A bull mar­ket de­pen­dent on a few big Tech names

Business a.m. - - FINANCE & INVESTMENT -

SIX MONTHS AGO, THE MOST widely fol­lowed in­dex in the US, the S&P 500, was down 34% from its peak. Today it has not only re­cov­ered from all its losses, but also man­aged to hit new record highs hav­ing ral­lied more than 55% from its trough. In­vestors bet­ting against this mar­ket have been crushed, leav­ing short po­si­tions at their low­est level in more than a decade. The speed and ve­loc­ity of this re­cov­ery have also been ex­cep­tional. By way of com­par­i­son, dur­ing the 2008 Great Fi­nan­cial Cri­sis, it took four years to re­cover all the losses from the lows and al­most five years to re­cover from the dot. com bub­ble sell-off.

But the record high on the S&P 500 does not ex­plain the full story of this mar­ket re­cov­ery. While Tech and Con­sumer Dis­cre­tionary stocks are up 28.6% and 23.1% year to date (YTD) re­spec­tively, En­ergy and Fi­nan­cials stocks are down 41% and 21.2%. That is prob­a­bly the most un­even re­cov­ery we have seen through­out his­tory. Today the FAAMG stocks (Face­book, Ap­ple, Ama­zon, Mi­crosoft, and Google) rep­re­sent 24% of the S&P 500’s $29.77 tril­lion mar­ket cap. A 5% rally in Ap­ple alone con­trib­utes 0.35% to the S&P 500. In short, the S&P 500 no longer rep­re­sents the 500 largest US com­pa­nies but in­stead a hand­ful of Tech stocks.

That also means per­for­mance on the in­dex will be vul­ner­a­ble to any cor­rec­tion in these big names.

From a val­u­a­tion per­spec­tive, the Tech ti­tans are way over­val­ued com­pared to the in­dex. Ap­ple, Mi­crosoft, and Al­pha­bet are all trad­ing at a for­ward price-to-earn­ings (PE) mul­ti­ple above 30, Face­book is slightly be­low 30, while the out­lier Ama­zon is trad­ing at a for­ward PE of 83. But if we ex­clude these five big be­he­moths, the S&P 500 is only on a for­ward mul­ti­ple of 20. While the over­all in­dex might look cheap when com­pared to these Tech firms, it has never traded above this mul­ti­ple since 2002.

Mone­tary and fis­cal poli­cies may jus­tify over­stretched val­u­a­tions for an ex­tended pe­riod of time. With in­ter­est rates near zero and long-term rates ex­pected to re­main at cur­rent low lev­els, in­vestors have few op­tions to choose from and that’s why Tech firms are en­joy­ing the lime­light. How­ever, if other sec­tors do not start catch­ing up, this would send a very alarm­ing sig­nal. If in­ter­est rates ex­plained the full story, then Ja­pan’s stocks should have been out­per­form­ing all their ma­jor peers, but that’s not the case.

Eco­nomic ac­tiv­ity is nowhere near its pre-pan­demic lev­els and so far, we have no clue on when a Covid-19 vac­cine will ar­rive, and if it does ar­rive when the mass pop­u­la­tion will be vac­ci­nated. The US elec­tion is an­other risk loom­ing with only 70 days re­main­ing to the big day on Novem­ber 3. These risks need to be taken into con­sid­er­a­tion if one still wants to par­tic­i­pate in this most un­even of bull mar­kets. …A take be­fore Fed’s Pow­ell speech

[Ahead of Thurs­day]Traders and in­vestors across all as­set classes were all ears what the Fed­eral Re­serve Chair Jerome Pow­ell had to say at the an­nual Jackson Hole meet­ing. In­fla­tion was the key­word and the pol­icy frame­work to tar­get it will de­ter­mine whether we were to see more up­side to risk as­sets in the months to come.

So far, we have only seen ris­ing prices in as­set classes such as stocks in par­tic­u­lar, but through­out the past decade, the con­sumer price in­dex has av­er­aged around 1.5% so miss­ing the Fed’s 2% in­fla­tion tar­get. The FOMC’s dual man­date has been to max­imise sus­tain­able em­ploy­ment and keep prices sta­ble and while they have been suc­cess­ful in the for­mer (prior to the pan­demic), they have failed mis­er­ably on con­sis­tently hit­ting their price tar­get.

‘Av­er­age in­fla­tion tar­get­ing’ was the new for­mula ex­pected to be en­dorsed by Pow­ell. It’s a pol­icy frame­work that al­lows in­fla­tion to run above or be­low the 2% tar­get, but given that in­fla­tion has been run­ning be­low tar­get for sev­eral years, the ob­jec­tive would be to al­low price rises to over­shoot for more ex­tended pe­ri­ods be­fore tight­en­ing pol­icy.

How­ever, the idea of al­low­ing in­fla­tion to run above tar­get for ex­tended pe­ri­ods is hard to sell to politi­cians, so it was in­ter­est­ing to see how Pow­ell was likely to pack­age the new pol­icy frame­work.

The pos­i­tive sen­ti­ment in US eq­ui­ties [how­ever] con­tin­ued Wed­nes­day with the S&P 500 and Nas­daq hit­ting new record highs ahead of the week’s key risk event. It seems ex­pec­ta­tions may be too high as Pow­ell – was ex­pected to – need to be overly dovish to meet these ex­pec­ta­tions. No one be­lieves that he will dis­ap­point the mar­kets but given the scale of the lat­est rally in stocks, chances of a pull­back are high be­fore bulls re­sume their march higher.

Chief mar­ket strate­gist, FXTM HUS­SEIN SAYED,

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