Jeff deGraaf: Erase Chips From Your Memory

Micron Technology

Across the shows: 2 speakers in other episodes, 0 bullish and 1 bearish calls, past 30 days

• Jeff deGraaf · Renaissance Macro ResearchBearish

  Micron's 85-90% margins signal a memory peak; prices and margins likely to fall.

  Historically, peak margins equal peak prices in memory and semiconductors. The 1996 and 2000 memory peaks are the precedent, and some companies nearly went bankrupt after overbuilding. Margins of 85-90% draw competition, because engineers and capital rush in to take a share of the profit. Expecting such margins to persist for five or six years is wishful thinking, and the stocks are already behaving as if the growth curve will kink.

  “peak margins equal peak prices, in memory and in semiconductors, right? So when you're gonna tell me that the Micron, you know, margins are 85%, 90%, and that's great news, I'm gonna tell you, go back and look at 1996”at 16:51

Super Micro Computer

• Jeff deGraaf · Renaissance Macro ResearchBullish

  Super Micro Computer is one of only two chip stocks he fully endorses after new relative-strength highs.

  Most semiconductor names are showing weakening relative strength. Only two chip names have made new relative-strength highs, which he says tells him they are doing something different from the rest. He will buy relative-strength highs, and the burden of proof is on the bulls for the other names. Super Micro and AMD are the two he fully endorses.

  “There's only two semiconductors right now that we are full throatedly endorsing. And that's because they made new relative strength highs.”at 27:05

Advanced Micro Devices

Across the shows: 1 speaker in other episodes, 1 bullish and 0 bearish calls, past 30 days

• Jeff deGraaf · Renaissance Macro ResearchBullish

  AMD is one of two chip stocks he fully endorses after making new relative-strength highs.

  AMD has made new relative-strength highs, which he reads as a sign it is behaving differently from the weakening semiconductor group. He will buy relative-strength highs in this environment, and he names AMD and Super Micro as the two stocks that stand out. Micron and Nvidia are mid-pack, and some memory and fab names look weaker.

  “[SMCI] would be one and then advanced micro devices is the other. So those two stand out”at 27:53

US stock market outlook

• Jeff deGraaf · Renaissance Macro Research

  Equal-weight S&P 500 breaking down; market is bifurcated and fragile despite cap-weight strength.

  The equal-weight S&P 500 is down almost 5% from its peak and trades below its 50-day moving average, which is now curling over, so the trend has turned down. Only about 43% of stocks (48% a week later) are above their 200-day moving averages, so most stocks are below long-term trends. Only a few mega-caps keep the cap-weighted index strong, which leaves diversified or equal-weight managers underperforming. He respects the tape and says he would be more bearish if he weren't a trend follower, and he is starting to short deteriorating groups.

  “I think we were down almost 5% from the peak. It's below the fifty day moving average. That fifty day moving average is now curling over, right?”at 4:37

• Jeff deGraaf · Renaissance Macro Research

  Seasonality is the tape's most bullish factor, with December historically positive about 73% of the time.

  The three-month forward return window from here has historically been strong, and December has about a 73% probability of positive returns. The best median return is November, not October. He time-weights the data to reflect recency and says the setup is a tailwind for equities. He never lets this change his call, though. Seasonality is the most bullish factor on the tape, but it ranks tenth on his list of things he watches.

  “it's the highest probability return, if I'm right on this is December. I think it's a 73 probability of positive returns.”at 23:00

• Jeff deGraaf · Renaissance Macro Research

  Equity risk premium is only about 170bp, too thin for the risk of owning stocks versus bonds.

  Jeff cites the equity risk premium at about 170 basis points on a real-to-real basis, which he calls low. He argues investors are taking on a lot of risk by owning equities relative to the assured return of a bond, even before accounting for the interest-rate risk that can be avoided by buying TIPS. He also notes that real yields above about 2.5% have historically tended to be bearish for equities, and that real yields are now well above that level. He expects an equity correction at some point within about three years, which would make bonds the better place to hold capital in the meantime.

  “the term, the equity risk premium, about 170 basis points on a real to real basis. And that's low. You're taking on a lot of risk owning equities versus the assuredness of a bond here.”at 35:42

US Treasuries & yields

• Jeff deGraaf · Renaissance Macro Research

  Last week's Treasury auction was among the best in a decade, giving some relief.

  He describes last week's Treasury auction as very good, one of the best auctions in a decade, depending on how it is measured. He links this to the oversold financials and the Fed's position, and he asks whether it gives banks some relief going into earnings. He notes that so far it has been good.

  “given the auction that we saw in treasuries last week, which was a very good auction, one of the best auctions in a decade, depending on how you want to measure it.”at 25:44

• Jeff deGraaf · Renaissance Macro Research

  Real yields near 3% drive most of the nominal Treasury yield, more than inflation expectations.

  His decomposition of the 10-year yield uses five-year, five-year forward inflation expectations, which make up roughly 42-43% of the differential. That leaves real yields with about 57-58%. Real yields are approaching 3%, so after inflation investors are earning about 3%. The decomposition shows that real rates, not inflation expectations, are doing most of the work in the yield move.

  “So that means the real yields are the other side of it. So 58, 57% of that. And the real yields are approaching 3%”at 34:01

• Jeff deGraaf · Renaissance Macro Research

  Treasury auction was good, but record-low 2.5% dealer uptake is reassuring and can't signal a rate top.

  Jeff judges the auction good because dealer uptake was only 2.5%, the lowest since 2008. Dealers are the safety net who take leftover bids and are expected to clean up the auction. A low dealer share means the market cleared on its own and did not need the backstop, which he finds reassuring. He is cautious, however. Low dealer uptake says nothing about whether high rates are about to top out, and he says he cannot read too much into the figure historically. Indirect bidders were interested at a yield of 5.30%, which he reads as buyers seeing value at that level.

  “There was only a 2.5% uptake by dealers. That's the lowest since 2008... I mean, they saw value at $5.30... there's nothing about that that says, hey, if this is low and rates are up, does that call a top in rates? It doesn't work.”at 36:59

Credit markets

• Jeff deGraaf · Renaissance Macro Research

  Higher real rates are filtering from low-tier credit into rate-sensitive equities, then earnings, with a lag.

  In a high-inflation, middling-growth regime the Fed raises real rates to flatten a curve the 10-year is slipping out of control. Historically, rate hikes take three to six months to reach markets, though this cycle is slower. The pressure starts in credit, first in private credit and then in the lowest-tier credits, then moves into rate-sensitive equities such as utilities and REITs. It then hits aggregate demand, shows up in earnings, and by that point the market has already rolled over. The process is slow but moving in one consistent direction.

  “usually with the lag somewhere between three and six months, though this one's taken longer... it does it, on a sequential basis. First, hits credit. It hits the lower tier credits that then transpires into the more interest rate sensitive equities”at 9:18

• Jeff deGraaf · Renaissance Macro Research

  Corporate credit is the litmus test: CCC is weak and BB spreads are trending the wrong way.

  Jeff says corporate credit markets matter because they show the real-world effect of tightening financial conditions, particularly through refinancing for weaker credits. He sees stress creeping higher. CCC-rated credit is 'not great', and BB-rated credit improved a little over the week but has been trending in the wrong direction. He expects these markets to be the litmus test going forward, which is why he watches them closely as a signal of when the Fed's tightening starts to bite.

  “the credit markets are so important here, particularly these corporate markets, because they give us a real world implication of what's happening in terms of the refinancing for the less than stellar credits... CCC is not great. BBs improved a little over the week, but they've been trending in the wrong direction. And I think that's going be the litmus test as we go forward.”at 43:09

US deficit & government debt

• Danny Moses · Moses Ventures

  Federal debt over $40T and deficits above 6% of GDP will start to matter if growth slows.

  The US has never had to reconcile debt at this level, with the federal total north of $40 trillion and the deficit north of 6% of GDP. These are now real issues that will begin to seep into the market. If the economy slows, these fiscal pressures will matter more. Rates reflect inflation, growth and a term premium that investors now demand because of the country's ability to pay its debts.

  “at the federal level north of 40,000,000,000,000 deficit north of 6% of GDP. These are now real things that are going to start to seep in. And if the economy does indeed slow, these things will start to matter.”at 32:15

• Jeff deGraaf · Renaissance Macro Research

  Treasury's cash-account bond buying is a limited tool, and its options narrow as the debt ceiling nears.

  Treasury is discussing using its TGA, its checking account, to buy long-dated bonds and suppress yields by arbitraging the curve. Jeff calls it 'not a bazooka' but a limited pea shooter that can only be used for a short period. Drawing down the account, like any household, reduces future flexibility. If Treasury then runs into a debt ceiling limit, it has nowhere to turn. As options narrow, the market can see that and press on the points where Treasury would feel the most pain. He hopes the situation does not get that far, but says it has to be watched.

  “they're talking about using that to take some of that juice out of the curve... It's not a bazooka, it's a limited pea shooter that they can only use for a short period of time.”at 39:00

US growth & recession risk

• Jeff deGraaf · Renaissance Macro Research

  High inflation with middling growth is historically the worst zone for equities since the late 1940s.

  Using his market cycle clock, which plots inflation against growth, the US is in a high-inflation, middling-growth zone. Data back to the late 1940s show this is the worst zone for equities on an annualized basis, roughly 71 basis points a year. In this zone the Fed usually raises rates, the 10-year slips out of its control, and the Fed then flattens the curve by raising real rates, which eventually pressures equities.

  “right now we're in a high inflation environment and a middling growth environment. If you go back and we've got the data back to the late 1940s and in that zone, historically, it's the worst performance for equities on an annualized basis.”at 8:28

IPOs, M&A & deal activity

• Jeff deGraaf · Renaissance Macro Research

  Speculative SPAC and IPO indexes have formed clear tops and look vulnerable.

  The SPAC and IPO indexes, which he describes as the most speculative areas of the market, have made clear top formations in an indexed fashion. That makes them look more vulnerable, and he cites this as part of the same bifurcation and credit-driven rollover he sees across the market.

  “If you look at say the SPAC or the IPO index, which again tend to be the more speculative areas of the market, those have clearly made top formations in an indexed fashion, right? So those look more vulnerable.”at 10:21

Private credit

• Jeff deGraaf · Renaissance Macro Research

  Stress from higher real rates shows up first in private credit, then moves into triple-C spreads.

  He sees the grains of sand piling up first in private credit, which then works into triple-C spreads. Private equity firms, which hold much of the private credit when pressure arrives, are forming big top patterns. He reads this sequence as a sign that the stress is spreading up the credit spectrum, and he says the lowest tier moves first as it should.

  “we're seeing it pile up first in private credit, then that's worked its way into the triple c spreads.”at 10:21

AI chips & semiconductors

• Jeff deGraaf · Renaissance Macro Research

  Semis and Korean/Taiwan chip names are bubbles near top; memory names look like top formations.

  He identified semiconductors, Korea and Taiwan as bubbles at the end of April. The call was about three months early, and he says these bubbles typically top three to six months early. He recommends selling into the rally only after the stocks crack and rally back, so the memory and fab names are now ready for the rollover. He cites SK Hynix, Samsung, Western Digital and Applied Materials, which he says look like top formations after parabolic runs, and says they need to be rinsed out.

  “the semiconductors and Korea and Taiwan as bubbles, back at the end of April. It was early. I knew it would be.”at 11:48

AI bubble & tech valuations

• Jeff deGraaf · Renaissance Macro Research

  Very bullish on AI's impact, but good AI companies aren't necessarily good investments.

  He compares the Amazon and Cisco experiences from the dot-com era. Amazon was a winner, and Cisco eventually won but traded in bubble territory. Investors should separate good companies from good stocks. Some AI companies will be great investments, but the valuations and the transition from 'everyone is a winner' to winners and losers mean that most will not be. He says the heuristics investors use to put money to work are ridiculous because they don't do the homework.

  “You need to disassociate good companies from good stocks because those are two very, very different things... I am very, very bullish on AI and what AI holds in store for us as humanity in the future. But that does not mean that they're gonna end up being great investments.”at 16:01

Software & SaaS

• Jeff deGraaf · Renaissance Macro Research

  AI may compress software's growth and margins, so SaaS valuations built on long growth could collapse.

  Software was valued at about 10 times sales on the assumption of ten years of exponential growth. Once the market worried that AI would chip away at margins, that growth curve could be squeezed into two or three years, or the businesses could disappear. Valuations depend heavily on where the growth kink in the hockey stick falls, because that determines the terminal value, so the software sell-off reflects this repricing.

  “the minute that it kind of became just the thought came that maybe AI is gonna chip away at some of that margin and you take these ten years of exponential growth and distill that down into three years or two years”at 19:42

AI infrastructure & data centers

• Danny Moses · Moses Ventures

  The AI spending math doesn't work: trillions in capex won't be matched by demand, at least not soon.

  As AI matures and the economics become real rather than theoretical, the math does not work at the macro level. Trillions of dollars of spending will not be met by demand in the way the supply will need. There will be winners and losers, but the aggregate demand will not keep up, and it may only balance over a much longer term. He draws a parallel to the dot-com bubble, where an overreaction in software and financial services eventually gave way to rationality once companies actually made money.

  “the problem with becoming real is we all know that the math doesn't work. That yes, there's gonna be winners, there's gonna be losers, but there's no way that the macro, the trillions and trillions is going to meet, the demand's gonna meet the supply correctly. Maybe over the longer, longer term.”at 20:22

Banks

• Jeff deGraaf · Renaissance Macro Research

  Bank loan books, not headline earnings, are the key canary for credit stress.

  Financials go into earnings oversold but still in uptrends, which he sees as an opportunity if the group holds up. His real interest is in what banks say about their loan books, because the credit problem has been festering for six months to a year, with a time lag in reporting. He sees loan-book commentary as the canary in the coal mine, the part of the earnings reports that matters most.

  “My real interest in what we're getting out of the earnings will be what do they tell you about the credit book, right? What's going on from their loan books... I think that's kind of the canary in the coal mine that we're most concerned about”at 26:09

Earnings & corporate profits

• Jeff deGraaf · Renaissance Macro Research

  Q3 expectations are high and so far met; good tech earnings may only give a short rally.

  Expectations are high going into Q3 earnings, and so far results have met them. Second-quarter adjustments typically come to fruition in the third quarter, which gives people relief before setting up the year ahead. He is doubtful that good tech earnings, such as 85% gross margins, will be rewarded in a sustainable way. Usually good news fails to lift the stocks, they become overbought on it, and they roll over. The chart formations favor that pattern over a return to the old highs.

  “maybe the good news actually just gives a rally. Don't think they're going go down on it, but does it give you anything that's sustainable?”at 26:48

Oil & fuels

• Jeff deGraaf · Renaissance Macro Research

  Energy is his favorite sector: massively under-owned, with the best risk-adjusted momentum of any sector.

  Energy is still massively under-owned because investors fear the next headline, but the market usually sniffs that out. Every oversold condition in energy has held. Energy has the best risk-adjusted momentum of any sector in his momentum work. He calls this an incredulous advance, where people do not believe the rally, which he has seen only about once every three years. He likes the tape over consensus, though he would trim if the group gets extended.

  “it's the best sector with the best momentum. This is risk adjusted momentum. So the best risk adjusted momentum of any sector. So I like it.”at 29:46

Pharma & biotech

• Jeff deGraaf · Renaissance Macro Research

  Healthcare is a natural hedge to tech and is absorbing AI benefits; pharma and biotech look strong.

  Healthcare tends to catch a bid when tech sells off, which makes it the yin to tech's yang. He says the sector is ingesting AI benefits and will drop some of them to the bottom line. Pharma and biotech, including life sciences, have produced potentially groundbreaking developments that are not yet household names. Their momentum is strong, and the recent negative volatility alerts look like buying opportunities, because these names are not yet widely owned.

  “healthcare usually catches a bid. And I think healthcare is one of these areas that actually is ingesting the benefits AI and seeing that and, you know, going to be able to drop some of that to the bottom line”at 30:23

US dollar

• Jeff deGraaf · Renaissance Macro Research

  Strong dollar is driven mainly by high real rates and Fed credibility, and it lowers imported inflation.

  Jeff says a strong dollar lowers the inflation impact of imported goods, which is good news and tends to help forward inflation. The dollar's strength reflects two things. The main one is the Fed's credibility, which shows in high real rates: the higher the real rates, the stronger the dollar. The more recent second factor is concern about Europe, specifically France. Japan and the UK face large fiscal problems too, but they have not gone over the cliff yet. He calls the combination a double whammy, but says the more enduring trend is real rates. Those rates pull the dollar higher and put pressure on gold. Over time, that tightens financial conditions and could hit aggregate demand.

  “the strong dollar is a reflection really of two things. One is the Fed's credibility and that credibility is through those real rates and the higher those real rates, the stronger the dollar.”at 40:32

Gold & precious metals

• Jeff deGraaf · Renaissance Macro Research

  High real rates put gold under pressure, and that is what is happening now.

  Jeff links gold to real rates. Gold moves the opposite way to real rates: when real rates are high, gold should be under pressure. He says this is 'exactly what's happening'. The same real rates that drive the dollar higher are the mechanism behind the gold weakness. Real rates are high because the market believes the Fed has credibility.

  “it's just the opposite for gold, right? So if you look at gold, if you have high real rates, you would expect that gold would be under pressure. That's exactly what's happening.”at 40:48

US rates & the Fed

• Jeff deGraaf · Renaissance Macro Research

  Fed is likely to overshoot and tighten financial conditions too far, then scramble to cut rates.

  Jeff argues that at this point in the cycle the Fed usually overshoots and makes a mistake. Tightening financial conditions push the economy over the top of the hill, and the Fed does not realise it has reached the crest. The market sees it ahead of time, and the Fed then catches up by cutting rates to get through it. He says 'we're not there yet', so the view is conditional and early. He points to credit markets as the way to see when the tightening starts to spill into the real economy.

  “The problem where we are in the zone it's usually a point where the Fed kind of overshoots and they do make a mistake. You have tightening financial conditions and they push the rock over the hill. They don't realize they've reached the crest of the hill.”at 42:45