by Jurrien Timmer, Director of Global Macro, Fidelity Investments
Moving parts
This remains a market in motion, with many moving parts. The S&P 500 index has broken out of its 2-month long consolidation pattern, and so far the stats do not suggest a false “upthrust.” Per the heatmap below, margins and earnings growth continue to make new highs, and so is breadth. Sentiment is catching up but is not at eyepopping levels. The energy markets have quieted down again, and the global money supply is making new highs again (providing a renewed bullish catalyst for gold). The dollar index is still directionless at around 100, and bond yields have steadied a bit following last week’s soft payroll report.
There are many cross currents of course. The bullish drivers are still driving, with valuations reasonable at 20x for the cap-weighted index and 18x for the equal-weighted index, breadth broadening with 74% of stocks above their 200-day moving average, and earnings momentum still gaining. Outside of recoveries from recessions, I don’t know that I have ever seen earnings cycle like this, where the 12m forward estimate has skyrocketed by $100/share in a year while the 2nd derivative continues to accelerate at a 35% clip. When the level and rate of change are growing at the same time, that’s a lot of momentum.
On the more cautionary side, a rising term premium remains a left tail risk, as does the risk of change in sentiment behind the AI juggernaut. Let’s explore below.
The cap-weighted index has broken out of its trading range, but the broader market is not being left behind. Breadth is now at an impressive 74% and the equal-weighted index is making new all-time highs.
With 90% of the S&P 500 having reported, Q2 earnings season has been another resounding success. The year-over-growth rate for Q2 EPS started the quarter at 23% and is now at 32%.
As mentioned before, it’s especially impressive that earnings have grown by more than $100/share in just a year, while the growth rate is still accelerating at a 35% clip. That’s momentum. When that second derivative peaks, it should reveal just how crowded or uncrowded the market is.
The AI space is attempting to find its footing after a two month correction, but so far we still see a series of lower highs and lower lows. The Silicon Data LLM token expenditures index continues to make new lows, which on the surface suggests that the Chinese open-source models are taking market share from the closed frontier models in the US. That raises questions about the ability for the big players in that space to go public and raise capital. Perhaps the circularity of the vendor financing model is reaching its limits?
I’m a little surprised to see the speculative flows into semiconductor ETFs be as sticky as they are. While the AUM of these ETFs is way down, the flows have not really reversed.
I’m no expert on semis but I can spot a cycle when I see one. While the earnings momentum remains strong, we are “due” for a cycle peak relatively soon. Perhaps we are about to reach peak rate-of-change.
The S&P 500 remains on track in terms of the price analog to the 1998-2000 period, so perhaps the above-mentioned semiconductor cycle and the potential for the second derivative of earnings to put in a peak will become a catalyst for the market to lose momentum in the coming months. Fortunately it’s broadening and there are plenty of places to diversify.
As similar as the parallels to 1998-2000 are in some ways, there are many differences as well. For one, earnings are stronger and valuations are lower. Note that in 1999 the earnings peak was already well in place, and all the gains came from valuations. That’s the opposite of what we have today (for now at least).
Also, that last rally in 1999 was extremely narrow, with only 20% of stocks above their 200-day moving average when the peak hit. This time, the market is broadening instead of narrowing.
On the interest rate side, real rates continue to rise, putting strains on the bond market
For bond investors the choice is always between nominal and real, and since 2021 TIPS have outperformed nominals. I expect that to continue as nominals seem too low given where the implied inflation expectations are.
Whether or not the TIPS break-evens carry a market signal (as is commonly assumed) remains an open question for me. Just like the oil futures strip, I’m not sure that break-evens reflect a conscious market opinion or are just a residual of two types of instruments. Case in point: the chart below shows the TIPS real yield along the horizontal and the break-even along the vertical. I don’t see a pattern between the two.
With the Fed Model back in action, and the AI momentum losing some steam, diversification is as important as ever. Fortunately, we are fishing from a big pond these days, with value, Eurozone banks, REITs, and ex-AI equities looking very attractive on the 60 side, while gold is building momentum on the 40 (or 20/20) side.
The non-AI stocks within the S&P 500 remain almost completely uncorrelated to the index. This could make for a favorable hedge.
Below we see that the Eurozone banks (SX7E) continue to show strong momentum, while gold is coming up from the bottom. Chinese equities are gaining momentum as well.
As for gold, it gained ground last week as the global liquidity profile has started to recover. Based on my regression between global M2 and gold, gold is worth around $5k.
Below is a longer chart, which illustrates how gold has gone from a pure play on real rates to a pure play on liquidity.
Will a rising tide for gold bode well for Bitcoin? So far Bitcoin continues to flounder around $65k, with no visible catalyst to push it higher or lower. My guess is that if gold starts to build momentum from here, that rising tide will take Bitcoin and Ethereum with it. But my opinion is that gold will likely be the leader of the pack until Bitcoin finds a new catalyst of its own.
This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.
1276523.1.0
Copyright © Fidelity Investments
