When Apple is larger than the English market and Tesla aligns with Visa, is this the dawning of the age of technology? With serious apologies to the 5th Dimension, it seems as though investors believe the is new age knows no limits. Indeed, Apple last week was larger than the entire equity market in England and Visa and Tesla were roughly equal in market capitalization. This new age may be showing signs of cracking, as the tech heavy OTC markets fell just over 6% in two days. Back at the economy, the much-awaited employment report was decent, but failed to excite investors. While still creating more jobs in one month than at any time prior to this year, the number was below last month, and prior months revisions were also lower. The sheer size of the monthly changes in all the economic data makes it hard to determine what is “normal” or how far we are from a more normal economy. We do know companies are making some of the temporary layoffs permanent and the consumer has pulled in their spending a bit during July. As makes its way to the autumnal equinox later this month, investors will be watching the election polls more closely, trying to divine the next big move in stocks. They may be looking in all the wrong places and instead should keep an eye on the economic data.
Could we finally be seeing the beginnings of a market correction that has been expected for the better part of two months? The tech run was going to end at some time, and without as much as a good reason (yet), investors started taking profits in companies that have run up 2-3 times their level just a few months ago. The broader market held up relatively well, but the tech market is providing some similarities to the late 1990s, if not with stratospheric valuations, but with still historically high prices to earnings estimates. Given that earnings will be taking a few years to reach once again the 12/31/19 peak, today’s prices project a total return of only a few percentage points from here. Better hunting grounds are in the stocks that have been left behind, like small US and even international. Staying away from tech in 2000-03 allowed investors to avoid the brutal 50% drawdown by tech issues in the aftermath of the 2000 tech bubble.
Interest rates bounced last week, providing little in the way of shelter from the equity storm late in the week. Investors felt the Fed’s shift toward “average” inflation will mean that inflation will be running “hot” in the years ahead and bond investors want to be compensated for that risk. However, as we highlighted last week, inflation is not likely to be running far ahead of the target 2% level due to slower population growth and lower overall productivity. Watching commodity prices as a clue as well shows pricing for a broad basket of goods remains below year ago levels. There should be plenty of time to get more defensive in the bond market ahead of higher inflation numbers. Right now, our best guess is that interest rates remain relatively stable around current levels for the next 2-5 years, so there is plenty of time before we need to worry about persistently higher inflation.
Almost as quickly as the calendar flipped to September, did stocks flip to the downside. As mentioned above, technology has been the main culprit for the particularly good markets since the March bottom and last week for the poor end of the week. We have seen technology stocks take a few breathers since the March bottom, most recently during July and again in late May. Each time, tech has come roaring back. Is this time different? It is way too early to tell, however the relative valuations of the sector vs. others as well as the large growth asset class vs. other asset classes are pushing levels last seen in 2000. We have begun to take some of the tech weight off the table in favor of more value and some small cap funds. The betting on Wall Street is that the Fed will ride to the rescue if the equity markets fall much beyond 20% from their peak levels, as they have done in past big market declines. As a result, investors are very willing to take risks beyond what makes sense in a “normal” functioning market. At some point that will change and maybe sooner than later.
As mentioned last week, we are shifting toward value and taking profits in many of the technology sector ETFs and individual names that have run up so much this year. While not yet increasing cash, we think the neglected parts of the market can do well through yearend, even if tech struggles.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.