Unravelling Earnings Season: Big Tech Dominance, Macro Crosscurrents and How to Navigate with Caution

Market Outlook

From Stropro's Investment Team

2023’s rally has tested the patience of many bears, even in the face of (relatively) high inflation, a developing banking crisis and fruitless debt ceiling discussions the S&P 500 is still up 8.14% this year. 

So the question remains the same, is this a bear market rally? Or the beginning of a new bull market.

In this piece, we will:

• Discuss S&P 500’s hidden bear market, the prospects of earnings season and Big Tech dominance
• Highlight some Macroeconomic crosscurrents
• Analyse movements made by hedge funds
• Delve into strategies for protecting and modernising your portfolio amidst these challenging financial times

The S&P 500’s hidden bear market.

Let's first look at the index movers: 60% of this move was driven by 6 companies: Apple, Microsoft, Nvidia, Meta, Amazon and Alphabet. This basket of stocks accounted for 224 points of the index’s total 366 point gain1. 

As for the rest of the index, performance is mixed. 47% of stocks in the S&P have fallen in price this year, compared to 11% in the early bull market of 2021.

S&P 500's Deceptive Rally: The Effect of Big Tech

This concentration of ‘losers’ is a telling sign that we may not be beginning a new bull-market. This skew in performance is the reality of having mega cap monopolies in a market-cap weighted index, we discussed the same thing early last year. 

Nervous About An Earnings Recession?: Big Tech Earnings Offset Banking Fears.

One of the biggest concerns in the stock market right now is the expectation that earnings growth would be negative in Q1 for the second quarter in a row.

This outlook for weak earnings is why numerous stock market forecasters have been warning of another market pullback in the first half of this year. (A pull back that has yet to materialise.)

However, Big Tech earnings delivered. Last week, Wall Street stocks experienced their best day since early January, driven by robust earnings reports from major tech companies. The S&P 500 surged by 2%, marking its largest daily gain since January 6, with Microsoft, Apple, Amazon, and Alphabet as leading contributors.

Meta outperformed the rest, climbing 14% following better-than-anticipated Q1 results and highlighting its investments in artificial intelligence. Meta’s huge recovery from last year is a perfect example of the adaptability of big-tech, the company’s focus on profitability has brought their stock price back up from the trenches of 2022.

Stropro’s investment strategy, ‘Tech Giants’ 11.50%p.a. Fixed Coupon delves into the factors behind the strength and resilience of Big Tech companies amid market uncertainties. The companies hold more than $500 billion in cash reserves, allowing them to invest and adapt to market changes. Their ability to convert sales into cash is unparalleled, in fact these companies convert 21% of sales into free cash flow, making them five times more profitable than oil giants.^{Fondapol (2018)}

One of the most significant advantages tech possesses is its ability to reinvest effectively. The market rewards them with high valuations and low-cost capital, enabling them to grow as long as their return on investment surpasses their cost of capital. This low-cost capital advantage empowers Big Tech to construct even larger moats and extend their dominance across various industries. This financial stability, coupled with their iconic brands, consistent cash flows, agility, and deflationary impact of innovations, enables them to maintain their market dominance.

Global Macro Crosscurrents:

There were a few notable data points from last week to consider:

• U.S. unemployment claims have risen but remain near levels seen during economic expansion, with the potential for further fluctuations.
• Regional U.S. Fed manufacturing surveys released two days ago point to a slower economy. The Philly Fed Services index and Richmond Fed’s Manufacturing Index continue to drop for the last 9 months, signalling a contraction in the U.S. economy.
• The Consumer Confidence Index by the Conference Board dropped significantly in April, hitting its lowest point since June. (Source: AFR)
• In our previous edition, we noted the expansion of central bank balance sheets (essentially increased liquidity in the economy). This is now materialising. A report from Citigroup now suggests the market rally may be driven by a surge in central bank reserves, or 'defacto QE,' rather than a strong economic outlook; potential pullback in reserves could lead to a sharp market sell-off. 
• According to BofA’s April Global Fund Manager Survey (via Notes), fund managers identified “bank credit crunch & global recession” as the “biggest tail risk.”
• Banking worries are fading. According to J.P. Morgan’s latest weekly client survey, 72% of respondents believe the worst of the regional banking crisis is over.
• Recession worries are fading. According to RBC Capital Markets’ analysis of S&P 500 company transcripts, mentions of “recession” are in recession.

What Market Wizards Are Up To?: Quant Funds Poised to Sell & Record Treasury Shorts By Hedge Funds.

• News broke this week that hedge funds are holding record short Treasury exposure right now, signalling they believe inflation may persist or that markets are overconfident about rate cuts (Source: Bloomberg). With signs of the U.S. economy contracting, will potential Fed loosening take hedge funds by surprise in their short positions? Once Treasuries are no longer influenced by the Fed, the stage is set for a potentially significant rally in long-dated government bonds. The sentiment shifted towards Treasuries last week, and this trend may continue. (Source: Reuters)

• Quants are ‘out of ammo’ for buying stocks. Goldman Sachs recently warned that after investing over $170 billion in global stocks in the past month, their positioning is at its highest since early 2022. A market decline could trigger forced selling of up to $276 billion. So, what does this mean? With quant funds running out of buying capacity, any significant market downturn could lead to a massive unwinding of their positions, putting additional downward pressure on the market. This comes at a time when the market is already cautious due to recession concerns and the looming deadline for the U.S. government debt ceiling. (Source: AFR)

Putting It All Together:

While there are signs pointing to a possible "Goldilocks" soft landing scenario, it's essential to remain cautious and vigilant in the face of market uncertainties. The Fed has adopted a less hawkish tone and signalled that the end of interest rate hikes is near. However, the uneven performance within the S&P 500, coupled with global macro crosscurrents, developing banking crisis, and inflation still yet to come down, questions about the sustainability of the current rally.  

A Modern Portfolio

Success in an uncertain economic landscape requires flexibility, high-quality investments, and a diversified strategy that can withstand and capitalise on rapid changes. As we've highlighted numerous times, BlackRock stated in their 2023 outlook, "Navigating markets in 2023 will require more frequent portfolio changes and a more granular approach to investments... A new regime of greater macro and market volatility is here to stay, and investors need a different playbook for 2023 "

In the face of uncertainty, it's crucial to break free from conventional investment wisdom and explore alternative opportunities. Our investment team remains dedicated to arranging investment strategies that we believe will benefit our clients and guide you through these uncertain times. Modern portfolios demand dynamic asset allocation, relying solely on low fees from passive vehicles doesn't cut it anymore.

What Caught Our Attention! 

We wanted to share the following news and articles with you which we here at Stropro found interesting:

• 07-03-23 - Reuters - Global supply chains have 'returned to normal,' according to NY Fed
• 25-04-23 - iCapital - Private markets outperform the traditional 60/40 portfolio over the long run
• 26-04-23 - AFR - Six inflation-busting strategies to boost income

Thank you for taking the time to read this update and we appreciate any feedback that you might have. Please reach out to the team at any time.

If you have any questions contact us at team@stropro.com.

Warm regards,

Stropro Team

This information is for educational purposes and is not a substitute for professional and tailored financial advice. This information expresses the views of the author(s) at a point in time, which may change in the future with no obligation on Stropro or the author to publicly update these views. This information uses information from sources the author considers to be reliable but does not represent that such information is accurate or complete, or that it should be relied upon.  Past performance is not a reliable indicator of future performance. Investments may rise and fall in value and returns cannot be guaranteed. Stropro makes no representations or warranties, express or implied, as to the accuracy or completeness of the information it provides.  Stropro is a Corporate Authorised Representative (CAR No. 1277236) of Lanterne Fund Services Pty Ltd (AFSL No. 238198).