TF SECURITIES' Song Xuetao: AI remains the biggest macro narrative

With the continuous underperformance of the technology stock earnings reports, the market is shifting from rate cut trades to recession trades. Furthermore, the rate hike by the Bank of Japan has caused carry trades to reverse, exacerbating volatility. The rate hike by the Bank of Japan has brought about the effect of deleveraging, but the impact depends on valuation and crowding. The problem does not stem from the rate hike by the Bank of Japan, but rather from whether the assets themselves are overvalued, trading excessively crowded, or experiencing excessive bubbles. However, after the storm passes, attention still needs to focus on the progress of AI in the United States, as the development of AI is currently the biggest macro narrative.

In the past month, we have seen changes in the market trading logic, with a process of nonlinear intensification. However, after the calm following the storm of carry trades, we believe that the most core benchmark observation still lies in the progress of AI; the trend of technology stocks that mirrors it relates to household wealth, consumption, and the economy, as well as affecting the strength of the US dollar and the expansion space of US bonds.

If the AI narrative can continue, the US stock market may just be undergoing a technical adjustment. We believe that the current US economy does not have major issues, just a cyclical slowdown under high interest rates. The Federal Reserve will not cut rates prematurely, nor will it steal the show from "AI".

A narrative does not necessarily have to come to an end, but it should continuously leave suspense and Easter eggs, while also needing some "dramatic contradictions" to keep everyone interested. The current contradiction is that Wall Street and Silicon Valley are beginning to oppose each other, with Silicon Valley still burning money while Wall Street talks about performance; Silicon Valley still emphasizes breakthroughs in basic technology, while Wall Street is starting to expect technological divergence. The recent intensification of contradictions started with the bias towards second-quarter earnings reports falling short of expectations, so there has been a noticeable increase in attention to the narrative. The capital expenditures of tech giants remain very active, the industry is still determined to engage in an arms race, fearing falling behind. However, capital's patience with the narrative is disappearing, so AI has entered a battle of beliefs, whether to focus on the present or the future. This is also a key issue for the US stock market, more important than the strength of the US economy, the timing of rate cuts, the reversal of the yen carry trade, and so on. However, this is only a "contradiction" that has not yet escalated to a "conflict". We believe that the test of patience may continue until the next earnings season, and the key to breaking the deadlock lies in whether there will be improvements in AI applications and models. Whether the US stock market undergoes a technical adjustment or a trend reversal will determine whether "recession trades" will be falsified or self-fulfilled. In other words, the potential source of a US recession does not come from the economic fundamentals themselves, but from the falsification of technological breakthroughs leading to a widespread deleveraging process. Recession trades based on economic fundamentals are merely a subsidiary in the grand narrative, and carry trades are just a wave of deleveraging, unrelated to the fundamentals themselves and will not affect the fundamentals.

With the continuous underperformance of the technology stock earnings reports, the market is shifting from rate cut trades to recession trades. In addition, the rate hike by the Bank of Japan has caused carry trades to reverse, exacerbating volatility. Recession trades are related to the past month's US economic data, showing significant asymmetry in economic data Although the direction of economic slowdown is obvious, there is no sign of a recession yet. Short-term factors have magnified economic data fluctuations, while carry trade reversals have amplified stock market volatility. The two factors influence each other, and in the most extreme scenario, the market has traded on the tail risk event of "intermeeting rate cuts," which is clearly irrational.

Recently, there has been widespread dissemination of images regarding the correlation between the Bank of Japan's rate hikes and global recession, but the two are only temporally correlated, not causally. The Japanese economy has long been in a slump, with relatively little spillover to the global economy. Therefore, when the Japanese economy feels the need to hike rates due to overheating, other economies often have already overheated to the point of entering a recession.

The reversal of the yen carry trade brought about by the Bank of Japan's rate hike follows a similar logic. Borrowing low-interest yen to long US stocks or Japanese stocks is essentially financial leverage. The Bank of Japan's rate hike brings about a deleveraging effect, but the magnitude of the impact depends on valuation and crowding.

The problem does not stem from the Bank of Japan's rate hike, but rather from whether the assets themselves are overvalued, trading excessively crowded, or experiencing excessive bubbles. The Bank of Japan just happened to exacerbate volatility in the storm of recession trading and bore all the consequences under the "proximate cause effect."

However, after the storm passes, attention still needs to focus on the progress of AI in the United States. The story of AI development is currently the biggest macro narrative.

Author: Song Xuetao, Source: TF Securities Research (ID: gh_fa3ddaa46ee4), Original Title: "TF Securities Macro Song Xuetao: AI Remains the Biggest Macro Narrative"