Bye iCar, Hello iAI

Here are some of the biggest stories from last week:

• Inflation in Japan topped expectations in January.
• Apple ditched its decade-long EV project.
• Cocoa futures prices surged to a record high.
• The world’s biggest digital currency continued to rally.

Dig deeper into these stories in this week’s review.

Macro

Inflation in Japan topped estimates in January, pushing Japanese two-year bond yields to their highest level since 2011. Core consumer prices, which exclude fresh food, rose by 2% from a year ago – a slowdown from the 2.3% increase seen in December but above the 1.9% expected by economists. It was the 22nd straight month in which core inflation matched or exceeded the Bank of Japan’s 2% target. The “core core” index, which strips out fresh food and energy prices, rose by 3.5% in January, also topping forecasts. The hot inflation data strongly supports the case for the BoJ to scrap its negative interest rates in the coming months. Traders widely expect a rate hike, which would be the central bank’s first since 2007, to come by April. But slightly complicating matters for the central bank is the fact that the Japanese economy unexpectedly slipped into recession in the second half of last year.

Stocks

In a surprise move this week, Apple canceled its decade-long EV project to focus on AI and headsets. For some background, Apple is still predominantly a one-trick pony, with its iPhone accounting for 52% of total revenue last year. However, the smartphone market is nearing saturation, with a 70% penetration rate globally and 82% in the US. Even India now boasts a penetration rate of 62%. What this means is that iPhone sales are mainly driven by the replacement cycle. Problem is, people are holding onto their old iPhones for longer and longer. Given these factors, it’s completely understandable why Apple wants to diversify beyond its hit smartphone, and started exploring EVs as far back as 2014 in an effort to create another blockbuster product and reverse stalling sales growth.

But things have changed since then. The EV industry is slowing down, cut-throat competition from Chinese manufacturers is rising, and a price war initiated by Tesla is squeezing profits at EV firms. In the US, for example, EV sales are expected to rise by just 9% this year, after growing at a compounded annual rate of 65% over the past three years. At the same time, the explosive launch ChatGPT spurred a competitive race among tech firms in the fast-growing generative AI market – an area where Apple has faced significant criticism for its delayed entry.

So by scrapping its EV project, the company can focus on catching up with rivals in generative AI. That could be a smart move, given the long-term profitability potential of AI revenue streams versus manufacturing and selling cars. The shift also lets Apple concentrate on turning its Vision Pro headset – still a fledgling product – into a mainstream hit. But the big question is how soon can Apple make serious money from AI. The firm is planning to reveal its new AI capabilities at a conference in June – a key moment for investors trying to justify Apple’s current valuation multiple. After all, 80% of the firm’s revenue comes from hardware but its stock trades on a software multiple (its forward P/E ratio of 27x is not too far off from Microsoft’s 32x).

Commodities

Cocoa futures have been on an absolute tear this year, yet the rally shows no sign of slowing, with prices hitting a record high this week. The most actively traded cocoa futures contract in New York neared $7,000 per metric ton on Tuesday – more than double the sub-$3,000 levels witnessed just a year ago. 

The usual culprits of supply and demand are to blame. Decades of underinvestment means cocoa production has failed to keep pace with demand, which has doubled in the last 30 years. Unlike most other agricultural commodities, cocoa is mainly grown by independent farmers who own or manage small plots of land. The crop never developed into a plantation business because it simply didn’t make commercial sense at the prevailing low prices of the 1990s and 2000s. The real money in this industry has always been made around trading the beans and processing them into chocolate – not planting, growing, and harvesting cocoa trees. 

The most recent wave of tree planting in West Africa took place in the early 2000s, particularly around the northwest of Ivory Coast, which produces more than 40% of the world’s cocoa. Those trees are approaching 25 years of age, which is well past their prime. Old cocoa trees present two key problems: lower yields, and plants particularly vulnerable to adverse conditions. The latter has been a big factor behind the recent surge in cocoa prices, with drought and disease ravaging crops in West Africa. With output falling short of demand by so much, cocoa inventories are expected to decline for the third consecutive year.

Adding fuel to the fire, hedge funds have piled into the cocoa market since the end of last year, exacerbating the record-breaking surge in prices. Speculative traders have amassed an $8.7 billion bet across London and New York cocoa futures contracts that prices will continue to rise – the biggest ever in dollar terms, according to the Commodity Futures Trading Commission.

Soaring prices present a big problem for the chocolate industry, which might struggle to pass all the higher costs onto consumers and, as a result, see their profit margins fall. Chocolate lovers will inevitably pay more, and demand growth for the brown stuff could slow down or even reverse. But, whether we like it or not, this pinch is kind of needed: to keep our chocolate cravings satisfied in the long run, higher cocoa prices are needed to encourage the replanting of millions of old trees and taking better care of current ones.

Crypto

Another week, another bitcoin milestone, with the price of the world’s biggest cryptocurrency rising above $60,000 on Thursday to its highest level since November 2021. That puts it within sight of its all-time record of nearly $69,000. The simple tenets of supply and demand are at the heart of the latest surge. See, demand for the token from the new US spot ETFs is outstripping both the supply of bitcoin that long-time holders are willing to sell and the amount being produced by miners. The nine newly debuted ETFs now hold more than 300,000 bitcoins – seven times the amount of new coins mined since their launch. At the same time, around 80% of bitcoin’s supply hasn’t changed hands in the past six months. Put differently, “HODLers” aren’t cashing out during the rally.

Will bitcoin surpass its record peak of nearly $69,000? Who knows, but many say it's quite possible. That’s because the supply and demand dynamics driving the price higher remain in place. Daily ETF inflows are only getting stronger, and the halving event, expected in late April, will lower the number of new coins mined every day to 450 from 900 currently. The biggest risk for investors chasing the rally is a sharp reversal in sentiment, especially considering that leverage within the crypto sector has roared back. For example, bitcoin derivatives – which can be leveraged up to 100 times – on centralized exchanges have risen by nearly 90% since October to sit at their highest level since early 2022.

Next week

• Monday: Eurozone economic sentiment (March).
• Tuesday: China PMI (February), eurozone producer prices (January), US factory orders (January). Earnings: CrowdStrike.
• Wednesday: Eurozone retail sales (January), Bank of Canada interest rate announcement, US job openings and labor turnover survey (January). Earnings: JD.com.
• Thursday: European Central Bank interest rate announcement. Earnings: Broadcom, Costco.
• Friday: Japan household spending (January), US labor market report (February), China loan growth (February).
• Saturday: China inflation (February).