Did we miss the top of the market?
While we’ve been sitting here in the UK, gawping at all the political drama, the market in the US has taken a bit of a bearish turn.
Tech stocks – which have been the main thing propping the US market up recently – took a nasty nosedive on Friday. The pace of the slide slowed yesterday, but they still closed down rather than bounced.
So is the overvalued US market finally waking up to reality?
What triggered the minor tech panic?
The Nasdaq Composite index in the US – which contains most of the big technology stocks, including the famous FAANG quintet of Facebook, Apple, Amazon, Netflix and Google (Alphabet) – took a bit of a bump on Friday, falling by nearly 2%. Meanwhile, Nvidia – an extremely “hot” technology stock, which was up by more than 50% on the year at this time last week – got knocked down hard too.
The tech sector took another knock yesterday, with the Nasdaq closing down 0.5%. Cue a slew of headlines talking of a “tech wreck”.
So what’s going on?
Andrew Lapthorne of Societe Generale is one of the most perceptive analysts out there. His take is that the main driver was a reversal in the “momentum” trade. Momentum investors take advantage of the fact that stocks that have gone up, tend to keep going up. The stocks that lost the most on Friday, are the ones that have demonstrated the most momentum over the past year.
That makes a lot of sense. But what sparked that particular sell-off?
You can go on about valuations, and these stocks are expensive, no doubt about it. You could – reasonably – argue that most of them have never, ever been cheap. Apple was cheap a good long while ago (and is still the least expensive), and Google has occasionally been cheap, but there has never been a point at which Facebook, Amazon and Netflix would have raised a value investor’s eyebrow.
Also, as investment strategist Ed Yardeni pointed out on his blog last week: “the FAANG stocks now account for 11.9% of the S&P 500’s market capitalisation”. That’s more than double the level they accounted for in April 2013. So they’ve come a long way in a short time.
But what was the wake-up call?
It’s never easy to pinpoint these things. But for now, the most obvious candidate is a well-timed note from Goldman Sachs. The one that might have got investors thinking twice was titled: Goldilocks and the three hikes: A fairy tale scenario behind the Tech stock rally.
This (oddly-capitalised) note by David Kostin argued that the market can’t have it both ways. Either the economy is getting stronger, which means the Federal Reserve will have to raise interest rates more aggressively than everyone expects, or current low rates might be justified – but that means growth is heading for a slump.
So that means everything’s going to go pear-shaped, right?
Well, no. It’s not that exciting.
When is a crash, not a crash? When it’s a “rotation”
You see, Goldman doesn’t think that anything as drastic as an actual bear market will happen. No, it’s all about “rotation”. In other words, money comes out of the stocks that have gone up a lot, and goes into the stocks that have lagged behind.
It’s a bit of a “growth” versus “value” story. Value (which in this context, just means the sectors that have been a bit beaten up, such as miners and banks) had a great start to the year last year, but has struggled this year, particularly as it became clear that Donald Trump’s “reflation” plan was going nowhere fast.
The theory is that the big tech stocks and similar companies do well in a low interest rate world where growth is hard to come by, because they are among the few companies that are actually growing.
If interest rates start to rise and economic growth improves, then the market won’t put such a premium on those sorts of stocks, and instead beaten up “value” plays come back onto the radar.
So that’s the theory. It’s a “healthy correction” in an overpriced sector of the market, and the beneficiaries will be stocks that have underperformed recently.
The reality, of course, is that it’s a waste of time trying to predict this stuff as an investor. Paying attention to every little up and down will get you nowhere, unless you’re a day trader, in which case, you’re beyond my help.
For the rest of us relatively long-term investors – if you thought US stocks were worth owning yesterday (generally speaking, I don’t), then you should still own them today. And if you thought they were overpriced yesterday – well, they haven’t got an awful lot cheaper yet, so it’s not time to buy.
For what little it’s worth, this doesn’t “feel” like the big one. There’s far too much eagerness to think that it is. Also, the level of panic over what is a slide of a few percentage points is rather overdone.
Instead, it really does feel more like the market wants to have another go on the “value” swings. The news that Glencore is bidding for Rio Tinto’s Australian coal mines, for example, is interesting. Glencore chief executive Ivan Glasenberg is nothing if not a survivor.
However, the biggest influence on the market will probably be whatever the Fed decides to do tomorrow. Rates are likely to go up, but how bullish will the Fed be on the economy? I reckon this market’s got at least one more cheap-money fuelled rally in it still. Let’s wait and see.