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.

March 27, 2023March 26, 2023

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.

March 20, 2023March 19, 2023

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.

March 15, 2023March 16, 2023

Mid-Month Market Update: March 2023

Technical Trends

US large cap stocks erased their hot start to the year, declining more than 5% over the past month. The S&P 500 Index has dropped back below a falling 200-day average. The Dow Jones Industrial Average is down just 2.4% over the last year, but it’s been the laggard so far in 2023. The NASDAQ Composite, meanwhile, has been the best performing major index over the last month and quarter.

Bond prices continue have risen dramatically over the past week, after turbulence in the banking sector spooked investors. Still, the 10-Year Treasury note remains below a falling 200-day moving average – clear evidence that a downtrend still exists. While yields are down from their October peak, the threat of continued policy tightening by the Federal Reserve remains a risk for fixed income investors.

March 13, 2023March 12, 2023

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.

March 6, 2023March 6, 2023

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.

March 6, 2023March 9, 2023

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.

March 2, 2023March 2, 2023

March Technical Market Outlook

February lived up to its reputation as one of the worst months of the year. Since the inception of the S&P 500 Index in 1950, stocks have averaged a negative return during the month. Only September has a worse track record. This year, stocks followed their seasonal pattern, as the S&P 500 dropped 2.6%, the Dow Jones Industrial Average fell 4.2%, and the NASDAQ Composite fell just more than 1%. Let’s take a look at how things are shaping up for March.

US Equities

Each month, we start our journey from the top, looking at the market from 30,000 feet up and focusing only on the biggest indexes. In just a handful of charts, we can see exactly the type of investment environment we’re in. Are stock prices rising or are they falling? Should we be erring on the side of buying or selling stocks?

Last month, our view was that stocks had made significant progress toward ending the bear market that began in 2022. Here’s how we put it:

We aren’t out of the woods yet, but we think we see the light at the edge of the forest.

The beauty of technical analysis is that prices offer us clear risk levels – we know exactly where we’re right and where we’re wrong. We entered the month with a clear view of what we needed to keep an eye on:

Small Caps are the ones to watch. With the last few days of gains, the Russell 2000 is above its own key area of resistance. That’s a good sign – small caps were the first to find a bottom last year and could very well lead us higher in 2023. But if IWM is back below 190, expect the rest of the major US indexes to be failing, too.

Well, the IWM fell back below 190. And the rest of the major indexes fell, too.

(Editor’s note: If you’re having trouble seeing any chart in this report, click on it to view a larger version)

We still aren’t out of the woods.

For months, we’ve been talking about resistance near 4100 for the S&P 500. That was our line in the sand – if prices were above that, we wanted to be buying stocks. If they weren’t, we believed a cautious approach was more appropriate.

Nothing changed during February. Stocks failed once again at 4100, and the bears still have the upper hand.

It’s the exact same situation for the NASDAQ. The level here is 12000.

These aren’t just numbers we’re pulling out of a hat. 12000 is the 161.8% Fibonacci retracement from the entire COVID selloff. The market respects these Fib levels, so we do, too.

But it’s not just weird rabbit math that has us watching that level. It’s also where growth stocks peaked relative to value. In September 2020, growth stocks ended a near 15-year run of outperformance. The NASDAQ, which is dominated by those same growth names, is paying attention.

There’s no reason to be aggressively buying stocks as long as we’re below those key levels. We know exactly where we want to be more bullish. So what would it take for us to shift from neutral to outright bearish on US stocks?

We’d need to see more indexes acting like the Dow.

The Dow Jones Industrial Average did more than just fail at overhead supply during February: it ended the month by breaking its December lows. This chart is the biggest threat to the bull case for stocks. If the index that’s been the leader for more than a year is now setting new lows, how can we be buying stocks?

The Dow needs to get back above 33000 in a hurry. If it does, that failed breakdown could be the catalyst that sends prices through that tough overhead resistance near 34500. The longer we’re below 33000, though, the more likely it is that stock prices overall will retest their October lows.