Market Musings 291022: Hebdomas Horribilis for Big Tech

Market Musings 291022:
Hebdomas Horribilis for Big Tech

A horrible week for mega-cap growth… But hope on the interest-rate front?

SUMMARY

• Poor Q3 mega-cap tech results were heavily sanctioned by investors
• Predictable to some extent given consumer weakness and the strong US dollar
• And yet, S&P 500 and Euro STOXX 50 indices rebounded further on the week
• Long-term interest rates dipped, as markets hope for a pause in CB interest rate hikes
• Earnings forecasts have suffered most in Growth stocks, resisted best in Value stocks

PODCAST

Winners and losers from higher interest rates

1. Why are central banks forced to raise interest rates when inflation goes up?
2. What is the impact on savers and borrowers?
3. What kind of companies benefit from rising interest rates?
4. How long will the policy tightening cycle last?
5. What is “financial repression”? Is it a good or a bad thing for financial markets?
6. In this context, what should people invest in?

Retail investors Pasted by Q3 Tech Results

Disappointing third-quarter results for US mega-cap technology companies has triggered a renewed sell-off in Microsoft, Google, Amazon and Meta. Over the year to date, FAANG stocks have fallen 40%, with a 5% fall over the last week alone.

A Tough Week, indeed a tough Year for Mega-Cap Tech

Source: BNP Paribas

The twin pressures of a slowing US (and global) economy hurting investment and consumption on the one hand, plus the drag on US earnings from the continued strength of the US dollar, together conspired to slow earnings progression in these oligopolistic tech names.

Since late 2021, US mega-cap Tech has suffered

Source: tradingview.com

Of these US mega-cap tech names, Apple was the only one to really beat expectations in its Q3 results, with no disappointment evident in the sales of its flagship iPhone 14 model and with Q3 earnings ahead of analyst forecasts. This resulted in a near-6% gain for Apple over the last week, in sharp contrast to the other FAANG names.

US earnings expectations have drifted lower for some time

Analysts have been gradually reducing their full year 2022 and 2023 US earnings estimates in aggregate since the middle of June, in the face of a worsening growth outlook, higher costs (on the back of higher inflation) and the stronger US dollar (reducing the US dollar value of overseas profits).

According to Factset, S&P 500 aggregate expected earnings for this full year have already drifted 4% lower, and look likely to drift even lower in the wake of this earnings season.

US earnings forecasts have been falling since mid-June

Source: Factset

Moreover, this chart below underlines that the worst cuts in earnings forecasts have come in Growth stocks, such as Technology stocks, while Value stocks (think Energy, Financials) have seen earnings forecasts hold up well.

Growth stocks see the worst trend in earnings revisions

Source: SG Cross-Asset Research

Major stock indices weather the mega-cap tech storm

And yet, despite these obvious profit-related headwinds, both the S&P 500 index and also the Euro STOXX 50 benchmark indices ended the week nearly 4% higher.

Clearly, it is not just near-term earnings that are driving stock markets at the moment.

A second important driver of stocks has been long-term interest rates. In the chart below, we can see that 10-year government bond yields in the US, Germany and the UK have all started to fall in the last week, after spending most of 2022 climbing inexorably higher.

US, UK and German 10-year bond yields finally start to fall

Source: tradingview.com

These lower long-term bond yields reflect the fact that inflation pressures look to be falling, especially in the US, as growth slows to the point that we seem to be facing economic recession in the US, UK and Europe over the next few months. The result of much slower economic demand should, in time, be lower pressure on prices, i.e. lower inflation rates.

One example of these easing inflation pressures is wage inflation in the US: lower job openings highlight that companies are no longer as ready to hire employees as before, given the slowing economy and rising costs. This slowing demand in US employment should cool wage growth over the next few months - crucial for interest rates as the US Fed has been particularly worried about the resurgence of wage inflation.

US job openings finally start to fall - wage growth should follow

Source: Bank Credit Analyst

Central Banks hint at an upcoming pause in interest rate hikes

A word of caution first of all. We have been here before several times this year, when financial markets have anticipated an approaching peak in central bank interest rates (led by the US Federal Reserve), only then to see these hopes crushed by persistently higher inflation rates.

But this time around, there seems to be good reason to expect a shift in interest rate policy by the US Federal Reserve, the European Central Bank, and the Bank of England. In each case, members of key policy making committees have commented that future interest hikes should slow or even pause, in order to see how much of a slowing effect on the economy today’s higher interest rates are having.

The rising probability that the Fed and ECB pause interest hikes in December this year or January next year has led short-term bond yields lower, as markets price a lower so-called “terminal” rate (i.e. the peak central bank reference interest rate level in this hiking cycle) than previously.

US, UK, Italian and German 2-year bond yields also ease

Source: tradingview.com

This has been most evident of late in the UK and Italy, as cooling political worries have eased budget-related concerns in both countries, which in turn has eased pressures on their national bond markets.

Conclusion

Retail investors who have been relatively over-invested in the “glamour” household technology stock names (as well as cryptocurrencies) have continued to be battered by the relentless fall in their stock prices.

Given that earnings forecasts have remained most resilient in Value stocks and sectors, investors may be well advised to stay in these less glamorous investments, such as:

• Energy (Oil & Gas)
• Financials (Insurance, Banks)
• US small-cap value (e.g. the £IJS iShares US Small-Cap Value ETF or £CUS1 )
• Healthcare (Pharmaceuticals)

Some of the highest StockRanks in each sector include:

• Energy: TotalEnergies SE (LON:TTE)  Shell (LON:SHEL) Marathon Petroleum, Equinor  
• Financials: Plus500 (LON:PLUS) Investec (LON:INVP) Principal Financial, BBVA
• Healthcare: Novartis, Pfizer, Merck

Have a great week,

Edmund