US Equity Market Stalls; Bond Yields Rise

Market Overview:

The vertiginous climb of the US stock market that began on October 27, 2023, appears to be plateauing as the S&P 500 fell for the second week running. Bonds sold off too, with a sharp rise in yields last week. Investors seem to be finally waking up to the prospect of fewer rate cuts. Unexpectedly high Consumer Price Index (CPI) and Producer Price Index (PPI) reports for February suggest the Federal Reserve might delay rate cuts. Unlike previous cycles where rate cuts followed recessions or financial crises, current indicators don’t forecast such drastic events, supporting a cautious approach to easing rates. Gold headed lower in line with bonds and Oil nudged higher.

As I have been at pains to suggest all year, unlike in the UK and Europe, the US economy probably doesn’t need any rate cuts. Why would the Fed ‘Mess with Success’? The economy seems to be doing just fine as it is and if anything there is a slight worry inflation could reignite. So, keep the powder dry and don’t pull the rate cut trigger unless we get concrete signs of a weakening in the jobs market. The question is, can the lofty valuations of the US equity market be justified without rate cuts and the answer is probably going to present itself over the next quarter.

Nvidia Fireworks or Damp Squibb

So, market momentum has stalled, but I don’t think that is necessarily a bad thing as letting a little air out of a potential bubble reduces the chance of anything popping and I for one was a little relieved to see the Nvidia price take a breather over the second half of the week (unbelievably it was still up again over the 5 trading days and more than 80% this year).  Expect Nvidia to dominate the headlines early next week as it is holding the eagerly anticipated, GTC Conference on Monday where we get the full song and dance from Jensen Huang which I expect will make the Steve Jobs polo neck Apple appearances look like an exercise in bathos. There will be lots of jargon, but the look through will be another new, super faster graphics processing unit (GPU) that will be the go-to card for companies training and deploying AI models. Some 300 exhibitors are set to take part in the conference with a wide range of top speakers including senior executives from OpenAI, Meta and Microsoft.

I really wish I was blessed with foresight at this moment in time, as I sense an epoch moment which could either come to define this conference as a peak bubble moment, or confirmation of the profound and secular impact that AI is going to have on all our lives and that Nvidia is actually a steal at 37 x forward earnings! We shall see…

US Inflation & the J Powell Dilemma

Fed Chair Powell’s dovish stance and hints at a potential rate cut seem to be increasingly incongruous to me, perhaps his rhetoric is strategic or, without wishing to sound like a conspiracy nut, even politically motivated. Chucking more fuel on the US economy now with rate cuts could see the economy run hot and the Stockmarket even more so, which are ingredients for happy Americans, making the incumbent Biden more likely to beat Trump. Could that really be allowed to happen, given the supposed impartiality of the Federal Reserve? I don’t know, but stranger things have happened and I understand that Trump is almost universally despised by the central bank cognoscenti.

Leaving aside my cynical comments, I think the Fed would be unwise to dismiss the core CPI’s higher-than-expected figures for another month. The Bureau of Labor Statistics measure of the core consumer price index, which excludes food and energy, increased by 0.4% in February, bringing the year-on-year change to 3.8% (versus 3.9% prior). Under the surface, the pace of shelter inflation is at least slowing and likely to keep heading lower, although core goods disinflation appears to have stalled.

Since the start of the year, the anticipation for interest rate reductions has moderated, aligning now with the Federal Reserve’s indications of up to three rate cuts by the year’s end with the first cut most likely in June. The Fed’s FOMC March meeting next week and subsequent updates to their rate projections could really be pivotal. The focus will be on any shifts in the ‘dot plot,’ a chart summarizing each FOMC member’s rate expectations, which could indicate changes to the median forecast for rate cuts. The outcome could refine market expectations and impact the bond markets, possibly more than the equity markets, which still seem to be wilfully ignoring the possibility of a delay in rate cuts passed June. I don’t really want to spook anyone, but the next few inflation readings could be disappointing as base effects alone could lead to higher inflation over the next three months. (Base effects – last year we had lower inflation numbers in March, April and May and these components will drop out of the one year annualised numbers as we move forward, mechanically raising the headline one year number all things being equal).

Climbing off the fence that I typically inhabit, I think investors are likely to have to deal with the fact that we are not going to get a rate cut in June and that this prospect will increasingly dawn on the markets over the next few months. It probably means bond yields heading higher and an uncomfortable period for the equity markets as investors digest this new reality. This negativity should be countered by something very comforting for long term investors, in that forward earnings projections are heading higher again.

Over the long term, earnings are the most significant driver of stock market performance, much more so than the vagaries of monetary policy. Providing US corporate earnings can deliver this year, then I think after a period of turbulence, the market will get over the sparsity of rate cuts and finish the year significantly higher than it currently is. The chart from Bloomberg, underpins a very healthy outlook in projected profits for Big tech and where Big tech goes, so goes the averages.

The Bubble you were probably unaware of …

You have to really do some searching to find an index that was significantly outperforming the Nasdaq over the last year, but up until the last week, Indian Small Caps had that honour. Now, I sit on quite a few investment committees and have the privilege of listening to the views of many other very experienced investment managers and the subject of India has cropped up on all of them recently. Specifically, the need to have market exposure to this rapidly growing economy and without a shadow of doubt the Indian economy is going to increasingly have a much greater impact on the global economy and it seems to offer the growth that China once did, without the threat of a politically controlled state, – unbridled capitalism and who wouldn’t want to fill their boots with high growth Indian equities ?

Here, all the ingredients are ripe for bubble formation and it would seem the authorities have also noticed the potential dangers. The Securities and Exchange Board of India (SEBI) has raised concerns over the significant investment in small- and mid-cap stocks, fuelled by a notable rally in this high-risk market segment. SEBI advised funds to develop strategies for controlling these investments to protect investors from potential losses due to sudden market drops. Additionally, SEBI suggested allowing fund managers to include more large-cap stocks in their small-cap portfolios to mitigate risk and highlighted issues with price manipulation in new listings on platforms for smaller companies. As a response to SEBI’s guidance, ICICI Prudential Asset Management and Kotak Asset have introduced measures to manage fund inflows.

We have witnessed a greater than 10 % correction, but we did at least see a little bounce at the end of last week . Maybe the correction offers investors who have so far missed out, the chance to get in or maybe it is the start of something more sinister. I think it probably prudent to sit this one out for a few months, but this is definitely a market worthy of direct long-term exposure and an addition we are considering for our own AQ models, just not quite yet….

With apologies to the UK and European markets for not covering them this week (they behaved just fine), and Japan where we saw encouraging signs of wage increases, but in the interests of brevity I will sign off on this week’s Market Matters here as I am told by Ash to try and limit the amount of content! It’s a big week ahead with the Nvidia conference and the FOMC and I suspect the world could look a little different by next Monday.