Dancing on the edge of irrational exuberance?

Interest Rate expectations in focus
Earnings slide back into the spotlight
Shipping disruptions in the Red Sea

In a bustling month marked by central bank activities, economic updates, and earnings releases, investors are gearing up for a dynamic period. With the earnings season gaining momentum, a keen focus is on identifying which companies thrive in the current environment and which struggle to sustain both top-line growth and margins. Notably, enthusiasm for artificial intelligence (AI) serves as a key driver. The surge in demand for high-end chips essential for AI applications has heightened optimism. Simultaneously, the persistent narrative of a "soft landing" remains prevalent, allowing markets to reach all-time highs while also moderating expectations for Federal Reserve (Fed) rate cuts.

As a result, developed markets’ stock index MSCI World has increased 2.91%, while emerging markets stocks’ index MSCI Emerging Markets has dropped by 3.03%. During the same period yields on bonds have increased slightly, with 10-year US Treasury bond yields rising to 4% (compared to 3.87% 1 month ago) and German 10-year bond yields increasing to 2.17%, up from 2.02% a month ago.

Central Banks at Crossroads

The European Central Bank (ECB) held interest rates at 4%, stating again that they are committed to fighting inflation, even though they are getting ready to make borrowing cheaper. In post-decision press conference, ECB President Christine Lagarde highlighted a shared view among decision makers that it was too early to consider rate cuts. She emphasized that future decisions would be dependent on incoming data. The ECB might wait for data that consistently shows a slowdown, review things in March, and be sure before deciding on a rate cut in June.

The Federal Reserve concluded its January policy meeting by deciding to keep its policy rate unchanged, as most investors expected, so attention shifted towards the Fed's tone and its outlook on future policy actions. Even though FOMC (Federal Open Market Committee) members voted to keep the benchmark rate within the target range of 5.25%-5.5% for the fourth consecutive meeting, Chair Powel introduced significant changes to its statement. Despite noting a decrease in inflation that could lead to interest rate cuts this year, the market reacted unfavorably to Fed Chair Powell's remarks, indicating skepticism about the likelihood of a rate cut in March. The statement turned out to be more hawkish than expected, with the Federal Reserve firmly resisting the market's more optimistic outlook. Therefore, the general expectation is for rate cuts to begin in May 2024, based on the current outlook.

Tech to remain a standout

Technology had a major impact on the market last year, with big tech companies continuing to wield significant earning power. This led to tech-related sectors performing significantly better than others. Despite concerns about these sectors’ stocks being expensive, their success appear to be grounded in solid fundamentals. In the fourth quarter, tech-related sectors are expected to excel in terms of earnings. While the rest of the more “traditional” companies are likely to see muted growth in both revenue and profit, both the technology and communication services sectors are expected to considerably outpace the broader market.

Projections indicate that six out of the seven companies in the “Magnificent 7” - NVIDIA, Amazon, Meta Platforms, Alphabet, Microsoft, and Apple - are anticipated to be the primary contributors to positive year-over-year earnings for the S&P 500 in Q4 2023. Collectively, these six companies are expected to demonstrate a 53.7% year-over-year earnings growth for the fourth quarter. If we exclude these six companies, the blended (combining actual and estimated results) earnings for the remaining 494 companies in the S&P 500 would show a decline of -10.5% for Q4 2023. Notably, the only company among the "Magnificent 7" not contributing positively to year-over-year earnings growth for the S&P 500 in Q4 2023 is Tesla.

The Magnificent 7 companies¹ vs. S&P 500 ex Magnificent 7

1 Seven stocks - Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.

Shipping disruptions in the Red Sea

Attacks on ships in the Red Sea have caused challenges in global trade. The political instability in the Red Sea is forcing international shipping companies to undertake more expensive routes. That, in turn, is placing heightened pressure on businesses to reassess their supply chains. Shipping disruptions in the Red Sea may affect product prices, although not to the same extent as observed during the pandemic. Stakeholders are scrambling to adapt, though many companies report not yet feeling the effects. Tesla and Volvo Cars previously announced the suspension of some production in Europe due to a component shortage caused by numerous ships being rerouted around the southern tip of Africa. In contrast, BMW reassured that their factory supplies are secure, stating, "All lights are green", while Norwegian fertilizer giant Yara mentioned it was only mildly impacted by the transit challenges in the Red Sea.

Market view

The financial markets have started the year positively, with expectations for lower interest rates in the coming months. Overall, we continue to see economic growth, inflation, and the central banks as key drivers of financial markets in the foreseeable future. Nevertheless, some volatility and consolidation can be anticipated, given that much of the economy's positive news may have already been factored into market valuations.

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