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 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.

The Weekly Wrap: March 13, 2023

Week in Review

The stock selloff that began in February has continued into March. Each the S&P 500 Index, the NASDAQ Composite, and the Dow Jones Industrial Average declined more than 4% last week. The S&P 500 is now up less than 1% on the year. The Dow, meanwhile, has fallen nearly 4%, while the NASDAQ is still up more than 6%. Crude oil dropped 3.8%, and Bitcoin fell 7.8%. Gold managed to shake off a weak Monday and Tuesday to end the week 0.6% higher, while the Dollar was mostly unchanged. Interest rates declined.

Any attempt to summarize last week’s market action will fail to do it justice. Things got off to a hot start, when Fed Chair Jerome Powell sat before the Senate Banking Panel and testified that recent economic data would likely require a higher terminal Federal Funds Rate and could force the committee to reaccelerate the pace of interest rate hikes. Financial markets responded in no uncertain terms – stock prices cratered, the Dollar index jumped to its highest level in 4 months, and short-term interest rates moved to new 15-year highs. Powell attempted to walk back those remarks somewhat on Wednesday when he appeared before the House, saying no decisions had been made about the upcoming FOMC meeting. All of that was overshadowed by what happened after the market closed. Silicon Valley Bank, one of the country’s largest regional banks, announced plans to raise capital on Wednesday evening. By Friday morning, the bank was placed into receivership with the FDIC. It’s the largest bank failure since 2008. Expect those 48 hours to be the basis of a collection of books.

Monitoring Macroeconomics

GDP grew at a healthy pace in the final quarter of 2022, helped by a surge in inventories and strong net exports. Economists widely believe that a recession will hit the United States sometime in the latter half of this year, as the Federal Reserve’s battle with inflation heats up and financial conditions tighten. The odds of a ‘soft landing’ – a scenario where the Fed successfully contains prices without creating widespread economic hardship – declined after February data showed the US economy continues to run hot.

Measures of inflation remain well above the Federal Reserve’s 2% target, but CPI has decelerated for 7 straight months, and measures of core price changes have dropped below 5%. Unemployment, meanwhile, remains near 50 year lows, and job creation to start 2023 has been well above the level needed to keep pace with population growth.

What’s Ahead

The SVB saga will continue to dominate the headlines on Monday, as investors grapple with the risk of contagion spreading across the financial system. On Tuesday, though, the narrative and focus could shift, when the BLS unveils its consumer price index for February. We’ll get additional inflation data on Wednesday with the producer price index, along with retail sales, business inventories, and the NAHB housing market index. On Thursday, look for updates on housing starts and import and export prices. The latest University of Michigan consumer sentiment survey results are scheduled for Friday, and so is industrial production. Additional business surveys are scattered throughout the week, including NFIB’s Small Business Optimism, the Philadelphia Fed’s Business Outlook, and the New York Fed’s Services activity.

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.

The Weekly Wrap: February 13, 2023

Week in Review

Stocks suffered their worst week of the year, with the NASDAQ Composite failing to closing higher for the first time since December. Despite its, 2.4% decline, the NASDAQ is still outpacing other US equity indexes year-to-date, with a 12% gain. The Dow Jones Industrial Average was flat, and the S&P 500 Index fell 1%. Crude oil is going nowhere fast – in 6 of the last 10 weeks, oil prices have moved 7% or more. From start to finish, though, the total change has been only 0.3%. Gold prices were flat for the week, despite a strengthening Dollar, and Bitcoin dropped 7.7%.

These days, inflation readings are the most important piece of the economic puzzle. Measures of price increases have steadily declined for the past few months, giving rise to the belief that Federal Reserve rate hikes will soon be at an end. Tuesday’s CPI report for the month of January could reinforce that narrative, or topple it. December’s reading dropped sharply, aided by declines in food, energy, other commodities, and autos. If some of those declines reverse and services inflation remains elevated, markets may respond by pricing in more action from the Fed.

Monitoring Macroeconomics

GDP grew at a healthy pace in the final quarter of 2022, helped by a surge in inventories and strong net exports. Economists widely believe that a recession will hit the United States sometime in the latter half of this year, as the Federal Reserve’s battle with inflation heats up and financial conditions tighten. Recent positive surprises in economic data, though, have increased the odds of a ‘soft landing’ – a scenario where the Fed successfully contains prices without creating widespread economic hardship.

Measures of inflation remain well above the Federal Reserve’s 2% target, but CPI has decelerated for 3 straight months, and measures of core price changes dropped below 5%. Unemployment, meanwhile, dropped to its lowest level in almost 70 years in January.

What’s Ahead

All eyes are on Tuesday’s CPI report, where forecasters expect to see inflation decelerate for the seventh straight month. The following day, we’ll see how consumer spending bounced back after a weaker December retail sales report. We’ll also get the January read on industrial production and the Empire State Manufacturing Index. On Thursday, we’ll be watching producer prices, as well as a housing data dump including housing starts, building permits, and the NAHB Housing Market Index. Fourth quarter earnings season also continues.

A Broad Look at Market Breadth

Stocks are surging to start the year, leading many to believe the bear market lows are in. This week, we’re taking a broad look at market internals to gauge the health of this advance.

The reason we watch breadth is pretty simple: the more stocks that participate in a trend, the stronger that trend is. A handful of large stocks can drive cap-weighted index prices higher (or lower) by themselves. Sometimes they can do it for longer than people expect. But they can’t do it forever. Monitoring stock market participation is one way to monitor the durability of a trend.

The cumulative advance-decline line might be the most well-known of breadth indicators. Its calculation is fairly simple: an index is created by cumulatively adding or subtracting the net of rising vs. falling issues for each trading day. If a greater number of stocks are rising than falling, the advance-decline line rises, and vice versa. No indicator is infallible, but the NYSE Advance-Decline line has reliably diverged from prices before several major stock market selloffs. Its track record is less reliable during bear market recoveries, but that’s not a reason to ignore the A/D line entirely – it can still offer useful information.

Right now, the A/D line for the NYSE is at its highest level since last August, and it’s broken the downtrend line from the 2021 highs. At the very least, that’s evidence of the downtrend in advances weakening.

Similarly, the A/D line for the NASDAQ Composite is at multi-month highs and just below the lows from last spring. For A/D lines like this, we don’t view prior lows or highs as areas of support or resistance, per se. This isn’t a tradable index, so there’s little reason to treat it as such. But conceptually, it makes sense that if this line recovers above those former turning points, breadth must be stronger than it was back then.

Continue reading “A Broad Look at Market Breadth”

A Changing of the Guard? Growth vs. Value

2022 was the year that Value made a comeback. For more than a decade, ‘Value Investor’ was synonymous with ‘Serial Underperformer’. From the lows in 2007 to the highs in 2021, the S&P 500 Growth Index outgained its Value counterpart by a whopping 170%. Last year, it gave up a third of those relative gains.

Now the S&P 500 Growth/Value ratio is nearing a pretty important level: the internet bubble highs. I’ve spoken at length on this blog about the significance of historical turning points, even ones from 20 years ago. Wouldn’t it make sense to see prices react as we approach those former peaks? If they do, that’ll pave the way for growth to outperform over the near and intermediate term.

It’s not just the S&P 500 flavor of growth/value that’s at a key level.

Continue reading “A Changing of the Guard? Growth vs. Value”

The Weekly Wrap: January 23, 2023

Week in Review

Stocks were mixed last week, as last year’s leaders have begun to falter, and last year’s losers continue to rally. The Dow Jones Industrial Average, an index more heavily exposed to value-oriented sectors like industrials and financials, dropped 2.7%. The growth-oriented NASDAQ Composite, however, still managed to rise 0.5%. The NASDAQ is up more than 6% to start the year. The US Dollar index has now fallen for 10 of the last 14 weeks after dropping another 0.2% last week. That provided a further catalyst to commodities and cryptocurrencies, which are off to strong starts this year. Crude oil jumped 1.8%, gold rose 0.3%, and Bitcoin rose double-digits for the second straight week.

Relatively Speaking

Risk-on sectors are outpacing risk-off areas of the market over the past month. Communication Services has risen 12%, while Real Estate, Consumer Discretionary and Energy are all up nearly 7%. Consumer Staples, Utilities, and Health Care, meanwhile, all posted negative returns.

Year-to-date performances are largely the same. Growth-focused sectors like Communications, Consumer Discretionary, and Technology are outperforming the broader index, while safety and value-oriented sectors are lagging. It’s the inverse experience of 2022, when growth stocks led the market selloff.

What’s Ahead

Nearly 20% of the S&P 500 index will report financial results for the fourth quarter this week, with large industrial companies in focus. There isn’t much economic data in the early going. The Chicago Fed National Activity index is released on Monday, and the Richmond Fed’s Manufacturing survey comes out on Tuesday. We’ll also preliminary results from S&P Global’s January PMI survey that morning. The schedule fills up after Wednesday, though. On Thursday, we’ll get our first look at Q4 GDP, along with durable goods orders, new home sales, and the KC Fed’s Manufacturing index. On Friday, we’ll see updates on personal income and spending, including PCE, the Fed’s preferred measure of inflation. We’ll also have pending home sales and the University of Michigan Consumer Sentiment survey.

Better Beneath the Surface

It’s a market of stocks.

Sometimes we can lose sight of that simple fact. We live in a world dominated by indexes. The media tells us all about the S&P 500, the NASDAQ, and the Dow Jones Industrial Average. Our portfolios are benchmarked against those same indexes, or ones just like them.

It’s hard to blame anyone for this flaw – huge baskets of stocks are the easiest way to describe market action, especially in a world where time always seems to run short. The problem is, the indexes most of us see aren’t perfect or complete descriptors. Most are weighted by market capitalization, meaning the largest companies like Apple and Microsoft matter the most. The Dow Jones Industrial Average is allocated by price, so the stocks with the highest price per share hold the largest weights. Both approaches have their merits, but they can obscure what’s happening beneath the surface.

Right now, those approaches are hiding strength.

Continue reading “Better Beneath the Surface”

The Weekly Wrap: January 17, 2023

Week in Review

Asset prices continued to rise last week, in stark contrast to last year’s broad selloff. The NASDAQ jumped 4.8%, leading gains in the equity markets. The S&P 500 rose 2.7%, and the Dow Jones Industrial Average gained 2.0%. The US Dollar index fell 1.6%, helping to spur gains in commodities and cryptos. Gold gained almost 3%, crude oil soared 8%, and Bitcoin rose a whopping 21%., reaching its highest level in more than 2 months. Treasury yields continued to fall, too, with 10 year Treasury notes rising 0.5%.

Consumer prices continued to slow in December, falling to an annual growth rate of 6.5%, down from 7.1% the prior month. Energy and other commodities are responsible for the contraction, as services prices rose to new cycle highs during the month. That may not be much of a surprise, but it is a disappointment for those hoping to see the Federal Reserve put a stop to interest rate hikes. FOMC members in recent days have shown continued support for tighter monetary conditions, with policy hawk Rafael Bostic saying he believes rates will need to stay above 5% for “a long time”.

Monitoring Macroeconomics

GDP rebounded in the third quarter of 2022 after two consecutive quarters of negative growth to start the year. A recession last year was never confirmed by the National Bureau of Economic Research, but economists widely expect one to occur in 2023.

Measures of inflation remain well above the Federal Reserve’s 2% target, but CPI has decelerated for 3 straight months, an encouraging sign. Unemployment remains historically low at 3.5%, and consumer spending, measured by retail sales, remains robust.

What’s Ahead

It’s a holiday-shortened week as the United States celebrates Martin Luther King, Jr. on Monday. We’ll only have the New York Fed’s manufacturing survey to look at on Tuesday, before producer prices, retail sales, industrial production, the NAHB housing market index, and the Fed’s Beige Book will keep us busy on Wednesday. Housing data will be in focus to close the week, with housing starts on Thursday and existing home sales on Friday. Fourth quarter earnings reports are also in full swing. The Financial and Industrial sectors dominate the schedule.