One of key market themes going into September revolved around the notion that in order for U.S. equities to sustain their historic rally, emerging markets (and ex-U.S. risk assets in general) needed a reprieve from the turmoil triggered by the surging dollar.
That reprieve came midway through last month following renewed Fed criticism from Donald Trump, the PBoC’s efforts to put the brakes on the yuan slide and a speech from Jerome Powell in Jackson Hole that the market read as dovish.
Over the past two weeks, though, the dollar has risen anew, playing havoc with EM and casting doubt on the notion that a sustainable bounce for developing economy assets is in the cards. That, in turn, raises the specter of the long-overdue spillover to stretched U.S. equities.
Given the ongoing rout in EM, just about the last thing U.S. stocks needed was a rekindling of regulatory worries for tech, but that’s exactly what came calling on Wednesday. Big-cap tech sold off hard as Sheryl Sandberg and Jack Dorsey testified on Capitol Hill – by the time it was all said and done, the Nasdaq 100 put up one of its worst showings relative to the S&P of the year. Here’s a useful annotated visual on that point:
That’s likely bad news for the recently resurgent Growth/Momentum strategy that had reasserted itself midway through last month after an egregious stretch of underperformance.
All year long, analysts have fretted about the possibility that regulatory worries could end up being big-cap tech’s Waterloo. The sector shook of those concerns after a late March selloff to hit fresh highs, as Apple and Amazon summited the $1 trillion market cap mountains even as Facebook’s stumble and Tencent’s ongoing trials and tribulations serve as stark reminders of vulnerability.
Given Wednesday’s action, this is probably a good time to remind folks about just how instrumental tech has been to U.S. equity strength. Fortunately, a lengthy new piece from Goldman has all manner of visuals that help illustrate the point.
“One of the most striking developments in this cycle has been the remarkable growth of Technology profits in an environment of otherwise weak profit growth”, the bank writes, in a sweeping new piece dated Tuesday. Here’s Technology profits versus profits for the global corporate sector ex-Tech:
When it comes to what’s driven returns in the current cycle, if you strip out tech, you come away with a less-healthy mix of drivers.
“Margins have driven c.30% of the rise in the market in the current cycle compared with just 15% on average in previous cycles since the 1970s [while] the sales contribution this time around has been just 20% compared with an average of 60% in the past”, Goldman writes, adding that if you look at the market ex-Tech, “sales have accounted for only 14% of the return, with the bulk of the return coming from valuation – roughly three times the average contribution.”
The read-through from Exhibit 4 above is that because the U.S. has a heavy concentration in Tech, disproportionate profit growth in the space versus the rest of the corporate world means U.S. stocks benefit disproportionately:
Now consider one final chart from Goldman which drives home the point above about how the mix of drivers is much healthier for Tech than for the rest of the market:
“The Technology sector has not only seen remarkable returns but has also seen a healthier mix of drivers of the returns than the rest of the market”, Goldman goes on to note, adding that “for the global market as a whole, returns in the Technology sector have been an impressive 460% since the crisis trough in 2009, around 60% of which have been a function of earnings growth.”
But if you look at that visual, only 23% of global equities’ return since 2009 has been attributable to bottom line growth. If you isolate the U.S., the disparity is similar (right pane in Exhibit 35).
That, right there, is why you don’t want Tech to succumb to a regulatory risk-related selloff at a time when EM contagion is threatening to show up and when the U.S. midterms loom large on the horizon.