Markets brief: As tech stocks continue to climb, is the end of the AI boom in sight?
Plus: As we wait for results from Tesla and Netflix, European banks are left out in the cold.
US stocks continue to climb
Last week provided another reminder that news headlines are poor predictors of returns, as the Morningstar US Market Index rose 1.7% despite growing concerns about weak lending standards and the ongoing economic drag from the Federal Government shutdown.
Tech giants dominate as banks have little impact
The key driver was a 3.7% gain in US communication services, which was itself driven by a 6.9% gain in Alphabet GOOGL, which accounts for 43.5% of this concentrated sector. The other key constituent with a 26.2% weight in the sector- Meta META- also contributed, rising 1.7%. In contrast, the financial services sector was flat over the week, despite several large banks delivering profits above expectations in a week in which financials dominated the results calendar.
The relative contribution of these sectors demonstrates how our perception of the health of the US market has become dependent upon the movements of a small number of companies. It also highlights the importance of looking beyond headline numbers.
On the lookout for cockroaches
The weakness in the financial services sector appears to have been triggered by concerns about the recent bankruptcy of First Brands and Tricolor that delivered losses to Fifth Third Bancorp, Jefferies & Zions Bancorp, and may indicate a broader weakness in lending standards. This was neatly summarized by Jamie Dimon, CEO of JPMorgan Chase (which suffered a $170 million loss on Tricolor) who commented that “when you see one cockroach there are probably more.”
European banks feel the chill
Despite the US orientation of the problems uncovered so far, the subsequent cockroach hunt appeared to have a greater effect on investors in European banks which fell 2.5% on Friday, indicating both the global nature of finance and a morbid belief among investors, scarred in previous crises, that problems in US credit tend to show up unexpectedly on the balance sheets of European banks. Negativity often creates opportunities for patient investors who are prepared to think independently. To help investors identify these opportunities, Morningstar has started publishing detailed asset class reviews.
Bond investors turn a blind eye to the cockroach theory
Credit investors appeared unperturbed by the cockroach warning as high yield credit spreads, the additional yield corporate debt holders receive for accepting default risk, fell slightly last week. Consequently, US high yield bonds, up 0.5%, delivered positive returns that were a little above those of US Treasuries, up 0.4%. As spreads remain tight, the potential reward for the additional risk of credit investing is unappealing.
All eyes on the impending end of the AI boom?
Further afield, emerging markets fell 0.4%, dragged lower by China, down 3.9% following the escalation of the trade dispute with the US. Taiwan also fell over the week, down 0.5% despite strong results from leading chip manufacturer TSMC TSMC, which accounts for over 45% of the market. TSMC’s earnings showed strong demand for semiconductors due to the ongoing boom in AI-related investment. While the stock appears fairly priced, it is worth remembering that the semiconductor business tends to be highly cyclical, driven by both fluctuations in demand and the amount of capital available for investment. Given the extraordinary capital sums being pledged to support the development of AI, it is not surprising that investors are anticipating the end of the current boom and consequently will be closely watching the results from technology-related companies over the coming weeks.
Results due from Tesla and Netflix
This scrutiny is likely to be directed first towards Tesla TSLA and Netflix NFLX which release results this week. Both stocks appear overvalued, given our analysts’ current estimates, and consequently their stock prices are vulnerable if the results disappoint investors.
More broadly, companies continue to deliver results ahead of elevated expectations. Profits are expected to be 8.5% higher in the last 12 months, rising from an expected 8% at the end of September, according to FactSet data. \
September CPI data out this week?
While the last couple of weeks have been a desert of economic information amid the government shutdown, September’s CPI data is expected to be released on Friday due to its role in calculating social security cost of living adjustments. Both core and headline inflation is expected to come in at 3.1% over the past 12 months. A significantly different outcome is likely to move assets prices, in a market starved of other economic data.
