Equities should remain supported despite tech sell-off
CIO Daily Updates
From the studio
From the studio
Thought of the day
Thought of the day
What happened?
US equities fell on Thursday, led by a sharp decline in tech stocks as investors absorbed the latest earnings results from megacap companies.
The S&P 500 dropped 1.9%, while the Nasdaq slipped 2.8%, marking their second straight day of losses. Despite reporting results better than consensus expectations, shares in Microsoft, Meta, and Alphabet all declined on Thursday. Investors appeared concerned by losses at OpenAI in Microsoft’s results, while Meta disappointed elevated market expectations on user growth and projected higher capex spending in 2025.
After the market closed, Apple's December quarter revenue guidance was weaker than expected, while Amazon's cloud unit revenue jumped 19% y/y. Nasdaq futures rose 0.4% during Asia morning trading on Friday.
Tech earnings overshadowed positive macroeconomic data. Thursday’s personal consumption expenditures (PCE) price index report for September showed the Fed’s preferred measure of inflation falling to 2.1% on an annual basis relative to 2.3% in August, marking its lowest level in three years. The core measure, however, did move higher to 2.7%. The Employment Cost Index for 3Q came in at +0.8% over the quarter, the weakest since 2Q 2021.
Ahead of Friday’s nonfarm payrolls report, initial US jobless claims fell 12,000 to a five-month low of 216,000 for the week ending 26 October, while continuing claims fell to 1.86mn, from 1.9mn the prior week.
What do we think?
Against a backdrop of strong year-to-date gains, election uncertainty, and crowded positioning in some widely held stocks, a setback for tech stocks is understandable. The tech sector has rallied by around 10% since the end of the 2Q24 reporting season, which has pushed valuations close to 25x 2025 consensus price-to-earnings.
But we see support for equities both from tech fundamentals and a positive macro outlook.
Third-quarter tech results have showcased improving AI monetization, evidenced by accelerating growth for cloud platforms. Microsoft highlighted increased adoption of copilots “from customers in every industry.”
With the Big Four (Microsoft, Alphabet, Amazon, and Meta) accounting for almost half of all AI spending, we believe their stronger balance sheets and willingness to invest will continue to support strong growth in AI spending. We now forecast their capex to be about USD 222bn in 2024 and USD 267bn in 2025.
In summary, we believe earnings growth will remain the key driver of stock returns, and the 3Q24 results further reinforce our strongly positive view on the AI theme. However, a growing divide between structural AI trends and a sluggish cyclical smartphone and PC recovery means that investors need to rightsize their tech exposure.
Beyond earnings, macroeconomic fundamentals are supportive.
The latest US data support a benign GDP growth (or “no landing”) scenario. Thursday’s unemployment claims data pointed to a resilient labor market. The ADP employment survey for October released on Wednesday showed a strong rise in private job creation (+233,000 versus 111,000 expected) ahead of Friday’s nonfarm payrolls release, which may be distorted by strikes and storms. The US economy grew at an annualized rate of 2.8% in the third quarter, primarily driven by consumer spending, which comes after Bureau of Economic Analysis (BEA) revisions showing that GDP growth averaged 2.5% since 2019.
Benign PCE inflation data should allow the Fed to cut rates next week, in our view. Recent comments from Fed officials suggest that a 25-basis-point rate reduction remains probable, as the US central bank continues to move toward a neutral policy stance. We expect 50 basis points of rate cuts for the rest of this year and a further 100 basis points of easing in 2025. Historically, Fed rate cuts in non-recessionary periods have been favorable for equities.
How do we invest?
The combination of solid growth and Fed rate cuts provides a supportive backdrop for risk assets, in our view, while the AI trend should lend further fundamental support to equities. We view US equities as Attractive, and we target 6,600 for the S&P 500 by end-2025. Against this backdrop, we advise investors to consider several strategies:
Seize the AI opportunity: Despite recent volatility and mixed reactions to tech earnings, we believe AI should be a key driver of equity market returns over the coming years. As a result, it is important that investors hold sufficient long-term exposure to the theme. We currently see the most compelling opportunities in the enabling layer of the value chain, which is benefiting from significant investments. We also like vertically integrated mega-caps, which are well positioned across the value chain. We recommend taking advantage of elevated volatility to buy potential dips in quality AI stocks and engage in structured strategies.
More to go in equities: While there has been a cautious response from investors, the 3Q earnings season started on a relatively positive note. Overall, we expect S&P 500 earnings per share growth to remain healthy, in the 5-7% range this quarter. For 2024 and 2025, we expect S&P 500 earnings growth of 11% and 8%, respectively. Our favorite sectors are information technology, communication services, consumer discretionary, financials, and utilities.
Position for lower rates: With recent macroeconomic data showing slowing inflation and steady growth, we expect further easing from the Fed. As cash and money market funds begin offering lower returns as rates fall, investors need to manage their liquidity more actively. We particularly like high-quality bonds that still offer relatively attractive yields and can perform well in the risk scenario of growth slowing rapidly.
Prepare for the US election: As the US election draws closer, volatility across markets is likely to continue. For investors concerned about protecting their portfolio from election-related volatility, we recommend hedging strategies like holding gold or purchasing structured solutions with capital preservation features. We do not recommend selling risk assets ahead of the election and waiting for the vote outcome before returning to the market. Instead, we recommend investors express their political preferences at the ballot box, not in their portfolios.