​Equity forecasters are at wit’s end in new environment

The tech-heavy Nasdaq 100 has not continued to outperform from July, the opposite of our expectation that signs of economic downturn might stop rate hikes sooner and fuel defensive investing.

America’s economic outperformance is a marvel to behold, according to a report from The Economist in April. Now it looks very much like a self-fulfilling prophecy.

The Atlanta Federal Reserve’s GDPNow suggests that annualised real GDP growth could come at an over 5% for the third quarter and professional economists see growth topping 3%.

That marks an acceleration from growth of over 2% for the prior four quarters. The Fed will most likely frown at it aggravating upward price pressure.

The S&P 500 has erased much of its gains in the past few months, rising around 10% year-to-date. Relentless climb in Treasury yields, which was absent for over a decade, are largely driving market action.

Only two of the eleven sectors generated positive return in the last quarter. The clear winner was energy stocks as OPEC+ pushed up oil prices by coordinated output cuts.

A tougher game

Stock investors have to confront a more volatile and less predictable environment after waving goodbye to quantitative easing that offered unlimited dry ammunition.

That is evident this year in particular. Equity strategist were blindsided by a strong rally and stocks began to lose steam right after they changed their pessimistic views.

JPMorgan Chase CEO Jamie Dimon warned that the fed funds rate may ellipse 7% and that central banks and governments are not as credible in macroeconomic projection as many believe.

“I want to point out the central banks 18 months ago were 100% dead wrong,” he said. If so whatever lies ahead for stock markets is still predominately murky.

The Fed are poised to leave short-term rates unchanged for a second time next week, while keeping open the door to more rate hikes.

Policymakers said rising yields may be helpful in offsetting price pressures. Markets were pricing in nearly 40% odds of an increase by year-end.

Meanwhile the fed also has to grapple with concerns about the US government’s debt boom. The current fiscal path is widely seen as unsustainable and higher borrowing costs only makes the problem less soluble.

bearish call

Firms including Goldman Sachs and Deutsche Bank think earnings could drive the S&P 500 another leg higher at year-end, while bears like Morgan Stanley see further downturn.

The S&P 500 Index peaked in July and is unlikely to trade beyond the mid-4000s for the next six months as higher rates weigh on corporate earnings growth, according to Stifel Chief Equity Strategist Barry Bannister.

The eminent forecaster accurately made a contrarian call on the stock rally in the first part of 2023 and has since said gains would stall in the second half of the year.

The benchmark is trading above 4,200 – a major support. While Bannister believes that yields will top around 5% during the current cycle, he projects a normalised 10-year yield of up to 6% during the mid-2020s.

The last time 10-year yields were this high 16 years ago, bond traders held out on buying until real yields peaked at about 2.8%, said Truist co-chief investment officer Keith Lerner.

While real rates have risen and inflation has largely fallen over the last several months, the current roughly 2.5% adjusted rate is below the recent historical high.

Tech frenzy

Global hedge funds reduced their exposure to mega cap tech stocks in recent days, ahead of the companies' third-quarter earnings, JPMorgan Chase and Goldman Sachs both said.

But Megacap tech stocks continue to account for a relevant part of hedge fund's book as stocks in other sectors were also being sold, the two Wall Street banks added.

The so-called Big Tech are expected to post a 32.8% gain in earnings for the full year, while the rest of the S&P 500 sees a 2.3% decline over the same time, according to LSEG.

Blackrock is underweight broad equities for the next 6-12 months, but it remains bullish on megacap companies. “The income in bonds is also more attractive than stocks on a relative risk basis.”

Alphabet, Microsoft and Snap kicked off earnings season with strong sales results for the quarter ended in September. But the Nasdaq 100 saw its worst day this year on Wednesday.

At just below 22, the Nasdaq 100 is still way above its floor valuation of around 19 in October of last year, and this with yields on 10-year Treasuries hovering around 5%.

Franklin Templeton said the Big Tech could come under pressure next year if AI enthusiasm wanes but the potential decline in interest rates may benefit.

Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.