Monday Macro: Bubble time? Rate cuts and asset allocation and a deep dive into Long-term returns
My quick skim through US equity measures suggests moving to a neutral position on US tech stocks. Plus, why the UK has under-performed and some great graphics on asset class correlations
US equities power ahead
On some measures, US equities do look expensive, especially on longer-term metrics
But on key earnings measures, US equities look fine
I’m going neutral on large-cap US tech stocks
Why the UK is underperforming - and the gaps widen
Positive signals for UK service sectors
Schroders analysis of past rates cutting scenarios says be in equities
FTSE Russell multi-asset class correlations tell a fascinating story
The Tech Rally – a bubble looms?
US equities are in fine form. Most newspapers at the weekend managed to pick up on the big story – the US benchmark index, the S&P 500, traded over 5,000 for the first time on Thursday (5000.40). It is the 10th new closing high of 2024, after none in 2023, the opening day January 3 closing high in 2022, and the 101st since the pre-COVID February 19, 2020 closing high (3386.15). The index has now doubled since September 15, 2017, when it hit 2,500 closing, which equates to an 11.52% annualized stock return. As positive momentum goes, that’s pretty positive! Here are some other useful facts to make your hair stand on end :
· Bloomberg’s Magnificent 7 index was up 107% in 2023, versus 54% for the NASDAQ 100. Individually, these mega-cap stocks rose between 50% and 240% across 2023 and accounted for over 60% of the S&P 500’s total return.
· Nvidia shares more than tripled last year to lead the S&P 500 and are the top performer in the index again in 2024, up 46%. The stock’s valuation soared to more than 60 times forward earnings last year
· According to Albert Edwards, global strategist over at SocGen, “ the value of the US tech sector once again comprises one-third of the US equity market. This just pips the previous all-time peak seen on 17 July 2000 at the height of the Nasdaq tech bubble. And that has been achieved with only three of the ‘Magnificant-7’ internet stocks actually being in the tech sector (Apple, Microsoft and Nvidia)! If you add in the market cap of Amazon, Meta (Facebook), Alphabet (Google) and Tesla, then the IT and ‘internet’ stocks dominate like never before.”
The chart above - from SG colleague Manish Kabra – “shows that tech stocks entirely drive the rise in the S&P 500 forward earnings. I regularly read reassurance that US tech valuations are nowhere near the extremes that we saw during the 2000 Nasdaq bubble. That may be true, but certainly, the sector commands a high premium compared to the market overall – the current PE premium of about 8x is as high as it has ever been since the 2000 Nasdaq bubble burst.”
· Next up, John Authers over at Bloomberg cites the following chart, which takes the ratio of the S&P 500 excluding technology relative to the S&P 500 tech sector, going back to the beginning of 2000.
· Bloomberg’s Authers also reports on comments by Charles Gave over at research firm Gavekal, who reckons that “the US stock market is now about 70% of world market capitalization, even though its economy is only 17.8% of global gross domestic product. Therefore, he says, the markets are implying that “over the next 20 years, less than 20% of the world economy will earn three times more profits than the remaining 70% or so,” or put differently, that US tech firms will be “entrenched global monopolies stretching into perpetuity.”
So, what should we make of the current situation?
First off, I think it’s almost impossible to deny that some – not all – US tech stocks are expensive. But not ludicrously so! The table below shows key measures of value for the Magnificent Seven. Look at the last two columns, which first show price-to-earnings ratios and second forecast EPS growth as a percentage. Nvidia, Tesla and Amazon all trade at over 40 times forecast earnings although Nvidia is expected to grow EPS in the next year by 468% while Amazon is likely to grow earnings by 47%. By contrast, Tesla looks straight overvalued. As for Apple, Google and Meta – they all trade at mid-20s in PE terms, but their EPS growth varies from 6.9% for Apple to 32% for Meta.
Next up, we can generally say that US equities are fully priced but not completely out of whack! Journalists at the WSJ reckon that based on trailing earnings, the S&P 500’s multiple is 24.18, above its 10-year average of 20.36. The index’s forward multiple, at 20.38, recently rose above 20 for the first time in two years. Its longer-term average is 17.96.
But, third, earnings growth is looking rosy – analysts think that the stocks in the will increase their profits growth by roughly 11% in the coming year. But according to analysts at Deutsche Bank, there are some warning signs to watch out for. Their preferred metric is to look at earnings growth on a sequential quarter-by-quarter basis adjusted for seasonality : on that basis,
“ growth turned negative for the first time in four quarters (-2.6%), albeit significantly less so than the consensus foresaw. Despite the Q4 weakness, forward estimates for Q1 have held up very well so far and point to a return to growth, contrasting with past weak earnings, such as in 2022 when estimates fell sharply through the season. We note that Q4s tend to be noisy as a variety of charges and one-time items tend to get lumped into year-end and that this quarter was on par with prior Q4s.”
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