What’s next for US equities?

At the risk of stating the obvious, a lot depends on what happens in rates and especially how things develop at the long-end of the US Treasury curve.

Stocks remain more resilient than they probably ought to be given where reals are, but at various intervals over the last two months, rates fatigue plainly set in. Valuations respond to reals, and 10-year real rates are the highest since 2008.

It’s not just the level. The rapidity of rate-rise was already remarkable, and it escalated materially from August. The figure above is simple and familiar to the point of being superfluous. But despite being a lazy choice as visual props go, it retains its poignancy. Indeed, if you didn’t know better, you’d be inclined to think the most recent escalation must’ve been the result of a sudden collapse in breakevens. It’s that acute.

The main reason this is so troublesome for equities is performance concentration in richly-valued growth stocks, which are particularly sensitive to higher reals through the valuation channel. That didn’t matter for the first seven months of 2023 because i) tech was oversold after last year (e.g., Meta down ~75% at one point), and ii) A.I. optimism trumped stubborn reals. Hence the Nasdaq 100’s best first-half in history.

The A.I. hype faded since July, but the headwind from higher rates only became more onerous. That raises the stakes for mega-cap tech earnings. Tesla disappointed, but it’s not a bellwether for the rest of the “Magnificent 7,” four of which report in the days ahead.

Time and again over the years, we’ve seen that nothing else much matters when the heavyweights post solid results. Note from the figure below that the top seven now comprise an even larger share of the market than they did at the height of the pandemic “everything bubble.”

We’re talking about nearly a third of market cap. Simple math dictates that in the presence of meaningful earnings-driven rallies (or selloffs) in the biggest names, the index will be at pains to argue no matter what’s happening in the manic US rates complex.

There’s nothing new or novel about anything said above. But for the first time in quite a while, circumstances have conspired to relegate mega-cap US “tech” results (with the scare quotes to denote that some of them aren’t classified as Info Tech) to below-the-fold coverage.

Obviously, Google, Microsoft, Meta and Amazon will demand top billing when they report this week, but between the Israel-Hamas war and high drama in the US bond market, the buildup to their results felt muted.

As an observer of humanity first, a macro documentarian second and a “markets guy” third and only by way of what I’d describe as serendipity and happenstance, I’m fine with that. But as someone who’s actively engaged in markets with a non-trivial sum of money on the line, I’m nevertheless compelled to gently remind readers that although one quarter’s “Magnificent 7” results are of little significance when set against an existential conflict in the Mideast and a slow-burning meltdown in the US bond market, they can be all that matters for equities, an asset class famous for being oblivious to anything and everything outside the figurative and literal bubble.