According to Merrill Lynch’s research, the market typically bottoms out six to seven months into a recession and once the FED has started easing!
Today, the FED is still in an interest-tightening process and, technically speaking, one can consider that the US will probably escape a recession while Europe and other regions may tip into one for a short period of time. Also, if the Central Banks were to stop rising interest rates, there is no tangible information available today indicating that the Central Banks were to start easing – the red hot job market report of last week was just about too good for that to happen.
As of now, we perceive that there is an important disconnect between investors who believe that there is a recession and market analysts who need to adjust EPS expectations (based on the input they get from the reviewed companies). To some extent, the strength of the overall economy is reflected by the job market. So, the question is who is wrong?
For the time being, some leading indicators point towards an economic slowdown. Typically, a good indicator of this is the yield curve. As of now, interest rates on long-term bonds have fallen lower than those of short-term bonds, creating an inverted yield curve. If this is to persist, then we would estimate that some changes may occur to the market configuration in the second half of 2023.
Ramifications for investors
Starting in mid-2022, value stocks started to outperform the market, and sectors such as energy, industrials, materials, and financials led. We believe that technology-tilted sub-sector segments of these four broad sectors are driven by secular growth trends. This has driven broad-based value recovery. But what about going forward? Is there any persistence in the value story?
When the dotcom bubble burst in 2000, technology-related investment opportunities corrected by more than 60% in the first year. Many investors tried to buy the dip, yet they got hit by another negative output of the sector the subsequent year. The sector was down another 22%.
This year could result in some similar readings, especially as the tech sector is ultra-sensible at the moment to any news. Typically, news such similar to Google’ one-day stock market valuation decreased by USD 100 Billion are expected to be more recurrent going forward as AI stakes are rising. Yet, on the other hand, we don’t see the broader sectors of Energy, Financials, Industry, and Materials moving ahead fully united as many of the value stocks show rather rich valuations.
Is the tech sector poised to bottom out?
Today, the five largest US tech companies trade with a PE of around 30, which we consider reasonable given the overall context. Is these growth and valuation assumptions a legacy from the gone uber-economy and the ultra-cheap money, or are there some fundamentals here for good? The quintessential question is what world do we want to have tomorrow? On the one hand, we have technology stocks that shape our day-to-day life and are dominating our economic approach. On the other hand, if we were to split these companies to comfort a better regulatory approach, the western economic system probably would lose out in the long run.
We note that technological developments are on their way either way; by breaking up these companies, the technology Marindustrial standards that come along with them would be developed elsewhere, and ultimately, new standards would be imposed on us either way.
Therefore, implementing more guided compliance in these companies is a good thing. This comes, however, with some lower growth, and the historic high premium valuations might not be reached again. Nevertheless, we believe that specific segments of IT have the capacity to provide large above-average numbers. In particular, we are selective buyers in IT security and key semiconductors foundries as attractive.