Time to Reduce Equity Risk: Why Underappreciated Macro Risks Could Derail the Bull Market | Warren Pies

Warren Pies discusses the growing impact of macro risks on the market, particularly following a strong earnings season that led to a downgrade of stocks. He expresses skepticism about how the market is pricing these macro risks and notes that correlations during the earnings season were lower than expected. Pies emphasizes the necessity of reducing risk in light of an unfavorable market structure and potential macro challenges ahead.

He predicts a blue wave in the upcoming midterm elections and highlights a significant decrease in the likelihood of a September Fed rate hike, dropping from 75% in July to 30%. Pies believes that political pressures and inflation concerns will likely compel the Fed to raise rates, despite the market's overly dovish response to recent economic data. He points out that the Fed's willingness to overlook economic indicators is waning, and the decline in the unemployment rate is being misinterpreted.

Pies notes that rising oil prices are contributing to inflationary pressures that the Fed cannot ignore. He expresses uncertainty about how the Fed committee, particularly with the influence of perceived dove Warsh, will respond to these pressures. If a rate hike occurs, he anticipates a flattening of the yield curve, consistent with historical patterns.

He discusses the current term premium, which stands at around 80 basis points, indicating limited credibility in the Fed's inflation-fighting efforts. While there are concerns in the tech sector, Pies highlights that nine out of eleven sectors have exceeded earnings expectations, suggesting overall market strength. However, he warns that the market lacks significant upside unless leadership from the tech sector broadens.

Pies raises alarms about the AI sector, noting that recent annual recurring revenue numbers fell short of expectations, which could impact capital expenditures in the AI ecosystem. He emphasizes the importance of the semiconductor sector, which now constitutes 18% of the S&P market cap. For the bull market to persist, he believes both mega-cap tech and semiconductors must regain strength simultaneously.

He discusses Apple's evolving role, suggesting it has become a defensive play for investors, akin to traditional offsets. Pies stresses the need for the market to regain confidence for stocks, particularly hyperscalers, to rise collectively. Despite some positive earnings reports, the return on investment in the tech sector remains uncertain.

Pies predicts that if data centers begin recontracting at higher GPU rental rates, cloud revenue could see a significant boost. However, he warns of potential downturns in technology that could negatively impact the market, alongside political challenges that may impede data center expansion. He notes that the recent earnings season has clarified the return on investment question for data centers.

He expresses skepticism about the influence of AI build-out issuance on the treasury market, asserting that net issuance from hyperscalers has not been substantial. Pies attributes rising capital costs more to federal government actions than to hyperscaler issuance, suggesting a tendency to find scapegoats for various economic issues.

The energy sector has performed well in the first half of the year and continues to show strength, with some advocating for a more permanent allocation of energy assets in investment portfolios. They maintain an overweight position in energy and do not foresee changes to this stance.

In the software sector, there is a sense of nervousness, particularly during IPO periods, with software and services outperforming semiconductors by about 30% in Q3. Pies emphasizes the semiconductor sector's critical role in market movements, noting that current dynamics show sector-level correlations despite claims of overall low correlations.

Pies concludes that if macro risks materialize, the market will revert to previously successful trades. He advises against planning trades without a clear understanding of how macro risks will unfold, while also highlighting that the AI trade is expected to lead the market. Multi-strategy funds are currently pairing trades, being long on AI while shorting unrelated stocks, as the market experiences a grind higher that requires a macro risk or earnings narrative to catalyze a breakout.