Charts of the Month

CHART 1 – STOCKS BREAKING OUT

A few weeks ago we said the odds favoured a “Santa rally” that sees equity markets finish the year on a positive note.

The chart below suggests that scenario is starting to play out.

It shows the Nasdaq index breaking out of a multi-month descending channel that saw it fall 12% from its late July peak. The index has now rallied strongly from its October lows.

In recent years the Nasdaq and crypto markets have tended to witness big trend changes slightly ahead of other risk assets. This was true of their bull market peak in late 2021 which, with the benefit of hindsight, signalled the start of 2022’s pervasive bear market losses. It was also true of the market lows last year.

So the fact both tech stocks and crypto prices are rallying strongly augurs well for other stock markets near-term. The key question is will this remain a narrow rally that sees only a handful of stocks perform well (as has been the case for most of 2023) or will other regions and sectors benefit too?

CHART 2 – A NARROW MARKET RALLY

The recent rally in tech stocks and crypto prices suggests risk appetite is improving and argues for other equity markets performing well as we head into year-end.

But does it?

The chart below shows the year-to-date performance of the market-cap weighted S&P 500 versus the equal-weighted version, both in dollar terms.

The market-cap weighted index (which is more commonly referenced) is up around 17% on a total-return basis, whilst the equal-weighted version is around flat. Why so?

This is all due to the stellar returns of the mega tech stocks: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla; the so-called “Magnificent Seven”. Collectively, they represent almost 30% of the market-cap index and have all produced strong double-digit gains this year. Without them, the S&P 500 has gone nowhere with many of the underlying stocks nursing substantial losses.

There are several reasons why the tech names are leading including their superior earnings growth (helped by the artificial intelligence boom) and the growing preference for passive over active investing. This naturally increases the demand for the larger-weighted stocks relative to their small-cap peers (at least when the overall market is trending higher).

Such momentum makes it hard to bet against the “Magnificent Seven,” but some of the more cyclical stocks have a lot of catch up potential if investor risk appetite continues to improve.

CHART 3 – BANK STOCKS: VUNERABLE OR CHEAP?

The equal-weighted S&P 500 index is essentially flat this year, meaning the vast majority of the 500 constituent stocks are either flat or down. In fact, many of them are down heavily.

The bank stocks are a case in point and the chart below shows the KBW bank index, which tracks the share prices of the largest 24 US banks. Its 20%+ year-to-date loss (in U$ terms) has left financials as one of the worst performing equity sectors this year, although utilities and consumer staples are struggling too.

The entirety of this year’s losses can be attributed to the index’s 25% slump in March, when three US regional banks (SVB, Signature and First Republic) collapsed in response to surging Treasury yields. A degree of stability has since returned, courtesy of the Federal Reserve’s intervention, but bank stocks remain weak.

Perhaps the key takeaway is what this infers about the health of the US economy. Whilst the much anticipated recession will be avoided this year, the bank stocks and economic wellbeing tend to go hand-in-hand, so this depressed KBW index is strong evidence that the economy is struggling. The counter-argument is that bank stocks are cheap and could produce material gains if the economy holds up in 2024.

CHART 4 – THE RATES OUTLOOK

Table Mountain and the Matterhorn are both famous landmarks, but what else do they have in common?

The answer is they are being used to describe the outlook for interest rates over the next few months.

The Bank of England’s Chief Economist (Huw Pill) recently said his preference is for UK base rates to follow the extended plateau of Cape Town’s stunning mountain peak, which stretches almost 2 miles from end-to-end. What he means is, absent a growth or inflation shock, he expects the target interest rate to stay around its current 5.25% for a considerable period of time.

Another plausible scenario relates to Switzerland’s emblematic Matterhorn, which peaks at 4,478 metres (much higher than Table Mountain’s 1,085 metre elevation) and is characterised by its steep faces. The relevance to monetary policy would be if interest rates are cut as aggressively as they have been hiked over the past 18 months.

The Matterhorn outcome likely only comes to pass if we see a major recession or financial crisis take hold in 2024. That cannot be ruled out but, all things equal, rates are likely to stay higher-for-longer, which means this chart of the US Fed funds rate may soon start resembling Table Mountain.

For what it’s worth, over the past 50 years the average period between the last Fed rate hike and the first cut has only been 8 months, which suggests the first cut happens next March. That’s possible, but not probable.