What is the focus of the market?
Last updated: 31.10.2022
The past week offered a tale of two markets, with gains for the Dow Jones Industrial Average putting the blue-chip gauge on track for its best October on record while Big Tech heavyweights suffered a shellacking that had market veterans recalling the dot-com bust in the early 2000s.
“You have a tug of war,” said Dan Suzuki, deputy chief investment officer at Richard Bernstein Advisors LLC (RBA), in a phone interview.
For the technology sector, particularly the megacap names, earnings were a major drag on performance. For everything else, the market was short-term oversold at the same time optimism was building over expectations the Federal Reserve and other major global central banks will be less aggressive in tightening monetary policy in the future, he said.
What’s telling is that the interest-rate sensitive tech sector would usually be expected to benefit from a moderation of expectations for tighter monetary policy, said Suzuki, who contends that tech stocks are likely in for a long period of underperformance versus their peers after leading the market higher over the last 12 years, a performance capped by soaring gains following the onset of COVID-19 pandemic in 2020.
RBA has been arguing that there was “a major bubble within major portions of the equity market for over a year now,” Suzuki said. “We think this is the process of the bubble deflating and we think there’s probably further to go.”
The Dow DJIA, +2.59% surged nearly 830 points, or 2.6%, on Friday to end at a two-month high and log a weekly gain of more than 5%. The blue-chip gauge’s October gain was 14.4% through Friday, which would mark its strongest monthly gain since January 1976 and its biggest October rise on record if it holds through Monday’s close, according to Dow Jones Market Data.
While it was a tough week for many of Big Tech’s biggest beasts, the tech-heavy Nasdaq Composite COMP, -8.39% and tech-related sectors bounced sharply on Friday. The tech-heavy Nasdaq swung to a weekly gain of more than 2%, while the S&P 500 SPX, +2.46% rose nearly 4% for the week. But the Nasdaq is significantly underperforming the Dow in October, with a month-to-date gain of 5%. The Dow’s 9.4 percentage point outperformance of the Nasdaq is the strongest since February 2002.
Big Tech companies lost more than $255 billion in market capitalization in the past week. Apple Inc. AAPL, +7.56% escaped the carnage, rallying Friday as investors appeared okay with a mixed earnings report. A parade of disappointing earnings sank shares of Facebook parent Meta Platforms Inc. META, +1.29%, Google parent Alphabet Inc. GOOG, +4.30% GOOGL, +4.41%, Amazon.com Inc. AMZN, -6.80% and Microsoft MSFT, +4.02%.
Aggressive interest rate increases by the Fed and other major central banks have punished tech and other growth stocks the most this year, as their value is based on expectations for earnings and cash flow far into the future. The accompanying rise in yields on Treasurys, which are viewed as risk-free, raises the opportunity cost of holding riskier assets like stocks. And the further out those expected earnings stretch, the bigger the hit.
Excessive liquidity — a key ingredient in any bubble — has also contributed to tech weakness, said RBA’s Suzuki.
And now investors see an emerging risk to Big Tech earnings from an overall slowdown in economic growth, Suzuki said.
“A lot of people have the notion that these are secular growth stocks and therefore immune to the ups and downs of the overall economy — that’s not empirically true at all if you look at the history of profits for these stocks,” he said.
Tech’s outperformance during the COVID-inspired recession may have given investors a false impression, with the sector benefiting from unique circumstances that saw households and businesses become more reliant on technology at a time when incomes were surging due to fiscal stimulus from the government. In a typical slowdown, tech profits tend to be very economically sensitive, he said.
The Fed’s policy meeting will be the main event in the week ahead. While investors and economists overwhelmingly expect policy makers to deliver another supersize 75 basis point, or 0.75 percentage point, rate increase when the two-day gathering ends on Wednesday, expectations are mounting for Chairman Jerome Powell to indicate a smaller December may be on the table.
However, all three major indexes remain in bear markets, so the question for investors is whether the bounce this week will survive if Powell fails to signal a downshift in expectations for rate rises next week.
Global stock markets wobbled in recent weeks as bond yields rose, driven by optimism in the vaccine rollout for Covid-19 and the resumption of consumption spending.
James Sullivan, head of Asia ex-Japan equity research at JPMorgan, says the investment bank expects cyclical and defensive stocks to lead the market higher in the medium-term instead of tech stocks.
JPMorgan is also positive on consumer stocks. “We are seeing very strong consumption trends across the board,” according to Sullivan.
Investment bank JPMorgan expects cyclical stocks to lead the market higher in the medium- to long-term as the business cycle improves.
“You’re going to see cyclicals and more defensive names continue the rally after we get past this period of adjustment,” said James Sullivan, head of Asia ex-Japan equity research at JPMorgan.
Cyclical stocks are companies whose underlying businesses tend to follow the economic cycle of expansion and recession. Some of these include sectors such as finance, energy and industrial. Defensive stocks — such as health care and consumer staples — typically provide consistent earnings and dividends regardless of stock market conditions.
Global stock markets wobbled in recent weeks as bond yields rose, driven by optimism in the vaccine rollout for Covid-19 and the resumption of consumption spending.
The move fueled expectations of higher inflation and investors worried it would prompt central banks to raise interest rates. Higher interest rates can knock down stocks with relatively high valuations.
Interest rates concerns also accelerated a market rotation — as investors took money out of expensive tech and growth stocks and put them into other cyclical sectors such as finance, energy and industrial. Stocks have rebounded in recent sessions but analysts still expect market conditions to remain volatile.
“What we’ve seen is a very, very sharp rebound in value, you’re likely to see a bounce in growth as a result of the extremity of that market move,” he said Wednesday on CNBC’s “Street Signs Asia.”
“On a medium-to-long term basis, though, we still see cyclicals and defensives leading this market higher,” Sullivan added.
JPMorgan positive on financials, consumer stocks
Steepening of the yield curve is positive for the overall profitability of large financial institutions, Sullivan explained, adding that the investment bank is overweight for both the banking and insurance sectors. Financial companies typically benefit from rising interest rates as it expands their profit margin.
A steepening yield curve occurs when rates for longer dated bonds rise faster than interest rates for shorter dated bonds and typically indicates that investors expect rising inflation and stronger economic growth.
JPMorgan is also positive on consumer stocks, according to Sullivan. “We are seeing very strong consumption trends across the board,” he said, adding the bank “would be positive on both financials and consumer as a result.”
As economies around the world reopen, consumption spending is expected to resume on the back of better growth prospects and stimulus measures. Overnight in the U.S., President Joe Biden signed a massive $1.9 trillion coronavirus relief package that will put cash into the hands of Americans.
Tech: Valuations ‘reasonably high’
Technology stocks were a big beneficiary in the markets last year as the coronavirus pandemic knocked global growth off track due to lengthy lockdowns around the world. Investors and traders, who typically turn to less risky assets in order to weather the market volatility, poured money into tech and software stocks which benefited from the lockdown.
“Overall tech leadership of markets was taken to an extreme last year,” Sullivan said, adding that despite some of the recent sell off in tech names, “we are seeing valuations that are reasonably high.”
JPMorgan’s argument is that within the tech space, investors should rotate out of platform names and move into companies that sell software as a service and into the semiconductor space given the ongoing global chip shortage.
“We don’t necessarily see the large platforms leading these markets higher for the rest of this year,” Sullivan added.
