By Peter Tchir of Academy Securities. Last weekend’s Fog of War T-Report listed ‘lack of liquidity’ as our number one fear, and even Friday’s ‘positive’ price action was highly suspect. We remain incredibly concerned about liquidity and market structure, such as leveraged ETFs, momentum strategies masquerading as passive, and 0DTE. Much of the rest of last weekend’s report focused on jobs and the economy, which to us crystallized on Friday as a likely 25 bps hike in September. We think markets will struggle with a ‘plodding’ Fed, and that seemed to play out.This isn’t about what we think the Fed should do, but what the Fed will do. Maybe they will surprise us with a 50 bp cut, but given all their messaging and available data, that seems unlikely.

Backtracking a touch, we started the week with more things to watch focusing on Bitcoin and Single Stock Leveraged ETFs, which remain topical. I remain bearish on equities based on my economic outlook, the Fed response function, and some valuations. Investors seem overly bullish and complacent, believing that the worst is behind us based on the VIX Hit 65 report. I suspect we won’t see a repeat of early August but note that the Nasdaq 100 closed at 18,421, lower than 18,441 on August 2nd. Although no one talks much about the yen carry trade, the yen closed at 142.30, lower than 144.2 on August 5th. Bitcoin, with its $1 trillion market capitalization, also closed near its August 2nd price and is at its lowest level since February.

The first Friday in August and the week leading up to it resemble what we’ve just experienced in September. I doubt we will see a similar trading pattern over the weekend. What’s particularly important is that most of August’s extreme moves occurred before U.S. stock markets were open, making it easier to ignore volatility. By the time U.S. markets opened on August 5th, the worst was over. This differs from when markets sell off during high media coverage. The Gell-Mann Amnesia Effect, as coined by Michael Crichton, is palpable here. You read an article in a field you know well and realize the journalist has no understanding, but then accept the next article in a different field as accurate.

Generative AI is hitting a similar point of disillusionment. Initial excitement fades as mistakes and inaccuracies emerge. Checking generative AI outputs takes time, and unlike researching on your own, you don’t learn much. Despite its promising future, the current costs for generative AI are high, with rising expenses in chips, storage, and energy. The popularity and demand have driven costs up rapidly, making it worth questioning if the investment still pays off today. Are companies seeing the expected ROI on their AI investments, or would other investments have yielded better results?

Confusion about these questions may trigger pullbacks in the market. I remember when simply having a ‘China Strategy’ made stocks pop, though it didn’t always end well. We should be cautious about the current market ebullience. If we consider the ‘First Friday’ graph, more downside remains if we revisit April lows or the start of the year levels.Single-name stock ETFs like NVDL, with built-in drag, bewilder compliance departments and corporate coverage teams. These ETFs see increased inflows despite underperformance compared to the stocks they track, signaling underlying market froth.

Too many Fed cuts are priced in, and though data might validate them, for now, I’d fight the number of expected cuts. The 2s vs 10s closed the week positive, targeting 20 bps, with anticipated weakness in Treasuries due to the auction.Credit spreads suggest a ‘bumpy landing’ scenario rather than a recession, although wider spreads are expected. High yield and leveraged loans might not face serious repricing because private credit and banks continue to put money to work. Equities might take out the August lows, with small caps and value sectors potentially outperforming. However, heavily weighted indices and trader behavior might hinder positive performance, making better buying opportunities available in the future.

Reflecting on the Gell-Mann Amnesia Effect in T-Reports illustrates the disconnect between perceived and actual market capitulation. I expect more bumps and lower lows, given the false belief in market stabilization.