July 18, 2023
Is the current tech rally fuelling a bubble?
Many hedge funds have been caught short this year (apologies for the pun).
A U.S. bull market has caught portfolio managers off guard, as they positioned earlier in the year for an economic downturn amid interest rates hikes, sticky inflation and geopolitical tension. Such short covering could, in turn, give fuel to the equity rally, further complicating the picture for remaining short-sellers.
The outcome for hedge funds so far in 2023 has not been good. Overall, hedge funds went up 3.45% in the first half of the year, lagging the main stock indexes and falling way below the TPP average of 13.23%. 😊
Amid the rally's persistence, investor sentiment has turned more positive, JPMorgan added in its note dated July 13.
Net buying, which excludes stocks sold, reached its largest level since October last year, according to Goldman Sachs. The move, however, was mainly driven by investors buying shares to cover their short positions. The doom and gloom have lost a fortune so far this year.
We’ve written many times that the buyback had to come as the market rallied and it would make stops jump. We are now hoping that a rally will do the same to the short sellers of UK stocks, of which there are many. This always gives extra fuel and is a wonderful thing to watch.
The irony of the situation is that now the short sellers have had to buy back, there is room for a fall. It sounds odd, but with fewer short positions in the market, fewer investors need to buy. This is one of the reasons shorting the market is so hard.
Morgan Stanley’s Mike Wilson has been reinforcing his status as Wall Street’s most-famous bear and he is convinced that the market has a long way to fall.
The bank’s top US equity strategist reiterated his year-end target of 3,900 on the S&P 500 Index warning that a profit recession is still underway. That level implies a nearly 14% drop from where the US stock gauge is currently trading.
“Inflation is going to come down. It’s not going to be good for stocks because that is where the earnings power has been coming from,” said Wilson.
His view comes as the Federal Reserve paused its most aggressive interest rate-hiking blitz in decades and an artificial intelligence-powered boom helped drive the S&P 500 into a technical bull market.
Wilson and his team of strategists said recently in a note that they expect S&P earnings to drop 16%, compared to predictions for a decline of just 2.4% for 2023 from sell-side analysts who have boosted their earnings expectations.
Wilson’s team anticipates a 2024 earnings-per-share growth of 23%.
The technology stocks that lead the recent market rally “had the biggest earnings recession,” Wilson said.
“The presumption is that it’s over,” but “it’s going to persist into the second half of the year,” he added. “It’s going to get worse before it improves next year.”
Morgan Stanley’s stock chief has maintained his bearish stance, even as a growing wave of peers at rival banks has ditched their gloomy outlooks.
Goldman Sachs Group Inc.’s David Kostin raised his year-end forecast for the S&P 500 to 4,500 – roughly where it is trading today; so ‘bullish’ would be a stretch, perhaps just less bearish.
Through the first half of 2023, nearly all the returns in the US Market Indices have come from the very largest stocks, including Apple, Microsoft, Google, Amazon and Nvidia.
Apple – the largest technology company in the world by revenue and the largest stock in the United States by market cap – returned 45% through July 11. That’s incredible. It is now larger than the entire market cap of the FTSE 100!
In the market index, Apple alone contributed 2.3 percentage points, or 14.3%, of the index’s total return of 16.6% for the period. In the equal-weighted index, though, the company only contributed 0.07 percentage points (less than 1%) of the index’s total return of 10.3%.
The contributions of the other leading stocks were almost entirely wiped away from the equal-weighted index as well. Microsoft (with a market cap of £1.5 trillion] and a contribution of 11.5% of the market-cap weighted index return), Amazon (with a market cap of £1.1 trillion and a contribution of 6.5%), and Google parent company Alphabet (with a market cap of £1.25 trillion and a contribution of 5.3%) each contributed less than 1% of the equal-weighted index’s total return.
On another note, index investors beware, The Nasdaq is rebalancing next week.
Here’s what you need to know about what a special rebalance is; what prompts one; and what the July 24 rebalance means for index and ETF investors.
The Nasdaq-100 Index includes 100 Nasdaq-listed nonfinancial companies. The index has become synonymous with tech investing, and it serves as a benchmark for ETFs and mutual funds globally. Funds tracking the Nasdaq-100 Index total nearly $300 billion globally, with $200 billion (£152 billion) in assets under management for QQQ alone.
The Nasdaq-100 Index methodology stipulates the following:
"A special rebalance may be conducted at any time based on the weighting restrictions described in the index rebalance procedure if it is determined to be necessary to maintain the integrity of the Index".
The special rebalance will not result in the removal or addition of any securities. Instead, it is intended to reduce the index’s concentration in its largest constituents.
This will be the third Special Rebalance in the history of the Nasdaq-100 Index, with the first two coming in 1998 and 2011.
What Prompted The Special Rebalance?
Growth stocks led the market rally in the first half of 2023 to the benefit of the growth-focused Nasdaq-100 Index.
The performance of a small group of mega-cap stocks, now known as the "magnificent seven", drove returns for the index and the broader market.
These seven companies (combining Alphabet’s share classes) top the Nasdaq-100 Index by weight, and now represent nearly 55% of the index. This concentrated portfolio has become increasingly so in 2023.
When the market has been driven by 7 stocks, it makes us aware of a very specific bubble on the horizon, and it’s the same one that we warned of in 2021: Big Tech. It’s tough to be against, and when it’s rallying, it really rallies, but when it falls…………….it really falls.
Mega US tech stocks tend to trade like cryptocurrencies with huge swings. If you can handle the volatility, there is some good money to be made, but don’t be left holding the balloon when it bursts.
Much like in 2021, it’s easy to say it’s a bubble, but the problem with bubbles is you don’t know how big they’ll get before they do eventually blow up; it could take years. Hedge funds have found that out once again this year. It’s not that they’re wrong to short the market, it’s that they did it too soon, and had to get out. You can be right, but at the wrong time, and that can lead to losses, not gains.
Investing is a difficult game, you have to be right about the stock, and right about the time, and volatility is the price you pay for your decision. The more you are prepared to accept the ups and downs, the more you MIGHT make in return. But if you’re looking for sure things, look elsewhere; that is what the bond market is for.
“TPP might just be about to revolutionise investment for the retail market.”
- London Stock Exchange 2020