by Tim Sharp
A strong finish to the earnings season particularly mega tech, and especially Nvidia and Meta Platforms whose reporting took on almost macro-economic event proportions, saw equity markets continue generally higher in February. Sticky inflation continued to vex investors as markets pared interest rate cut expectations back further to only three cuts in the US this year which has caused further adjustment in bond markets. Despite a slightly stronger dollar Emerging Markets rallied 4.6% outperforming the developed world as China bounced strongly following central bank easing of lending rates. Japan remained a dominant force up 5.7% on the back of a weak Yen that finished the month at 150 vs. the dollar. The laggard amongst the major markets was the UK where equities were flat on the month despite resilient data although unable to avoid a technical recession in the latter part of 2023, while Europe which continues to flatline saw equities boosted by China to finish up 3.4%.
Nvidia once more reported earnings that were ahead of expectations in the 4th quarter with revenues up 265% to $22.1 billion vs. $20.4 billion expected guiding even higher for first quarter to rise to $24 billion vs. $22 billion consensus. The markets were unashamedly enthused pushing the shares up 16.4% the next day which was recorded as the largest change in market capitalisation of any stock, anywhere, ever, leaving the shares up 28.6% on the month, 59.7% year-to-date, while the wider S&P500 gained 5.2% in February. The CEO stated a surging global demand for accelerated computing and generative AI had hit a “tipping point” although there are some that believe that many Nvidia customers are over-stocking for fear of demand outstripping supply which may leave an inventory overhang later in the year. In any case the focus on the big 6 technology stocks continues to dominate returns with Meta Platforms also starting the month with bumper earnings. The performance of Meta Platforms following its results when it announced a 3% new dividend added $200bn to its market cap in one session, the equivalent of a gain in the total market cap of Cisco Systems – the darling of the 1999 technology stock boom.
Many active investment managers, including us, run strategies that include exposure to a diverse range of assets and asset classes quite often starting with an equally weighted positioning rather than concentrated in a small number of large positions. This kind of strategy would continue to lag headline indices while they are dominated by a small number of heavy weights even if we had exposure to these main stocks. This means that we must have a view on Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, and Nvidia, even if we do not intend to invest in them because of their ability to influence returns. There is a diverse range of forecasts for forward earnings for mega tech depending on the level of conviction which means that investors can view them as expensive, or fairy valued at today’s prices.
We have been adding to our software exposure this year viewing the mixture of innovation, cash flow generation, and low levels of debt as quality defensive in nature. Absolute Strategy Research (ASR) point out that Global Software has the best earnings momentum of any sector and a strong 4th quarter earnings season. The sector has the highest delivered EBITDA margins, seeing a rise of 4% over the last 12 months, sales outgrowing costs, strong profitability, and fast growth on a valuation of 28x forward earnings[i]. Elsewhere, the emphasis on quality defensives sees us continuing to favour Industrials, Energy, and Consumer Staples.
In terms of fixed income, it was reassuring in some ways to see the negative correlation between bonds and equities return as bond markets priced out aggressive easing of rates particularly in the US where Fed Governor Powell ruled out a cut at the March meeting during the post FOMC press conference. During the month US Treasuries fell 1.4% and the speculation spread to Gilts (-1.3%) and European Government Bonds (-1.2%) where the likelihood of a summer cut is perceived more likely due to the current negative growth environment. Whilst Eurozone Services PMI’s were stronger than expected, manufacturing was weaker, and services continue to outperform manufacturing in the UK too. UK inflation remains higher than other developed countries where headline and core CPI were 4% and 5.1% although lower than anticipated, while US inflation surprised on the upside at 3.1% and 3.9%. Japan and China complete the picture with Japanese Q4 GDP reporting a 2nd negative quarter to join the UK in technical recession while inflation continues to strengthen to 2%, and Chinese disinflation came in weaker than expected at -0.8% yoy[ii]. In summary, the resilience of the US economy is one of the reasons why global growth remains in positive territory presenting the Fed with a dilemma when it comes to the right time to ease monetary conditions.
Although the UK is in a technical recession i.e. back-to-back quarters of negative growth there are tentative signs of a pickup in activity as falling mortgage rates bring buyers back to the housing market pushing prices in January 1.3%, 2.5% yoy which is the strongest rate since 2022. The Business Activity Growth PMI rose to 54.3 vs. 53.4 in December in contrast to the manufacturing index which is affected by Red Sea traffic restrictions. Retail sales rebounded 3.4% in January after a record fall of 3.3% in December although volume of sales remains 1.3% below pre-pandemic levels of February 2020[iii]. Furthermore, the unemployment rate continues to fall, now showing 3.9% to November 2023. The BoE will be watching the path of inflation to try and balance growth and inflation with rate cuts. However, a flat stock market in contrast to the positivity in other developed markets is an indication of the hangover still being felt from Brexit trade restrictions, and the lack of growth stocks within the main indices leaving the UK unloved at present.
Overall, our reasons for caution have not diminished, and the markets readjustment of future rate moves while welcome are still optimistic compared to feedback from the Fed. The possibility of a soft landing is still on the cards although unprecedented in recent market history. The US consumer should not be underestimated, however, there are signs in data and delinquencies that higher rates may be affecting areas of consumer credit notably auto loans and credit cards. US equities appear at a stretched valuation relative to the UK, Europe, and Emerging Markets, but the drive in technological innovation is likely to be reflected in US indices where weightings to growth sectors are higher than elsewhere meaning that US exposure may remain key to future returns.
[i] Nelson, Nick _ Absolute Strategy Research _ Equity Strategy _ Upgrade Software and Telecoms_ 29/02/2024
[ii] Ward-Murphy, Zara _ ASR Investment Committee Briefing _ 01/03/2024
[iii] Razi Salman _ Barclays Private Bank Daily Talking Points _ 16/02/2024
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