moves at a both a single stock and index level, with systematic momentum funds selling S&P500 and NAS100 futures as the respective indices traded through their rules-based trigger levels, with volatility dynamic funds heading out of equity and into cash as the higher volatility dictates that they do.

For those positioned for a late-stage rally on the hope that Amazon, Intel, and/or Apple could lift the mood, well, it’s been disappointing as Intel has been smashed -20%, Amazon is -4.8% lower, while Apple is up only smalls in the afterhours session.  

Copper is always a go-to market for traders to express a view on economics, and we see an ugly tape here (-2.7%), with selling also seen in Dalian iron ore futures.

In FX markets, carry trades continue to be taken out to the woodshed.

Clearly, all the focus now falls on US nonfarm payrolls in the session ahead and Asia-based equity traders will be highly cognisant that they will have to hold positions through the US session with the threat of gapping risk on the Monday open.

With the market firmly moving to a mantra that bad news is bad news for risky assets and sentiment, where swaps are pricing an element of more emergency cuts, poor US job numbers will not be digested well at all. While the unemployment rate is calculated from the far more volatile Household survey (as opposed to the Establishment survey), should we see the U/E rate at or above 4.2% and it could get dark in the markets, especially if weather events seen when the survey was conducted result in payrolls coming in below 160k.

Of course, we could see far better jobs numbers, and that may send some relief through markets, but given the market is so focused on whether growth is indeed slowing at a faster pace, there are now some bringing up the notion of a central bank policy mistake, I would therefore argue the broad suite of market players will be far more sensitive to a downside miss to jobs and a higher U/E rate, than a beat.

Milad Azar Market Analyst at XTB MENA

The results season is in full swing and Alphabet and Microsoft brought their numbers from the really biggest companies. The companies are quite different in their original focus (Alphabet was in advertising, Microsoft in computers, office suites, etc.), but in recent years they have become increasingly close and compete in many areas.

The companies also have in common that, together with Amazon, they are dominant cloud players who have jumped on the AI wave. Microsoft cooperates with OpenAI, Google works more or less independently, but both companies have a wide range of products and services in which AI tools can be applied. The companies are also among the richest in the world, earning tens of billions of USD every quarter, and can thus afford to invest huge sums in new projects and areas where AI naturally falls.

But artificial intelligence needs a large and expensive infrastructure and high computing power. For this, companies need to invest in new data centers and servers. Figures from recent quarters show that companies spend literally tens of billions of dollars each quarter for this purpose. Investing is also largely about the future and what investors think the companies will achieve in a few years, and for this reason, the shares of the mentioned companies have grown significantly by more than 70% in the last year and a half.

However, investors often sooner or later want to see the real impact on the numbers without hesitation, not just promises, and it was this fact that caused the negative reaction of the shares of both companies after the publication of the latest economic results. Those were really good, but investors were also looking for signs of whether or not AI will start making money soon, and whether the growth rate of the cloud that AI runs on will continue.

Companies are very cautious about publishing numbers related to the impact of AI on their business. We find practically nothing in the reports, and we learn partial information, for example, on subsequent earnings calls.

Alphabet’s management recently mentioned that AI is already generating billions in revenue and that it is a much greater risk for the company to invest little in this area than to invest too much. In turn, Microsoft management said, for example, that AI-related tools accounted for 29% of the growth of the Azure cloud, with an increase of 8 percentage points, which is more than the previous quarter.

However, cloud growth has slowed slightly, which has spooked the market. There is really a lot of hype around artificial intelligence, so any hesitation can be taken very negatively. In addition, the financial director of the company said that they are investing huge money in the IT infrastructure to support monetisation over the next 15 years and more. I personally read between the lines that whoever expects that AI tools will start generating more profits for companies in the foreseeable future is mistaken. Anyway, none of the companies will say how much AI generates in sales and profits.

In the course of the last months, various pieces of information have also leaked out. According to them, for example, Microsoft’s sales are growing thanks to AI, but in the area of profits, it still subsidises services to users and processes tens of USD per month on a large part of them.

On the one hand, we have investments in the order of tens of billions of USD per year, but on the other hand, we only have a relatively small impact on sales and probably a negative impact on profits. Therefore, investors were waiting for some indication in the latest results that the companies will bring positive news in the area of profit prospects in connection with AI, or that the rate of revenue growth will be higher.

But they basically did not come, and companies continue to compete in terms of how much they invest in infrastructure. It is for this reason that the shares of Alphabet and Microsoft took a beating after the numbers were published – investors simply expected more in connection with AI. Alphabet essentially kicked off the stock market’s biggest one-day selloff in a year and a half, with Microsoft shares down about -8% in the aftermarket, though it eventually erased most of its losses after accompanying information from management that said it would increase the pace of cloud growth by a couple of quarters.

But it doesn’t change the fact that investors are apparently starting to be sensitive to whether AI will ever make money and how it will continue to grow. So it looks like the phase of AI euphoria and that the promises are enough is behind us, and sooner or later companies will have to show that AI is not just an expensive pastime, but a business capable of making real money.

Of course, no one knows whether it will be successful. AI monetisation models are still a big unknown and differ in many ways compared to previous inventions. Take common software, you program it once, which involves high costs, but each copy sold has practically zero costs.

AI is different, each additional user increases the need for computing power and energy consumption, therefore scalability may be worse. The reliability of AI tools for more important things is still questionable, but also how much they will cost users. It is already clear that some of them increase productivity.

But it is important that the increase in productivity does not cost more than the cost of the given tool. Even if AI proves to be widely usable and the costs of operating it are lower than the benefits, it may still take some time before we see widespread adoption. If we look at previous office revolutions, such as the creation of the typewriter or the arrival of the first usable computers, we will see that it benefited individuals really early, but from a macro perspective, the first real effects were not noticeable until maybe 10 years later.

People do not like change, they are afraid of new technologies and it takes time to learn to work with them in a way that is beneficial. Nobody really knows how it will work in the case of AI, because there are really a lot of unknowns. But maybe it’s time to slightly reconsider the fact that AI will start bringing profits soon and accept that possible wider adoption with an impact on companies will still take a while. It looks like at least part of the investors are already starting to admit it, and because of that, the shares reacted negatively.

On the calendar today:

-Australia 2Q PPI

-US July unemployment

-US Non farm payrolls July

-Capstone Copper ((CSC)) June Qtr update

-Pinnacle Investment ((PNI)) earnings report

-ResMed ((RMD)) earnings report

-Block ((SQ2)) earnings report

-Virgin Money UK ((VUK)) quarterly trading update

Corporate news in Australia:

-Block ((SQ2)) upgraded its full-year guidance and flagged a new US$3bn share buyback

-ResMed ((RMD))’s quarterly surprised through a much better-than-forecast gross margin, but there were signs of weakness in the US market (see further below)

-Sky City’s ((SKC)) Auckland Casino will close its gambling area for five days in September following its failure to comply with requirements

-Takeover contest for Pacific Smiles ((PSQ)) is heating up (another bid)

-ACCC has approved Louis Dreyfus Company’s acquisition of Namoi Cotton ((NAM)), subject to divestments

-Sonic Healthcare ((SHL)) is raising debt in the US private placement market to refinance existing debt, repay bank loans, and extend its debt maturity profile

Wilsons’ initial commentary on ResMed’s result:  broadly in line (2% revenue beat, non-GAAP EPS US$2.08 matched WILSe).

Stock is down -5% in US aftermarket given the recent aggressive share price run and the idea that market share gains are now probably done’.

Global flow generator was up just 5% recalling that pcp growth was 30% in US and 14% ROW.

Leading into the result the chatter was around the GM outlook with freight costs in doubt.

ResMed guided FY25 GM to 59-60% for FY25 which is ahead of consensus (58%). That in itself holds upgrade potential noting that the opex guidance metrics were also in line. Stay OVERWEIGHT.

Spot Metals,Minerals & Energy Futures
Gold (oz)	2490.90	– 2.40	– 0.10%
Silver (oz)	28.64	– 0.52	– 1.78%
Copper (lb)	4.07	– 0.13	– 3.05%
Aluminium (lb)	1.02	– 0.02	– 1.60%
Nickel (lb)	7.46	+ 0.03	0.40%
Zinc (lb)	1.21	– 0.00	– 0.37%
West Texas Crude	76.93	– 1.68	– 2.14%
Brent Crude	79.99	– 1.56	– 1.91%
Iron Ore (t)	102.83	+ 2.73	2.73%

Hasn Market Analyst and part of the Research Team at XS.com

Gold’s moves come after a sharper-than-expected contraction in US manufacturing activity and an unexpectedly sharp rise in initial jobless claims to the highest level in more than a year, which in turn reinforces market hypothesis about multiple rate cuts this year.

The ISM manufacturing PMI hit its lowest reading this year at 46.8 in July and initial jobless claims rose last week to 249,000.

These figures, combined with yesterday’s Fed speech, have made markets almost certain of a cut in September and one or two possible cuts in November or December, according to the CME FedWatch Tool.

The rapidly escalating geopolitical tensions, with fears of a wider regional war in the Middle East, are also keeping gold on track to record further gains.

Headlines have been full of indications of a wider war and further escalation as hopes for a ceasefire in Gaza have waned. This came after the assassination of Hamas political leader Ismail Haniyeh in Iran and Hezbollah leader Fouad Shukr in Lebanon.

Meanwhile, the US and regional countries are seeking to contain the escalation and revive the fragile and faltering negotiating track for a ceasefire in Gaza before it is dragged into a wider war, according to The Wall Street Journal.

These assassinations may require a multi-front response from various countries in the region, which in turn may result in a counter-response that could ignite escalation in the region, potentially dragging the US along. In addition to all of this, this could encourage Iran to ramp up its nuclear program, according to The New York Times.

The Australian share market over the past thirty days

Index	01 Aug 2024	Week To Date	Month To Date (Aug)	Quarter To Date (Jul-Sep)	Year To Date (2024)
S&P ASX 200 (ex-div)	8114.70	2.44%	0.28%	4.47%	6.90%

BROKER RECOMMENDATION CHANGES PAST THREE TRADING DAYS
AIS	Aeris Resources	Upgrade to Outperform from Neutral	Macquarie
ANZ	ANZ Bank	Downgrade to Underweight from Equal-weight	Morgan Stanley
CCP	Credit Corp	Downgrade to Neutral from Outperform	Macquarie
FMG	Fortescue	Upgrade to Add from Hold	Morgans
MGR	Mirvac Group	Downgrade to Neutral from Buy	Citi

For more detail go to FNArena’s Australian Broker Call Report, which is updated each morning, Mon-Fri.

All overnight and intraday prices, average prices, currency conversions and charts for stock indices, currencies, commodities, bonds, VIX and more available on the FNArena website.  Click here. (Subscribers can access prices on the website.)

(Readers should note that all commentary, observations, names and calculations are provided for informative and educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views expressed are the author’s and not by association FNArena’s – see disclaimer on the website)

All paying members at FNArena are being reminded they can set an email alert specifically for The Overnight Report. Go to Portfolio and Alerts on the website and tick the box in front of The Overnight Report. You will receive an email alert every time a new Overnight Report has been published on the website.

Find out why FNArena subscribers like the service so much: “Your Feedback (Thank You)” – Warning this story contains unashamedly positive feedback on the service provided. www.fnarena.com

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms