Hello and welcome to this month’s equity market review with me, Ritu Vohora.
Despite strong earnings growth and reasonable valuations, equity markets continue to be buffeted by swings in sentiment from an escalating trade war. Global equities, however, staged a defensive rally in July. The US was the best performing region over the month, closely followed by Europe. Cyclical regions posted positive returns, but lagged the global index, with China and Korea falling over the month.
Oil finished the month lower, down some 7%, posting the biggest monthly loss since July 2016. Crude oil declined as trade tensions weighed on the market, alongside an unexpected rise in US stockpiles and a surge in production from Saudi Arabia and Russia. Gold continues to be a laggard, with its safe-haven status being questioned, given a highly uncertain global political environment and an escalation in trade tensions.
From a sector perspective, the rally was led by the most earnings stable sector, with healthcare the top performer, followed by industrials and financials. Consumer discretionary, real estate and technology were the laggards. Globally, balance sheet risk was a key determinant of overall performance.
Earnings season is upon us again. And while its still early days, more than 85% of S&P companies have beaten analyst estimates so far. Second quarter earnings are expected to increase by 20% from Q2 2017. But the tug-of war goes on between bulls who are relishing solid corporate fundamentals and the bears who are fretting about trade uncertainties and higher borrowing costs. The bear’s highlight reel includes big-name disappointments and earnings misses from the likes of Netflix, Twitter and Facebook – which saw its biggest one-day drop in history during the last week of July. The sell-off spread to other major tech names and underlined the risk of depending on a few elite names.
It’s extraordinary how quickly a narrative can change. The FAAMG stocks of Facebook, Amazon, Apple, Microsoft and Google have been the unstoppable titans of Wall Street, with a combined worth of a staggering $4.1 trillion, that’s worth more than the bottom 282 companies in the index. US market gains so far in 2018, have almost been wholly attributable to massive rallies in these few select stocks. But suddenly Facebook’s recent fall, has sparked concerns that the stupendous growth of these companies will see a repeat of the dot-com bust of the late 1990s. Is this a watershed moment in the value versus passive investment saga?
What was interesting to see is that Facebook shares fell on the back of fundamentals – prospects for growth, users and margins. Not data scandals nor GDPR. It’s an important reminder that ultimately, fundamentals such as earnings growth, trump headlines as drivers of stock returns. High growth rates don’t tend to continue into perpetuity and high valuations create vulnerability. As high-profile companies have disappointed on earnings growth, valuations have come back into focus - they need to be justified by strong prospects.
The retracement of these growth stocks has provided some respite for long suffering value investors. Tech weakness has been the driver of a 4% outperformance of US value over growth stocks over the last three trading days in July, making this the most aggressive rotation out of growth stocks in more than nine years. Over July, value has outperformed growth, whilst momentum has lagged. The rotation could persist for several reasons. Valuations for US growth stocks are at the highest levels relative to value stocks since 2006 and suggest room for further growth underperformance. Slower growth in Europe and emerging markets in the first half prompted investors to rotate out of value stocks into growth stocks. There are signs that Europe is recovering, and if global growth remains resilient, value stocks should benefit. Additionally, as QE is reversed, and we move into quantitative tightening, this could help the growth and value cycle to re-establish itself.
While recent dialogue about the tech titans has turned negative, today’s tech boom is powered by big companies with strong revenue streams and largely, credible business models. This is different from the dot.com equivalent. Technology stocks still look attractive, but we are seeing increasing dispersion within the sector, especially among the mega-cap names. While Facebook and Netflix have been hurt, on the flip side companies such as Microsoft have continued to deliver on earnings.
This highlights the wide range of opportunities. It is important to ascertain what is already reflected in valuations and whether earnings can continue to grow in a sustainable manner – particularly with growing pressures from competition, increasing regulation and rising investment eating into margins.
It remains to be seen if the recent moves represent a sea change for the reemergence for value, which has been overshadowed by growth plays. An important difference with 2000 concerns concentration risk and liquidity. The five largest technology stocks account for 12% of the S&P 500 index and 27% of the Nasdaq 100 index. Not blindly chasing momentum, focusing on fundamentals and diversifying risk will be important going forward.
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That’s it from me and see you next time!