US Equities - Hot or Not?

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For financial professionals only

Summer is well and truly here. As I write, the UK is basking in a period of glorious sunshine. Across the Atlantic however, it’s the US stock market that’s causing a heatwave. The S&P 500 and the NASDAQ are up around 15% and 31% respectively this year and, in a case of déjà vu, are  leading the way for large capitalisation global equity indices. Could this be the start of a new bull market? Or is it just more  unsustainable market exuberance?

To answer that, we need to look at what’s driving the rally: the large capitalisation tech stocks.

Eight of these companies (Alphabet, Amazon, Apple, Meta, Microsoft, Netflix, Tesla and Nvidia) now make up 30% of the S&P 500’s market capitalisation, which has increased from 22% at the start of 2023. Phenomenal share price gains in the first half of this year have seen these companies make some huge percentage gains, as you can see in the table below.

Name2023 Total Return
Meta Platform125%

Source: Google

A remarkable turnaround

Considering the substantial declines seen in Big Tech in 2022 this is a scenario no commentator could have predicted, given the economic backdrop and issues the regional US banks faced this year. Take Apple, for example. As of 15th June, the company hit a new all-time high, despite the continuing squeeze on the consumer.

This situation isn’t reflective of the wider US stock market – it’s very much a concentrated rally. In reality, the average stock in the index isn’t faring so well.

In our latest Let’s Talk Markets webinar, we discussed the graph below, showing the performance of the eight large tech stocks, the overall index performance and then the index stripping out the eight large stocks.

For the ‘rest’ of the index constituents, it’s been a negative start to the year. Large cap tech stocks have massive influence on overall market performance and this works on the way up and on the way down, as we saw in 2022.

You can see further evidence of this in the market cap weighted S&P 500 index, which is outperforming the equally weighted index by over 10%.

Table 1

Source: Premier Miton

Why is Big Tech rallying?

The first, and probably most obvious answer here is the growth of Artificial Intelligence (AI). This has been the big theme of the year following the release of ChatGPT (an AI chatbot that uses natural language processing to produce humanlike text) in November 2022.

While the big tech names will clearly be the initial beneficiaries of AI’s efficiencies, its influence is likely to spread far wider and, as more industries adopt it, will revolutionise current working practices across every sector.

NVIDIA in particular is reaping the rewards of playing a pivotal role in adapting Graphic Processing Units to infuse AI into existing products and services. However, this could become unsustainable - trading is now on a Price to Earnings ratio of 200 times.

Secondly, the economic outlook in the US is looking better than predicted. Inflation is falling, with the Consumer Price Index (CPI) year on year figure now sitting at 4%, and the Core CPI figure (which excludes food and energy) moving down to 5.3%, making the Fed comfortable enough to pause its interest rate rises for the time being.

The current Fed Funds Rate stands at 5.00-5.25%, although markets are preparing for another hike in July.  There’s cautious optimism in the markets at the moment. The impending rate cuts are contributing to this, but as the rate hiking cycle draws to a close, investors can see light at the end of the tunnel. Growth as an investing style has made a comeback in the first half of 2023, and this trend may continue, especially if rates are cut sooner rather than later.

Another theory is that the large cap tech stocks exhibit the same qualities of traditional ‘defensive’ stocks. During times of crises, investors favour stocks with consistent earnings and high-quality balance sheets, as they tend to navigate economic downturns more easily.

A lot of the large tech companies now exhibit all these qualities so in tougher economic times, they are likely to fare better than the average.

Is this sustainable?

Thanks to a 20% rally in June following a low in October 2022, the S&P 500 entered a bull market, bringing an end to the bear market we've been in since January 2022. 

This market exuberance may not last though. The stock market is yet to feel the full extent of the Fed’s monetary tightening over the past year and a half. And considering the 12-month forward Price to Earnings ratios above the 10-year historical average and several big economic headwinds still to contend with, it’s possible that valuations in the US will be unsustainable at headline level.

Earnings, although better than expected recently, were previously slashed by analysts, so companies doing well should be considered in the light of heavily reduced earnings targets. Earnings are driven by consumers, and it’s no secret that they are hurting. US retail  sales fell 3.3% (when adjusting for inflation) over the last year -  the 7th consecutive decline and the longest down streak since 2009.

Is this just the calm before the storm?

Given the exuberance in tech stocks you’d  be forgiven for thinking this is just a bear market rally. The chart below maps the unwinding of the tech bubble in the early 2000s. As you can see, the market almost hit an all-time high in September of 2000. The  peak to trough shows how the S&P 500 fell by 49% during this same period.

Table 2

Source: The Moneyshow

In times of market exuberance, it's important to remember the words of the Nobel prize laureate Harry Markowitz, the godfather of modern portfolio theory who said, 'the only free lunch in investing is diversification'.

Anyone who regularly reads and listens to our thoughts will know it's a subject we continuously promote. It may be tempting for investors to dive head first into a near term market rally, but the implications can be severe. We strongly recommend a balanced approach, weighing up both risk and return.

Another great quote I read recently stated that 'diversification is most needed when it seems like you don't need it at all'. Wise words right now. 

This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity.

Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.  

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