Markets may have to brace themselves for more rate hikes
Stocktake: Fed chair strikes ‘hawkish tone’. Plus: S&P’s fall and rise; tech stocks power back
Jerome Powell: Investors, accustomed to “dovish” former Fed chiefs such as Janet Yellen, Ben Bernanke and Alan Greenspan, may have been disconcerted by Powell’s “demeanour and forcefulness”. Photograph: Saul Loeb/AFP/Getty Images
Apple, Amazon and Microsoft all hit all-time highs last week. Photograph: Leon Neal/AFP/Getty Images
Stocks sold off after Powell struck an apparently hawkish tone when addressing the US Congress last Wednesday. Attention focused on his comment that the economic outlook had strengthened since December, with markets deducing he may be open to the idea of four rather than three rate hikes this year.
Some analysts suggest Powell’s hawkishness was more apparent than real; that he didn’t say anything especially surprising – nothing that would conflict with his dovish predecessor, Janet Yellen. Investors, accustomed to the academic tone adopted by former Fed chiefs such as Yellen, Ben Bernanke and Alan Greenspan, may have been disconcerted by Powell’s “demeanour and his forcefulness”, said the Leuthold Group’s Jim Paulsen. Direct and business-like, Powell’s “lack of back-pedalling” and tone may have made him seem more hawkish than Yellen, suggested Paulsen.
Maybe, but economics professor and Fed Watch blogger Tim Duy thinks markets are right to brace themselves for more hikes. Powell, Duy pointed out, emphasised the risks of an “overheated economy” – a notable emphasis, given inflation, at 2.5 per cent, remains shy of the Fed’s official target of 2 per cent.
Of course, Powell’s fellow Fed board members might disagree, resulting in no policy changes. Still, markets are probably right to see Powell’s testimony in a slightly hawkish light. Similar bouts of rate-induced turbulence are likely to be a feature of 2018.
Historic winning streak ends, but it’s not game over
The S&P 500’s fall of almost 4 per cent in February means an unprecedented winning streak has ended.
The US index and the broader MSCI All-Country World Index had not suffered a monthly decline since October 2016, gaining 15 months in a row. That’s extraordinary – stocks are meant to rise most of the time but not all of the time. Investors might assume further bloodletting is likely, given the S&P 500 gained 36 per cent during that uninterrupted 15-month rally.
However, there’s no evidence that long winning streaks, once they end, are inevitably followed by further falls. In fact, it’s more common for the previous uptrend to resume and for indices to get back to winning ways.
Typically, volatility picks up well in advance of major tops. 2007 was typical in that respect – stocks ended the year near all-time highs but uncertainty over the changing financial landscape was reflected in a number of corrective episodes during the year.
A 15-month, 36 per cent rally may seem unsustainable, but bears should be careful. “Uptrends don’t end with that level of positive momentum,” to quote Fat Pitch blogger Urban Carmel.
Tech stocks power back after market reboot
February may have been a gruelling month, but technology stocks bucked the trend, with the tech sector the only industry to post monthly gains.
Tech stocks endured a rapid double-digit correction only to stage an equally rapid rebound. Apple, Amazon and Microsoft all hit all-time highs last week while the NYSE FANG+ Index, an index consisting of 10 of the sector’s “sexiest” stocks, has gained some 20 per cent this year.
Typically, red-hot growth stocks suffer the most in corrective episodes, with investors rotating into defensive sectors, but not this time. Clearly, the assumptions that caused investors to pile into all things technology remain intact.
This nonchalance indicates two things: firstly, that investors will continue to look to buy the dip in tech stocks; secondly, that the ongoing market correction is just that – a correction, not a major market top.
Tech sector now a quarter of the market
The strong rebound in technology stocks means the sector now accounts for more than 25 per cent of the S&P 500 – the biggest weighting since the dotcom bubble burst in 2000, according to Bespoke Investment data.
There are, of course, huge differences between then and now.
Firstly, valuations are very different. At the peak of the technology bubble in 2000, the sector traded on 60 times estimated earnings. Today, it trades on 19 times earnings, in line with the broader market.
Secondly, the move higher in index weighting has been “slow and steady”, notes Bespoke, with the tech sector’s market share nudging upwards over time. In contrast, the 1999-2000 ascent was almost vertical: accounting for 25 per cent of the S&P 500 in November 1999, the tech sector’s weighting peaked at 35 per cent just four months later.
Still, few would disagree that sentiment towards the tech sector, up 35 per cent over the last year, has grown a little frothy. No sector – not even the financial sector at the peak of the 2006-07 housing bubble – has accounted for 25 per cent of the S&P 500 since late 2000.
One sector accounting for a quarter of the index is “nothing to sneeze at”, says Bespoke. “It bears watching for sure”.