In a month when the highest ever temperature on earth of 54.4 degrees celsius was recorded in Death Valley, California, demand for technology stocks across the way in Silicon Valley continued to heat up.
The five big technology platforms—Alphabet, Amazon, Apple, Facebook and Microsoft— all posted double-digit gains to help drive the Nasdaq higher by 9.6% during August, thereby outperforming the broader S&P500 (+7.0%) and the MSCI World Index (+6.5%). Apple reached a market capitalisation of $2trn, the first American company to do so. It took 38 years for the company to reach the $1trn mark and just two years to double that, according to Barclays.
Strong demand for technology stocks has sparked the IPO market back to life in a flurry of activity not seen since the dotcom bubble. ‘Unicorn’ companies reportedly filing for IPO include Airbnb, Snowflake Computing, DoorDash and Instacart. Add-in Palantir, a cryptic data-management firm preparing for a direct sale, and the estimated valuation of these five is $80bn, according to PitchBook [i]. Yet, none of Silicon Valley’s upcoming listings rival that of Ant Group, the payments arm of Alibaba, which has cried ‘open sesame’ to investors’ wallets with plans to raise a record $30bn, which could value the firm at around $200bn.
With the IPO market resurgent, the Nasdaq having gained almost a third year-to date and the S&P500 making all-time highs, there has been talk of whether the equity market is in the realms of “irrational exuberance”. Certainly, there has been a lack of breadth to the recent rally; the five big technology platforms having accounted for a quarter of the S&P500’s rally since March. They also represent more than a fifth of the index, the biggest weighting for the top five since at least 1980. Notably, the majority of S&P 500 constituents are still below their levels when the market last peaked on 19th February.
In terms of valuation, US stocks are now priced at more than 22 times forward earnings, according to FactSet, representing levels not seen since the dotcom bubble burst two decades ago. Yet, the composition of the S&P500 index has changed considerably since 1999 when its largest components consisted of GE, Exxon, Pfizer, Citigroup and Cisco. Therefore, it is not surprising that the shift to high growth technology stocks has resulted in a higher valuation. Further, as a result of the sharp decline in bond yields, US stocks compare well on a relative basis; the earnings yield on US stocks is 3.8% versus a yield of 0.7% on the 10-year US Treasury, representing a gap slightly above the long-term average [ii].
With the dust having settled on Q2 reporting season, earnings revisions have turned positive according to Barclays Bank, which has also buoyed investor confidence. Greater visibility from the impact of Covid-19 has led to a slightly improved tone from companies. Cost cutting coupled with nascent signs of an economic rebound should help the earnings recovery during the rest of the year, so the theory goes. Nevertheless, weekly initial US jobless claims rose back above one million for two consecutive weeks at the end of August and the recovery in mobility traffic and other high-frequency indicators has eased. Further, the Vix volatility index has decoupled from equity markets, which has previously been a signal of trouble on the horizon [iii]. Therefore, we retain some caution.
Whilst US stocks ended August in positive territory for the year, most other equity markets remain negative. European stocks gained 3.1% during the month but remain under water by 11% for 2020. The German Dax Index has been exceptionally resilient, briefly turning positive during August, assisted by strong returns from technology stocks Infineon and SAP, together with logistics company DHL Deutsche Post.
Japanese stocks gained 8.2% during August, despite suffering a set-back at the end of the month, following the resignation of prime minister Shinzo Abe due to ill health. During his eight-year tenure, the Topix index has produced a total return 85% in dollar terms, underperforming the S&P 500 but significantly outperforming both the MSCI Europe and MSCI Emerging Market indices. Since Mr Abe’s election, the dividends of Japanese companies have doubled and buybacks have quadrupled, according to Jefferies [iv]. Japanese stocks could be fragile in the short-term until Abe’s successor is instated but initial market consensus is that some form of Abenomics will ultimately prevail.
The FTSE100 index (+1.1%) was the laggard among the major indices in August, held back by the Oil & Gas and Banking sectors. Whilst it was a quiet month for earnings reports, HSBC unveiled an almost seven-fold jump in reserves set aside for bad loans and a steep drop in Q2 profits.
FTSE100 companies, which make two-thirds of their earnings from abroad, were not helped by the strength of sterling which gained 2% versus the US dollar to 1.3353 and 1% versus the euro to 1.1215. Although the UK economy suffered one the sharpest falls in gross domestic product (GDP) among the developed economies in Q2, recent data suggest it could experience a record-breaking recovery in the current quarter. City of London economists forecast GDP will rise by 14.3% in Q3, which could result in the UK moving to the top of the G7 performance table, having propped it up in Q2. The rebound is being driven by the consumer; according to the Office of National Statistics, retail sales in July were 3.6% higher than June and an improvement from a year earlier. Of course, several factors could impede the recovery, not least the winding down of the furlough scheme and a second wave of the virus.
Increased optimism surrounding economic growth not only lifted equity markets but sovereign bond yields as well. The benchmark 10-year bonds yields in the US and UK rose by c. 20 basis points to 0.72% and 0.31%, respectively, and marked their highest levels in two months.
The main development in the fixed income market came from the annual ‘Jackson Hole’ economic symposium. US Federal Reserve Chairman, Jerome Powell, announced that the US central bank will tolerate higher inflation in future as part of its longer-term review of monetary policy. This is a significant development as, in effect, the Fed will now target an average rate of 2% over time allowing it to run with a rate above 2% to compensate for periods when it has been below [v]. As a result, short-term rates should remain lower for longer and the yield curve should steepen, which could be a catalyst for value stocks to outperform in equity markets. Further, if borrowing costs are going to remain anchored and the Fed is encouraging inflation, then the real cost of debt will be eroded which should encourage corporate America to raise capital expenditure.
Of course, inflation would need to pick-up first and only once in the past five years has the Fed’s preferred inflation gauge, the core Personal Consumption Expenditures rate, risen above its 2% target. Nevertheless, the Fed has made its intentions clear and we will watch closely.
[i] The Economist – Initial Public Offerings are back in Silicon Valley; August 22, 2020
[ii] FT.com – The uneven rally that took US stocks to a record high; August 18, 2020
[iii] The Felder Report – The VIX is raising a red flag for the rally; August 26, 2020
[iv] FT.com – Investors in Japan lament the departure of ‘Abenomics’ architect; August 28, 2020
[v] Axa IM – Word up; August 28, 2020
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