Daily Brief - What can bring down the market?

TLDR: It’s been easy to look smart investing in stocks. The S&P 500 index has jumped by over 70% since a trough in 2022, and it’s up 28 of the past 37 weeks. Neither sticky inflation, less dovish Fed, or increasingly volatile election campaign have managed to bring down the teflon market. Are there any downside risks left?

It turns out, plenty.

The best place to look is increasingly dour notes being published by Street strategists. It turns out that nothing helps you stand out as a financial guru like predicting a market crash. Goldman Sachs’s strategists lead with a note called “Summertime blues”, highlighting divergence between stock and bond prices. JPMorgan argues investors have aggressively crowded into positions based on improbable expectations of earnings growth. Mike Wilson at Morgan Stanley said on TV that a 10% correction is highly likely some time between now and the election.

So, what are they looking at?

First, valuations. They have gone from “ a bit pricey” to alarming. The index’s cyclically adjusted price-earnings (CAPE) ratio is 36. It has been higher only near the worst of the dotcom bubble and in 2021, both of which preceded crashes.

Second, Trump … If Trump wins America’s presidency and enacts the tariffs he has promised, a tit-for-tat response will trigger a downturn and most definitely drive up inflation. A far larger conflict in Europe or in Asia no longer seems far fetched, especially with Trump at the helm. Of course, such extreme scenarios with low probabilities and mighty consequences are notoriously difficult for markets to price.

Third, interest rates. Traders have priced in three cuts by the year’s end. What they have priced out almost entirely is the chance that rates could rise. For now, Fed speak makes that scenario increasingly unlikely. Yet disinflation has slowed to a crawl and wages are rising far faster than productivity growth. In 2022, the prospect of unanticipated tightening tipped shares over the edge - it could happen again.

Fourth, corporate earnings. To meet consensus expectations, they will have to shoot the lights out across the S&P 500 companies, with nominal growth in the double digits for the foreseeable future. Historical evidence is against this bet: over the three decades to 2019, real profits rose by 4% a year. Btw, Nvidia stands in a class of its own - revenues are expected to double over the coming year, before doubling again over the next four. Wow.

How does it all end? Prosaically, most likely. A bad earnings report. A corporate scandal. The catalysts are almost always unremarkable even as they bring down the house. But the kindling has most certainly been set quite spectacularly.

Earnings Spotlight: TSM falls despite strong earnings

Taiwan Semiconductor (TSMC) reported strong earnings and a positive revenue outlook for the quarter, benefiting from the ongoing global AI boom despite waning pandemic-driven electronics demand.

TSMC's second-quarter net profit surpassed market expectations, and the company raised its 2024 revenue growth forecast to the mid-20% range in U.S. dollar terms. However, the company's Taipei-listed shares fell by 3.5% on Friday due to ongoing geopolitical concerns and substantial losses in U.S. markets, particularly in the tech sector.

This decline was exacerbated by Donald Trump's remarks accusing Taiwan of undermining America's semiconductor industry. Despite these challenges, TSMC continues to invest heavily in its U.S. operations, with a $65 billion plan to build three factories in Arizona. The company remains a cornerstone of Taiwan's economy, though it faces emerging competition from Intel and Samsung.

Market Movers: When Taiwan Semiconductor falls

Here is the historical 1-month response from Semi-stocks when Taiwan-listed TSM drops 3.5% in a day:

1. Nvidia: 4.10%
2. Broadcom: 3.81%
3. Micron: 2.44%
4. Taiwan Semiconductor ADR: 1.94%
5. Intel: 1.87%
6. ASML Holding ADR: 1.77%
7. Texas Instruments: 1.69%
8. Applied Materials: 0.42%
9. AMD: 0.00%