Magnificent 7: Mostly surpassing lofty expectations
In our recent Market Outlook brochure, we made a strong call for the technology and telecommunications industry as well as pointed out why this year would be a good year for equities. Scepticism was abundant, with European investors especially, who have been in the market long enough to remember the ‘dot-com bubble’ at the turn of the millennium.
This past week US companies delivered earnings results which included the ’Magnificent 7’, who came out with updates that mostly surpassed lofty investor expectations. Comprising of Apple, Amazon, Alphabet, NVIDIA, Meta, Microsoft, and Tesla, the stocks that make up the ’Magnificent 7’ led the way with a gain of 4.9%, while the equal-weighted S&P 500 lagged at 0.5%.
While many investors are making a comparison to the early 2000s, when the rise of the internet led to the dot-com/tech bubble. Our strategists point to the striking difference that today’s high-flyers trade at half the valuation and double the cash yields compared to 25 years ago, or the fact that within the ’Magnificent 7’ Meta celebrates its twentieth anniversary, while Alphabet went public in the same year. As a result, neither were even in the market in the age of ‘irrational exuberance’.
More specifically this rise of the ’Magnificent 7’ differs from the dot com boom because:
- Current valuation of the megacap technology stocks is still only a fraction of that of the leaders in 2000.
- The companies are highly cash generative.
As a result, this past week’s solid results and outlook are driving 2024 earnings higher, sustaining continued upside for mega-cap technology stocks in the US.
Does this affect when the US will cut rates?
In the January US employment report published last week, non-farm payroll growth surprised strongly to the upside, with 353,000 newly created jobs vs the 185,000 expected. In addition, payroll growth for the previous two months was revised up, lifting the December 2024 payroll growth to 333,000.
Back-to-back monthly payroll growth of over 300,000 shows the US labour market’s remarkable strength but raises concerns that strong demand in the US may keep inflation pressure high. Once the supply-side factors that caused the past inflation overshoot have receded, demand-driven inflation may take over, compromising the return of inflation to target. In general, the US appears to be staving off the anticipated soft landing, with economic growth still on a robust path.
Fourth quarter 2023 gross domestic product (GDP) growth had surprised to the upside at 3.3% annualised two weeks ago. The recent data confirms that markets have likely been too aggressive in pricing in US Federal Reserve (Fed) rate cuts for this year.
We see our forecasts confirmed that the Fed will wait until May with its first federal funds target rate cut, and cut three times in 2024, lowering the upper bound to 4.75%.
What about the rest of the world?
Last week, policymakers in three Latin American countries advanced their easing cycles. In Brazil, the central bank lowered its policy rate by 50% to 11.25%, marking its fifth consecutive reduction. The committee expects the same magnitude in reduction for at least two more meetings. In Chile, the central bank accelerated its easing pace and cut interest rates by 100% to 7.25%. The decision demonstrated the bank’s expectation that the 3% inflation target will be reached sooner than projected. The decision of the Colombian central bank to lower rates by only 25% to 12.75% reflects the nation’s still-challenging disinflation process, following a minimum wage increase and raging wildfires amid severe El Niño weather episodes.
The trend of disinflation and forward guidance by central banks towards more rate cuts is not limited to Latin America. Across other emerging market economies, central banks are moving towards lower rates more aggressively and earlier, driven by significant downside surprises in domestic inflation and the softening of commodity prices. The backdrop of this easing cycle is particularly striking compared to developed economies: nearly 40% of emerging market central banks have delivered first rate cuts already.
As a result, we expect headwinds from tight financial conditions to continue fading across emerging market economies, which bodes well for a growth recovery throughout 2024.
What does this mean for investors?
Bubble or not, it seems more of a judgement call these days. However, we do not see another dot com boom on the horizon. The secular growth drivers remain firmly in place, while some shareprice consolidation is possible after the massive rally. Although valuations are not on the cheap side anymore, they are far from excessive. We recommend investors to stay invested with a preference for US growth stocks.