US economy leaps as equity markets chop
Sometimes good news is bad news in terms of market reactions. In this case, Fed watchers have been closely watching economic data for signs of softness.
Following an almost unprecedented level of monetary tightening which includes over 500 basis points of interest rate tightening by the Federal Reserve, American economic growth generally appears to be weaker at the margin.
That’s actually considered good news for the markets as any relief in the ongoing restrictive policies might bode well for beleaguered stock and bond markets.
However, last week’s ostensibly robust Q3 GDP report seemed to contradict the economic downshifting narrative.
A government report released last Thursday showed the US economy grew at the fastest pace in almost two years last quarter on the back of surprisingly strong consumer spending.
Gross domestic product accelerated to a 4.9 per cent annualised rate, which was more than twice the second-quarter pace.
Growth was spurred by personal spending which jumped 4 per cent in the quarter as the labour market remained resilient against one of the fastest interest rate hiking campaigns in history.
At this week’s Federal Open Market Committee meeting, policymakers were expected to leave the benchmark interest rate unchanged in light of the substantial amount of monetary tightening already in the system and the historical lag time for its effects to be realised.
The ten-year Treasury yield touched five per cent last week for the first time in 16 years.
So far, the data suggest by all measures that inflation has been on a downward trend this year, even though recent prints remain above the Fed’s 2 per cent target.
The latest Consumer Price Index is at 3.7 per cent on a year-over-year basis while the Fed’s preferred gauge of inflation, the Personal Consumption Expenditures index is running at 3.9 per cent.
Service-sector inflation excluding housing and energy, a narrower measure watched closely by Fed officials, rose at a 3.6 per cent rate, a slight pick-up from the prior quarter.
While the US consumer appears resilient, headwinds abound. US mortgage rates which have jumped up to almost 8 per cent will likely be a serious drag in months ahead.
However, only about three per cent of houses are sold every year. As most American mortgages are locked in for 30 years, those that need to borrow at the current high rates are still a relatively small percentage of the overall population.
Last week also saw a continuation of the slide in big tech which has been undergoing a correction since last summer.
The sell-off is likely a combination of slightly worse forward guidance than had been expected and effects of rising interest rates which tend to negatively impact the intrinsic value of longer duration securities including richly valued tech stocks.
After leading the market during the first half of this year, the tech-heavy Nasdaq 100 has fallen about 12 per cent since last July.
Last week saw further declines in a few of the so-called “Magnificent 7” stocks’ reported earnings.
These are a group of mega cap stocks including Alphabet (Google), Meta, Amazon and Microsoft.
Investors lately are fickle. For example, Meta Platforms stock fell sharply despite beating estimates on both the top and bottom lines. After initially rising, the stock slid on cautious forward guidance.
Although the S&P 500 index has returned more than 10 per cent and the Nasdaq Index has returned more than 20 per cent year-to-date, the gains are very concentrated in only a few stocks.
Removing the “Magnificent 7” from the S&P index, the remaining 493 companies are approximately flat this year.
Technology companies, including the Mag 7 have clearly outperformed in 2023.
These stocks have benefited from expectations that rates peaked while generally possessing strong underlying earnings trends, in some cases spurred by strong demand for Artificial Intelligence products.
Although technology companies’ current P/E is above historical levels, it’s worth noting their P/E excluding cash would be lower.
Sitting at high cash reserves, these companies could earn above 5 per cent return from money market instruments.
Furthermore, compared to smaller cap companies the mega caps required significantly less need for external funding at these higher interest rates.
Technology stocks could once again lead markets into a year-end rally as fund managers scramble to add winning positions in a bid to boost performance going into the historically strong months of November and December.
Moreover, assuming an eventual stabilisation of the bond markets, we could well see a broadening of the market beyond the Mag 7 as investors begin to look through to the next cycle.
• Bryan Dooley, CFA, is the Chief Investment Officer at LOM Asset Management Ltd in Bermuda. Please contact LOM at +1 441-292-5000 or visit www.lom.com for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority