Welcome to the latest episode of my monthly YouTube show where I discuss what is happening in investment markets and what to look out for. This episode I talk about how the 'Magnificent 7' have continued to propel the market higher as we head into March.
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Abridged transcript - Damien's Market Update - February 2024
After my last market update the US dollar continued to strengthen after bouncing off the key 101 support level before breaking above its 200 day moving average. This strength started to pose a challenge to the rally in US equities and ultimately global equities.
This resurgence of the dollar was linked to the market reassessing its optimism over US rate cuts following the publication of a number of US economic data points but also hawkish comments from US Federal Reserve members. The shift in US interest rate expectations translated into bond markets where we’ve seen the 10 year US treasury hit a new 2024 high of almost 4.35%. Remember higher yields means lower bond prices. But despite the dollar rally raising concerns over the sustainability of the US stock market bull run, big tech came to the rescue of equity markets. When we often refer to tech stocks it is usually in reference to the list of so-called “Magnificent 7” companies, whose business models go beyond just being technology providers.
The Magnificent seven comprises Nvidia, Meta Platforms, Tesla, Amazon, Alphabet, Microsoft and Apple. These seven stocks account for over 27% of the S&P 500 and have been the driving force behind the equity market rally in the index, both in 2023 and 2024. The Magnificent 7 themselves have been moving higher on the back of hopes for interest rate cuts from the Fed and, especially in the case of Microsoft and Nvidia, enthusiasm for the AI theme. Right now, it’s a case of as goes AI so goes the market.
A string of positive blowout earrings results from some of the Magnificent 7 (albeit not all of them) has continued to propel the market higher as we head into March. Nvidia’s earnings report last week marked a pivotal moment for the company and for the stock market more widely. The outcome of Nvidia’s quarterly earnings report was being heralded as a judgment or validation of the sustainability of the wider stock market rally as well as the AI theme itself. Especially as Meta and Nvidia have been doing nearly all the heavy-lifting in driving the wider stock market higher since the end of January. There were plenty of vocal commentators stating, with surprising authority, that Nvidia was doomed to disappoint and it would be a catalyst for a deep stock market correction.
But what transpired was nothing short of mind-blowing. Nvidia’s latest earnings report disclosed a staggering $22 billion in revenue for its last quarter and a forecast of $24 billion in revenue for the next quarter, outstripping expectations and underscoring the insatiable demand for AI technology. The earnings report appeared to validate the bullish outlook on AI which also sparked a broader rally in tech stocks, pushing indices like the S&P 500 and Nasdaq 100 to new highs. European and Asian markets were not left behind, as the Stoxx Europe 600 and Japan’s Nikkei 225 also reached historic peaks. Even Chinese stocks have rallied. The laggard, of course was the FTSE 100, a result of its relative lack of tech company exposure
The sharp rally in tech stocks, particularly those related to AI, has prompted some analysts to again raise concern about a disconnection between valuations and fundamentals. At the same time, drawing parallels to the dot-com bubble of 2000, where excessive speculation on internet companies led to a market crash. It is true that if you dig below the surface of US stock markets there are signs of a deterioration in breadth which is starting to impact the wider stock market. By one measure of market breadth the percentage of stocks within the S&P 500 that are outperforming the wider index has fallen to around 26% of the stocks in the S&P 500 in recent weeks. The last time we had such a low breadth reading was before the dotcom bubble burst, after which the S&P 500 fell 50%.
Of course the trouble is that this is only one indicator. Another indicator of market breadth is the S&P 500 200-Day Index which calculates the proportion of S&P 500 stocks that are trading above their 200-day moving average. When this figure exceeds 50%, it typically indicates a bullish market sentiment. Additionally, particularly high or low values of this indicator can assist traders in identifying conditions where the market is either overbought or oversold. Right now this indicator sits at 69% which suggests that market breadth remains ok, but it is admittedly lower than its recent peak at the end of January. The point is that there are cracks beneath the surface of this stock market rally but not enough to confidently predict when a correction will happen.
One thing I want to finish on is to point out the recent change in correlation between bond and equity markets. Up until the end of January both assets were moving in tandem, as they had done for much of the last 2 years, meaning that they both rallied and slumped at the same time. But they've since begun to diverge and become negatively correlated once again. Or in other words, now when equities fall, bond prices rally (i.e. yields go down) and vice versa just as they did prior to the current rate hiking cycle which started at the end of 2021 when inflation began to soar.
It highlights just how the stock market is ruling out the possibility of a second-spike in inflation and is looking towards the next part of the economic cycle which means economic contraction and rate cuts. If we’ve not hit peak inflation or peak interest rates then the stock market is in for a shock and if that happens then they would likely crash with rate sensitive tech stocks leading the charge.
