Can the rally continue?
We are cautiously optimistic about the global economy. The key question for investors remains whether the better outlook is now fully reflected in markets.
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Slowing growth and rising inflation were a toxic combination for investors in 2022. Over the past year, we have seen the near opposite scenario, with growth forecasts rising and inflation falling. This “immaculate disinflation,” as it is often called, has been very good for investors. Stocks in the US, Europe and Japan are at or close to record highs.
Today’s rally may have more solid foundations than the last peak in US stocks, in 2021. Back then, interest rates were near zero and a wave of money from retail investors inflated “meme stocks”, SPACs1 and new cryptocurrency launches. There is less of this behaviour today. Nor can anyone claim that markets today are benefiting from artificially low interest rates. Having said this, investors are currently very optimistic and could easily become disillusioned if economic growth is weaker, or inflation higher, than expected. Other areas of concern include disappointment over the speed of artificial intelligence (AI) adoption, an overestimation of its productivity benefits or the underestimation of its costs.
The Magnificent 7…or should it be the Fab 4?
We are often asked whether the incredible performance of the largest US technology companies (Microsoft, Apple, Nvidia, Amazon, Alphabet, Meta, Tesla) constitutes a bubble. As I mentioned last quarter, these companies are now worth more than many national stock markets.
The US market’s concentration is a concern. A strong set of results from Nvidia, which designs the semiconductors that power AI systems, sparked the latest leg of the rally in US stocks. Disappointments from any of these companies could have a similarly outsized, negative impact.
Even so, we think talk of a bubble is probably misplaced. The seven technology giants are on average valued at a little over 30x forecast earnings for 2024. That is far from cheap and does not offer much protection in the event of setbacks. But, given their earnings growth and prospects, it is not unjustifiable.
We also think the opportunity in AI is real. There is uncertainty about the timing and the cost of adoption, but there is good reason to expect this technology cycle to move faster than previous ones. AI does not involve replacing or overhauling existing IT systems, which can take years. In many cases, it can be added to existing systems very quickly.
We are encouraged to see the market more clearly distinguishing between the Magnificent 7. Nividia recently wowed markets with quarterly revenue of $22 billion, up from $6 billion a year earlier, and has clearly led the pack. The outlook for Tesla, which is seeing lower demand for electric vehicles, is less inspiring. Denmark’s Novo Nordisk, which makes anti-obesity treatment Ozempic, recently overtook it in the rankings of the world’s largest companies.
The performance of the Magnificent 7 has been diverging
Share price performance since 30 September 2023
Past performance is not a guide to future performance and may not be repeated. For illustrative purposes only and not a recommendation to buy/sell.
Source: LSEG Datastream, 12 March 2024
It’s the economy
Last October, the Magnificent 7 had risen by 50% on the year while the rest of the US stock market was flat. Performance is now looking slightly more balanced. Since US stocks started to rebound from last autumn’s short-lived slump, the “S&P493” have rallied by close to 20% (as of mid-March). This broadening out may reflect greater optimism about the US economy.
US consumer spending remained relatively resilient over the past few years, thanks to the savings built up during the pandemic. However, high inflation meant that real (or inflation-adjusted) earnings came under significant pressure. The picture today is looking much healthier, as the cost-of-living crisis eases while wages continue to rise. Interest rate cuts will further help consumers, even if there are fewer of them than investors anticipated at the start of the year. Capital spending is also picking up as the US government's huge infrastructure and investment programmes are implemented.
Inflation-adjusted wages are finally rising again
US real average hourly earnings, annual percentage change
Source: LSEG Datastream, 12 March 2024
Strong performance not confined to the US
Japan’s Nikkei index is also breaking records, as it finally regained the level it last reached in December 1989. Recent performance has been very strong, but the longer-term track record remains underwhelming. In the 34 years it has taken the Nikkei to get back to its former peak, the S&P500 has risen 14-fold and even the FTSE100 has more than tripled.
The key shift has been the end of deflation, which has restrained economic activity in Japan for decades. Falling prices meant that many Japanese companies spent the last 30 years hoarding cash and operating very conservatively. But with the country’s inflation rate now back at healthier levels, businesses and consumers have much more incentive to spend. Reported economic growth remains sluggish, but markets are anticipating that it will accelerate over the coming years.
Closer to home, European stock markets (excluding the UK) are also at record highs. Europe’s growth remains unexciting. However, a mild winter meant that the economy faced less disruption from energy markets than many were expecting. And the success of companies such as Novo Nordisk, LVMH and ASM Lithography is a reminder that Europe still has world-leading companies whose success is not dependent on the continent’s economic performance.
Traders on the floor of the New York Stock Exchange. With the US election looming, markets could be jolted if politicians make unaffordable spending promises.
Politics vs economics
It is still possible that politics upsets the better news on economics, with the US election in November the key event. Historically, the party that prevails has had little impact on long-term market returns. Since 1936, the 10-year annualised return of the S&P500 from the start of an election year was 11.2% when a Democrat won and 10.5% when a Republican triumphed, according to Standard & Poor’s. The bigger worry is perhaps that politicians start making promises that countries cannot afford, given very high levels of public debt, which could unsettle bond markets. The UK went through this experience in late 2022; it is not beyond the realms of possibility that we see something similar in the US.
To end on a more positive note, I wanted to share some interesting data from my colleagues in Schroders. It can feel uncomfortable to remain invested after a very strong run in markets. However, record highs in US equity markets have not been associated with lower future returns. Their research found that of the 1,176 months since January 1926, the US stock market was at an all-time high in 354 of them – so roughly 30% of the time. Returns over the next one, two or three years have either been in-line or better than average.
US stock market returns have been slightly better than average if you invested at an all-time high
Average annual inflation-adjusted return for US large cap equities, 1926-2023
Past performance is not a guide to future performance and may not be repeated.
Source: CFA Institute, Schroders
1 Special purpose acquisition companies, which raise capital to acquire an existing company.
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This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital unless otherwise stated.
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