Broadcom earnings, Walgreen's buyout, and a weak market into FOMC

What can we do with this mess of a market?

In early June, if you didn’t own Nvidia in your portfolio, and in size, your performance against the market ranged from awful to horrible. Nvidia bulls were out in force, spamming things like ‘oh why don’t you just buy the stocks that go up.’ or the more company specific taunt ‘XYZ company is an eventual zero when AI takes over, unlike Nvidia’. It didn’t even help to own all of the mega caps, as Amazon and Google were hit by underperformance during this period as well. If it wasn’t Nvidia or viewed as a company that was directly going to benefit from Nvidia going to a 10trillion dollar market cap it was being sold for Nvidia.

This just over two-week period of time culminated with Nvidia ripping up every day, then hitting a brick wall at 140 a share. Eventually reversing the gains, it made not just that day, or that bullish period, but over the next 6 weeks all of the gains of the last four months. Falling below 95 a share.

While talking heads talked about how the fundamentals pushed the price up or down, what really happened was a massive Gamma squeeze that chased the momentum buyers of Nvidia higher and higher, causing shorts of Nvidia to sell longs to cover margin calls, and long Nvidia buyers to be disinclined to buy anything else as Nvidia was the only thing that was working. Put another way, Nvidia became a black hole of liquidity. Nvidia in June was basically doing what GameStop almost did in January 2021 if Robinhood didn’t turn off trading, buyers were chasing the stock higher and it was briefly hurting the structure of the market.

The easiest way to see Nvidia’s affect on the market during this period was the massive outperformance of the S&P 500 over RSP (equal weight S&P 500). While its natural in bullish periods for market cap weight to do better than equal weight due to the higher weight of bad names in equal weight, in June, for the 1st of the month until Nvidia peaked the spread expanded to more than 4% at its peak. In just over two weeks! Without earnings, or a macro event. Almost entirely due to market structure.

I bring this up, not to reiterate recent history, but to talk about price action of the last two weeks. This is a 2h chart of RSP (the bars) vs SPY (the red line) since December 1st, again two weeks ago:

In ten trading days the spread between equal weight and market cap weight is more than 3%. Unlike back in June, this market has been held up by Google, Apple, Amazon, and Tesla. Not Nvidia. So at least there’s more than one or two mega cap holding the line this time. Much like in June, owning things that aren’t ‘on theme’ like bitcoin related eventual zeros, or quantum eventual zeros, makes getting your account to go up feel like running through mud.

I don’t bring this up to talk about what happened, but to talk about what I think will happen next. After Nvidia broke, value stocks massive outperformed as the short sides of the pairings to the Nvidia longs captured huge amounts of the escaping liquidity from Nvidia/semis. Heck energy even outperformed until the end of July. Crazy times!

This gap between equal weight and market cap weight will close at some point near term, maybe not back to zero, but it will shrink. The question is do you think it’ll be because equal weight will again out preform (flat mega caps long smaller sectors), will it be because market cap will come down (short Megas against flat rest of the market), or some mix of the two? I have some more thoughts below.

On top of how you think the gap will close, is when do we think it will start to. I think that is an easier answer. It either starts Monday midday as tax loss selling/de-grossing abates or at the latest after we get the FOMC decision mid-day Wednesday. Even if it takes until Wednesday I think the worst of the performance spread is behind us as more and more investors shut down for the remaining part of the year.

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Before we jump into Broadcom’s earnings, I wanted to talk about what 2 weeks of negative breath, while the market went higher, means. It means we’re getting close. The next 6 - 8 weeks are usually bullish as once the liquidity suck, in this case bitcoin and tesla, break, the broad market rallies and keeps the market flat at the worst. Then once that rebalancing is complete the whole market pukes its guts out, and we go down. How far down is answered by how the real economy is doing, as a stronger economy means a higher floor. Again, looking back at June Nvidia peak, from mid-June until the last week of July value massively out preformed as stuff like the PHANTVM index cruised to almost a 14% spread versus the index. This is what the heat map of the last week of July looked like:

The stuff that was losers going into the Nvidia peak found massive bids, and the stuff that had been ripping threw up. Once the rest of the market joined them in the sell off because short covering was done, the market flew downwards. Not helped by the yen explosion.

I think we can expect a similar timeline to then. Once the rotation toward RSP/the laggards happens, it will likely continues until the end of January, which puts us right at the inauguration. Then the market will decide what it wants to do next.

To be clear I’m not saying I expect a crash around the end of January. No. I’m expecting a solid 8 - 10% pullback within the next six months, but not sooner than at least two months out. That’s the window for when this advantage decline divergence tends to affect the top part of the index. At some point between the end of month two and month six. With the first little aggressive sell off happening around the two-month mark. The party isn’t over, but its time to start thinking about how much longer until last call.

Until then? Mostly still risk on. Though a risk on from here that favors the short pairings in the long/short Hedge fund trades.

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I think Broadcom’s earnings gave us some hints as to what stocks NOT to buy if the rotation thesis plays out. Broadly, Broadcom has two divisions, they have their AI related chip set division, and EVERYTHING ELSE. While this isn’t how they defined the parts of their business on their slide deck nor in their comments that is how the market, at least on Thursday, deemed their earnings.

AI business? Booming, and based on guidance gonna boom even harder over the next 12 months. The non AI part, missed. Not great. The AI beat and implied guidance raise was so nice to completely overshadow the rest of their business. VMware has been a real winner for them though.

There’s were some warning signs within the AI space ones I think the market is starting to pay attention to.