Is Big Tech Back in the Driver’s Seat?

Do you remember when big tech was the ONLY place to invest?

Let’s rewind to the days before half the world closed its doors. From the end of 2018 to the pre-pandemic peak, the S&P 500 Information Technology Sector rose 65%. The Communication Services Sector, which sported 20% weights to both Alphabet and Facebook, jumped 40%. The S&P 500 itself climbed 35%. Not a bad year for investors, right? So long as they had their money in the right place, that is.

Over that 13 month period, every other sector underperformed the index.

Every market historian knows that the bulk of historical index returns are generated by a handful of names (that’s why we focus so much on identifying relative strength). Rarely, though, has that phenomenon been so readily apparent as it was that year, when more than 80% of sectors lagged the index.

COVID wasn’t the end of that story. In fact, forcing millions of people and their employers to embrace a digital transition was just gasoline on the fire. In the first 8 months of 2020, the Russell 1000 Growth index surged 45% relative to its Value counterpart.

Then came September 2020.

In just 3 days at the start of the month, growth stocks dropped 10%. Value fell only 4%. We couldn’t have known it at the time, but that day would mark the end of growth’s dominance. Value oriented stocks – especially in the Energy and Industrials sectors – have been in the driver’s seat ever since.

Big tech’s trouble couldn’t have started at a more logical place – the same place trouble began more than 20 years ago. Tech’s relative strength peaked exactly at the monthly highs from the internet bubble. Last time, it resulted in an 80% collapse for the sector, and a run of lackluster performance that didn’t reverse until the financial crisis. The question is, will history repeat itself?

The answer may rest on the path of interest rates. Financial assets have benefited from 40 years of falling interest rates since the early 1980s. Not only have lower rates reduced borrowing costs and helped drive economic expansion, they’ve also forced investors out the risk spectrum. An investor that once was happy with a risk-free Treasury yielding 6% hasn’t had that option since the turn of the century. Instead, they’ve had to allocate funds towards riskier asset classes – high yield bonds, real estate, stocks, etc. And because interest rates are a primary component of the discount rate used to estimate the value of most assets, stocks with higher long-term growth expectations have disproportionately benefited.

That 40-year run for rates may be at an end, though. With inflation far above the Federal Reserve’s 2% target, they’ve raised short-term borrowing costs at 9 consecutive meetings since last March. Interest rates across the curve have risen to levels not seen since the Financial Crisis.

Growth stocks felt the consequences in 2022. Information Technology, Communication Services, and Consumer Discretionary (dominated by Amazon and Tesla) were all leaders on the downside. Value and risk-off sectors, meanwhile, held up significantly better.

In 2023, though, the narrative has reversed. Tech, Communications, and Discretionary are each up double digits, while everyone else is in the red.

Interest rates again are largely to blame. The 10-Year Treasury yield has retreated from last year’s highs and is threatening to fall below support. If it does, big tech is set to remain in the driver’s seat.

Besides a resurgence in yields, what’s the biggest risk to this narrative? The ‘why’ of interest rates breaking down.

In the first few months of the year, economists and investors began to believe the Federal Reserve was close to achieving a so-called ‘soft landing’, i.e. controlling inflation without causing a recession. If so, rate hikes would soon be at an end, and investors could be more confident in valuing a growing company’s prospects.

With the failure of Silicon Valley and Signature Bank, though, that soft landing scenario seems unlikely. Deposits are flowing out of banks across the country and into money-market funds, and banks will almost certainly respond by pulling back on credit issuance. Those types of credit crunches often lead to recession.

Markets have responded by pricing in a series of rate cuts by the Fed in the back half of this year, and the prospect of lower rates brings with it all those growth stock tailwinds of the 2010s. While Financials, Industrials, Energy, and Materials sectors have all dropped since SVB’s collapse, Tech, Communications, and Discretionary are doing just fine.

The question is, will Powell & Co. play along? Powell isn’t forecasting cuts this year, and neither are his colleagues. But they don’t sound too confident in a soft landing either. Instead, they continue to point towards the risks of removing restrictive policy too early, lest they repeat the mistakes of the 1970s. Their mandate is to maintain price stability and full employment, and they can’t achieve the latter without first ensuring the former. In other words, Powell’s Fed may not offer the same monetary support that we’ve grown accustomed to during recent recessions.

If that’s the case, it may not matter which sectors are showing relative strength – they’ll all be facing some serious pressure. Bear markets that coincide with recessions often take years to find a bottom. And you’d be hard-pressed to find one that’s bottomed before the recession even began. That’s the crux of the bear case for stocks.

Here’s one final chart to chew on: Tech is back above those monthly, internet bubble highs, and it’s set to challenge the weekly level.

If Information Technology, the biggest sector in the index, is setting new all-time relative highs… well, good luck defending that bear case.

The Weekly Wrap: March 27, 2023

Week in Review

Stocks rebounded last week, rising more than 1%. The NASDAQ Composite continues to be the leader in 2023, up nearly 13% for the year. The Dow Jones Industrial Average, meanwhile, remains in negative territory. Interest rates fell modestly, and the US Dollar had its largest weekly decline since January. Oil prices rose 3.8%, offsetting some of the prior week’s 13% drop. Gold slipped 0.6%, and Bitcoin rose 1.9%.

The Federal Reserve raised its benchmark interest rate for the ninth consecutive meeting last Wednesday. The 0.25% hike was smaller than what most analysts expected prior to the failures of Silicon Valley Bank and Signature Bank, but turmoil in the financial sector was not enough to make the inflation-focused Fed keep rates unchanged. Notably, the FOMC statement, along with the quarterly Summary of Economic projections, implied that rate hikes will soon be in the rearview mirror. Markets are priced for more extreme reversal, including a series of rate cuts by year-end. Federal Reserve Chair Jerome Powell, however, reiterated at his post-meeting press conference that containing inflation was his top priority, and the Fed wouldn’t hesitate to reaccelerate the pace of policy tightening if needed.

Market Internals

Less than half of all S&P 500 stocks are in an uptrend, and that’s true whether you’re looking at them on short, intermediate, or long-term timeframes. Recent weakness has been most pronounced in cyclical sectors – Energy, Materials, Industrials, and Financials. Those sectors were the leaders in 2022. Now they’re the clear laggards.

Trends within the Information Technology sector are the healthiest. Nearly two-thirds of stocks in that sector are above their 100 and 200 day averages. And more than half are above short-term averages. Health Care, Consumer Staples, and Utilities all benefited from risk-off action within the last week.

What’s Ahead

Here’s the key economic data scheduled for this week.

The Weekly Wrap: March 20, 2023

Week in Review

Price action was mixed last week, as markets digested the failures of Silicon Valley Bank and Signature Bank. The Dow Jones Industrial Average declined for the sixth time in seven weeks, dragged lower by cyclical sectors like financials, industrials, and energy. Both the S&P 500 and the NASDAQ, however, rebounded sharply, helped by their exposure to growth stocks. Crude oil dropped nearly 13%, falling to its lowest level in more than a year. Commodities not exposed to economic activity, though, rallied sharply. Gold rose 6.5%, and Bitcoin jumped by a third to its highest point since last June. Interest rates were volatile during the week, falling sharply on Thursday and Friday. The US Dollar Index declined 0.9%.

Investors will be watching closely this week, as they wait to see how Fed Chair Jerome Powell and his peers respond to recent turmoil in the banking industry. On Wednesday, the FOMC will decide whether or not to continue hiking interest rates in their battle against inflation. They’ll also release an update to the Summary of Economic Projections, which details members’ internal forecasts for future activity and policy actions. Just two weeks ago, it seemed another hike of 50 basis points was inevitable. Now, even a 0.25% increase is questionable. In any case, expect Powell to face some difficult questions at his post-decision press conference. It will be his first opportunity to publicly address bank failures.

Relatively Speaking

Information Technology and Communication Services are the only two sectors that managed to gain ground over the last month, as the S&P 500 index dropped 4%. Losses were led by Financials, which dropped more than 15%. Other economically sensitive sectors also lagged, as Energy, Real Estate, and Materials each underperformed the index.

Year-to-date performances are largely the same. Growth-focused sectors like Information Technology and Communication Services are outperforming the broader index, with each up by double-digits. Energy and Financials, thought, are each down by double-digits. It’s the inverse experience of 2022, when tech-like stocks led the market selloff.

What’s Ahead

Here’s the economic calendar for the week ahead. Market watchers will be most focused on the Federal Reserve interest rate decision, scheduled for Wednesday afternoon.

Don’t Sleep on the Small Caps

The return of high-flying growth stocks has stolen the show this year.

The NASDAQ Composite, which lagged throughout all of 2022 and ended the year 35% from its all-time highs, has risen more than 11% in 2023. That far outpaces gains in the value-oriented Dow Jones Industrial Average (+0.7%) and the benchmark S&P 500 Index (+5.4).

Slipping under the radar, though, have been small cap stocks. They’ve quietly gained 9.8% to start the year, and that run of outperformance could continue. Compared to the S&P 500, the Russell 2000 bottomed last May.

It’s been all higher highs and higher lows since then.

Last year’s back half outperformance was largely attributable to differences in sector weights. The Russell 2000 has more exposure to Financials, Health Care, Industrials, and Energy, (all areas that outperformed) and is underweight Communication Services and Tech (sectors that lagged).

But that isn’t the story this year. On a like-for-like basis, small caps have simply been better.

Continue reading “Don’t Sleep on the Small Caps”

The Weekly Wrap: March 6, 2023

Week in Review

Stock prices rose last week on the back of continued leadership from the NASDAQ Composite, which climbed 2.6% to push its year-to-date gains to 11.7%. The S&P 500 Index rose 1.9%, and the Dow Jones Industrial Average, which has lagged so far in 2023, rose 1.75%. Crude oil volatility continued, as it jumped 4.4%. For the year, it’s relatively unchanged. Gold rose into positive territory for the year, while Bitcoin dropped 5.4%. Interest rates rose, and the US Dollar Index declined.

Layoff announcements have filled the newswires of late, but that hasn’t seemed to dampen the US labor market. In fact, jobs growth during January surged to more than 500,000, the highest level in six months. We’ll see whether that strength continued in February. The Bureau of Labor Statistics will release their latest payrolls data on Friday, where investors will be watching for signs that the Federal Reserve’s war on inflation is starting to take effect. Another strong report would likely raise the odds of a 0.50% hike at the Fed’s March meeting. Today, markets are pricing in expectations of a more mild quarter-point hike instead.

Earnings Expectations and Valuation

The equity selloff in 2022 was not driven by a deterioration in corporate earnings. Though stock prices dropped well over 20% from their peak to trough, expected future earnings remained stubbornly high. That divergence pushed the S&P 500 forward price-to-earnings ratio from more than 20x (a level previously seen only during the late-1990s) to 15x (a level in-line with historical averages).

So far, 2023 has been the opposite experience: stock prices are rising, but earnings are not. In fact, consensus expectations for future earnings are falling. At the beginning of the year, analysts expected 7% EPS growth in 2023. Now they expect earnings to decline. The result is that valuations are elevated once again. The S&P 500 currently trades at a forward multiple of more than 18x.

What’s Ahead

The labor market will be in focus this week, with the BLS announcing February jobs data on Friday. ADP’s estimate of jobs growth arrives on Wednesday morning before the opening bell, followed by January job openings a few hours later. The final estimate for January durable goods orders is released on Monday morning. On Tuesday and Wednesday, Fed Chair Jerome Powell will have ample opportunity to reshape expectations for the upcoming FOMC meeting, when he testifies in front of the Senate Banking Panel and the House Financial Services Committee.

The Weekly Wrap: February 27, 2023

Week in Review

The S&P 500 had its worst week since December and the Dow Jones Industrial Average dropped 3%, falling into negative territory for the year. The NASDAQ Composite led equity declines for the week, but the growth-focused index is still the best performing major index in 2023, up 8.9% since December. The US Dollar Index jumped 1.3%, its largest 1-week gain in 5 months, and bond returns continued to disappoint as 10-year Treasury bonds fell 1%. Crude oil was flat, and gold prices fell. Bitcoin dropped 6%.

Inflation data released in the month of February consistently disappointed market participants and Fed-watchers alike, as disinflationary trends from November and December slowed. Last week, market declines accelerated when the BEA published updated GDP estimates for Q4 2022 and the PCE Price Index for January. Together, the reports painted a rather bleak picture: growth from consumer spending is slowing and will face even more pressure as excess savings are depleted. Meanwhile, the disinflationary benefit from goods deflation is dissipating, while services inflation continues to creep higher. One month of data does not make a trend, but anyone hoping for evidence that the Fed can achieve a ‘soft-landing’ was surely disappointed by last week’s news.

Market Internals

Despite February volatility, more than half of all stocks in the S&P 500 are in long-term uptrends, as indicated by their positions relative to a moving average price. Between 50% and 60% of issues are above 100 and 200-day moving averages. Short-term trends, though, are significantly weaker. More than 80% of stocks companies are trading below a 20-day moving average.

Uptrend breadth is strongest in risk-on areas of the market. Three-quarters of stocks in the Financials and Consumer Discretionary have healthy, long-term technical structures, while more than 60% of members in the Materials and Industrials sectors are similarly strong. The Utilities and Real Estate sectors are in the weakest technical positions.

What’s Ahead

We’ve got a full week of economic releases ahead, but it’s mostly second-tier data. On Monday, we’ll get January numbers for durable goods and pending home sales. The Dallas Fed will release February numbers for their Manufacturing index as well. On Tuesday, it’ll be home prices, Consumer Confidence from the Conference Board, and three more Federal Reserve bank activity surveys: Chicago, Richmond, and Dallas (services). February manufacturing PMIs from both S&P Global and the Institute for Supply Management are set for Wednesday, and the services portion will come out on Friday. The final read on Q4 unit labor costs and productivity is slated for Thursday.

The Real Market Leaders

In case you haven’t been paying attention, it’s the tech-like names that have led to start 2023. Communication Services, Consumer Discretionary, and, of course, Information Technology. Those sectors were the undisputed champs of the raging bull market of the 2010s, and they’re at the front of the pack again in 2023.

Just don’t let a few weeks of outperformance distract you from who the real leaders of this market are.

The Industrials are still showing relative strength.

Continue reading “The Real Market Leaders”

The Weekly Wrap: February 21, 2023

Week in Review

The NASDAQ continues to lead equity gains in 2023, as the tech-heavy index rose 0.6% last week. Both the S&P 500 and the Dow Jones Industrial Average, meanwhile, ended up in the red. The US Dollar Index rose for the third week in a row, putting a lid on commodity prices. Crude oil fell 4%, and gold prices dropped 1.3%. Bitcoin rose nearly 8%, adding to its impressive year-to-date gains, while 10-Year Treasury futures flipped into negative territory for the first time all year.

Relatively Speaking

Risk-on sectors have outpaced risk-off areas of the market over the past month. Consumer Discretionary has risen 7.5%, while Information Technology and Communication Services have each more than doubled the return of the benchmark S&P 500. Energy stocks have brought up the rear, lagging the index by nearly 9%.

Year-to-date performances are largely the same. Growth-focused sectors like Consumer Discretionary, Communication Services, and Information Technology are outperforming the broader index, with each up by double-digits. Risk-off and value-oriented sectors are lagging. It’s the inverse experience of 2022, when tech-like stocks led the market selloff.

What’s Ahead

Markets are closed on Monday as we celebrate the birth of George Washington. On Tuesday, look for preliminary results from S&P Global’s February PMI surveys. We’ll also get the January number for existing home sales. Minutes from the latest FOMC meeting come on on Wednesday, before a flurry of data arrives to end the week. On Thursday, it’ll be the second read on Q4 GDP, along with the Chicago Fed’s National Activity Index, and the Kansas City Fed’s Manufacturing Index. On Friday, we’ll get the January measure for the Fed’s preferred measure of inflation, the PCE deflator. We’ll also get personal income and spending, new home sales, and results from the latest University of Michigan Consumer Sentiment survey.

Inflation Matters to Mr. Market

Whether we like it or not, economic data matters to the markets. Not every report will move prices, but each one has its place in building the macroeconomic puzzle. This week’s inflation update could be particularly important. Equity prices for the last year have mirrored changes in interest rates and foreign exchange rates. Rates and currencies are being impacted by central bank policy. And central banks are being forced to act in response to high inflation. Let’s break it all down.

Those who’ve followed this blog know that interest rates and currencies were the big drivers of equity price action in 2022. Check out how closely the three moved together:

Those relationships seem natural – a stronger dollar negatively impacts corporate earnings, and higher interest rates increase the cost of capital and decrease the present value of future cash flows. Still, the correlations typically aren’t that strong. Last year was nearly unprecedented.

So if interest rates and currencies are what’s driving the stock market, what’s driving interest rates and currencies? The most obvious answer is central bank policy. The US Federal Reserve began using forward guidance to tighten financial conditions in the summer of 2021, and then began hiking short-term rates last March.

Continue reading “Inflation Matters to Mr. Market”

The Weekly Wrap: February 6, 2023

Week in Review

The NASDAQ Composite rose another 3.3% last week, bringing its year-to-date rise to 14.7%. The S&P 500 index rose 1.6%, while the Dow Jones Industrial Average, which has less exposure to the high-flying tech stocks that led the markets this year, fell slightly. The Dollar index rose 1%, putting pressure on commodity prices. Gold dropped 3.3%, and crude oil prices fell 7.9%. Interest rates rose modestly, pushing bond prices lower. Bitcoin continued its strong start to 2023 by climbing another 2%.

The Federal Reserve hiked interest rates another 0.25% last Wednesday, taking their targeted overnight lending rate to a range of 4.50% to 4.75%. That’s the highest their policy rate has been since 2007. At his post-meeting press conference, Fed Chair Jerome Powell reinforced previous guidance for continued hikes and a terminal rate above 5%. He’s encouraged by recent inflation data and the resiliency of the labor market, but said it’s premature to declare victory. When confronted with the reality that markets are pricing in rate cuts in the latter half of the year, Powell repeated that rates will likely need to remain elevated for ‘some time’ in order to achieve the Fed’s mandate of price stability.

Earnings Expectations and Valuation

The equity selloff in 2022 was not driven by a deterioration in corporate earnings. Though stock prices dropped well over 20% from their peak to trough, expected future earnings remained stubbornly high. That divergence pushed the S&P 500 forward price-to-earnings ratio from more than 20x ( a level previously seen only during the late-1990s) to 15x (a level in-line with historical averages).

So far, 2023 has been the opposite experience: stock prices are rising, but earnings are not. In fact, consensus expectations for future earnings are falling. At the beginning of the year, analysts expected 7% EPS growth in 2023. Now they expect earnings to be flat. The result is that valuations are elevated once again. The S&P 500 currently trades at a forward multiple of more than 18x.

What’s Ahead

The Q4 reporting period continues this week. About half of S&P 500 constituents have reported so far, and nearly 100 more will released results for the quarter in the week ahead. The economic calendar is virtually empty – aside from NFIB Small Business Optimism on Tuesday, the only top-tier release will come on Friday when the University of Michigan updates its consumer sentiment index. The void will be filled by Fed-speak. Jerome Powell talks at a conference in Washington on Tuesday, and most other FOMC participants will update the markets on their own views throughout the week.