GS Basics Loose Financial Conditions. OPEX Week. Rising Term Premium

GS Basics - Loose Financial Conditions. OPEX Week. Rising Term Premium

Markets: Markets basically back at the highs, unperturbed by the weekend. Some modest escalation in the Middle East and more attacks on vessels, but oil barely moved. Financial conditions are about as loose as they get, VIX has a 14 handle and we’ve had a pretty broad melt up. In hindsight, July’s consensual unwind and deleveraging now looks largely done. Gross and net are healthier and there is simply less leverage in the system.

AI: The big winner from AI remains the broader market. We are on a one way trajectory towards lower token costs and more useful output per dollar. That accrues to basically every corporate and every vertical….making most businesses more profitable (eventually). The real winners might just be the companies spending the least to get the benefits. So much has happened in AI over the past two weeks….clearly tomorrow’s note. Earnings have smashed the lights out and put a lot of the bear concerns to bed (CRWV). I was slightly taken aback by Gavin Baker describing Nvidia as the “central bank of AI” (all-in podcast). The financing and residual value guarantees take vendor financing to a whole new level. That said, as far as I can tell ARR is still compounding and the TAM is bigger than anyone thought. For now…most things pointing in the right direction. The hyperscalers are giving me a headache, so I’m just parking that argument for now. People got very excited about AI ROI, maybe inference ultimately becomes very profitable. I remain in the Cuba Gooding Jr. camp… If the free cash flow isn’t there, I’m not buying it.

Rates/Fed: The only real sticking point is rates. JPY coordinated intervention happened while I was away...impact seemed modest and partially a second derivative of that long ends everywhere continue to underperform. In the US, I don’t think the long end is reacting to any one policy decision….we’re just issuing an enormous amount of Treasury and IG paper against 6–7% fiscal deficits. The crowding out effect is real, term premium is rising (see below) and real yields are incredibly high. The word salad from Warsh in July didn’t help. Softer data since then gives the Fed an excuse to stay put in September, which is good for equities but just steepens the curve further.

Alternative View: I’m starting to form a slightly different view on both Japan and the US. If you miss your inflation target for long enough, eventually you lose credibility. Hammack, Logan, and Kashkari already voted for a hike in July, and the long end of the curve may ultimately force the committee’s hand.. We have both the minutes and Jackson Hole before the September meeting, leaving plenty of time for a policy course correction. Perhaps the Fed ends up hiking simply to restore credibility; the front end is anchored by policy, but the long end isn’t. A flatter curve might actually help.

Technicals: This week looks pretty supportive. We’re into expiry near the highs, through most of the overwriting strikes, and positioning is still lower than you’d expect at these levels. People probably have to chase when they come back in September. Yes, supply picks up then, but September weakness usually comes in the back half, not the first. For now, the upper right tail is cheap….single-digit Euro Stoxx vol and a 14 handle VIX. Think owning upside short term.

Big Picture: We are running 6% to 7% deficits while still trying to finance trillions of dollars of private sector investment. YoY tariff effects are being absorbed for now, but NFIB hiring intentions have surged to a multi-year high of 20%, and we are seeing clear hints that pockets of wage pressure are returning. Every administration is going to choose growth and tolerate slightly more inflation. Consequently, you want to own nominal assets: SPX, gold, short bonds, and cheap VIX calls or spreads around the portfolio. Financials, pockets of tech (specifically semiconductor capex), Industrials and broader cyclicals likely outperform. I still dislike bond proxies without pricing power...such as staples, telecommunications (where nobody wants to compete with Elon), and REITs..and I prefer pairing those shorts with…