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• 2024-10-22

"No landing" Shocks Markets: Tech Giants' Valuations Drop Record Levels

The scenario of “No Landing,” which was once dismissed as a whimsical notion, is increasingly being recognized as a potential reality. Coupled with the rising tensions in the Middle East, this has triggered a dramatic sell-off in global risk assets, signaling a significant correction in stock markets that had previously spent all year on an upward trajectory, particularly in the United States and Japan.

To understand "No Landing," we must first delve into its theoretical definition. It describes a situation where inflation remains persistently high, failing to return to the Federal Reserve's target of 2%, while the American economy continues to grow. This scenario stands in stark contrast to the more desirable "soft landing," where economic growth decelerates without leading to a recession, and inflation subsides back to a manageable level.

Several key data points have contributed to the emergence of the “No Landing” outlook. Notably, the U.S. retail sales for March experienced a month-on-month rise of 0.7%, significantly surpassing the anticipated 0.3%. Additionally, the Atlanta Fed's GDP Now model recently projected a 2.9% growth rate for the first quarter of 2023, an improvement from the earlier estimate of 2.3%. Furthermore, March's Consumer Price Index (CPI) surpassed expectations with a year-on-year increase of 3.5%, highlighting market underestimations of inflation persistency and pushing the timeline for the first interest rate cut to September, with growing apprehensions around the potential for further rate hikes.

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During the past week, major indices faced notable corrections, including the Nasdaq 100, which fell by 6.09%, the S&P 500 by 3.54%, and Japan's Nikkei 225 slipping 5.09%. The collective market capitalization of the so-called "Big Tech" companies in the United States saw a staggering $950 billion evaporate. Nvidia was among the hardest hit, with a substantial decline in market value, while Tesla's shares dropped over 14% in a single week.

In the Asia-Pacific region, excluding Japan, an alarming total of $82 billion was shed from markets over the past week. The Chinese A-shares experienced a net outflow of $9 billion, while investment outflows from India and ASEAN markets reached $8 billion and $7 billion, respectively. Foreign investment managers interviewed expressed a consensus that risk aversion is dominating market sentiment, indicating that the pullback could persist for the time being.

The prospect of a “No Landing” scenario is becoming increasingly plausible. Predictions surrounding interest rates in the U.S. have shifted dramatically, affirming that while the U.S. economy displays robust resilience, inflation might remain elevated for an extended duration beyond the Federal Reserve's comfort zone. This development poses significant concerns for capital markets, dispelling earlier expectations for three to four interest rate cuts in 2024 and creating a sudden impetus for market sell-offs.

A recent Bank of America survey revealed that over a third of investors believe the U.S. economy is headed toward a "No Landing" situation, a stark contrast from just ten months prior, when only 3% anticipated this outcome. There has also been a notable decrease in those predicting a "soft landing" or "hard landing."

For months, both the Federal Reserve and market participants were optimistic about a decline in inflation rates, with signals pointing toward future interest rate reductions. However, with a sustained upward trend in the CPI over three consecutive months and consistently exceeding forecasts, Federal Reserve Chair Jerome Powell adjusted his previously optimistic stance. Powell indicated last Tuesday that inflation's sticking power had dampened the Fed’s confidence in a near-term rate cut, categorically stating that high rates might be maintained longer than previously anticipated.

Looking specifically at the components of March's core inflation, transportation services represent only a small portion at 7%, yet they contributed more than a third of the overall core CPI increase. This sharp jump can be attributed to automobile insurance surging beyond expectations and increased costs associated with car maintenance. Non-housing services inflation and medical service prices also saw robust increases, while prevailing housing metrics displayed stability amid a slight easing of rent inflation.

Goldman Sachs argues that despite unexpected factors contributing to the March CPI overshoot, the downward trajectory of key metrics like rent and used car prices bodes well for potential future interest rate cuts. However, given the recent data surprises, the Fed will likely need to evaluate incoming data over the next few months before leaping to decisions. Senior analyst Jerry Chen from the brokerage firm stated that the chances for two reductions in July or November have heightened, while expectations for an upcoming cut have also begun to intensify.

The recent market turmoil has been exacerbated by what many analysts call a "profit-taking rush.” The prior aggressive expectations surrounding rate cuts set the stage for a rush to secure profits, further amplifying the market's corrective phase. The yield on the 10-year U.S. Treasury note rose from 4.20% at the beginning of April to around 4.6% currently, marking a notable increase in borrowing costs. This rise has dramatically impacted equities, with the Nasdaq 100 falling sharply from nearly hitting the 19,000 mark back down to around 17,000. The S&P 500 also tumbled below the 5,000 level, falling directly from levels above 5,200.

The sell-off has wreaked havoc on the market valuation of major tech players, amassing a historic loss of $950 billion in a matter of days. Among these losses, Tesla's sharp decline stands out, yet larger contributions to market capital loss came from tech behemoths like Apple, Microsoft, and Nvidia. Nvidia faced the most devastating impacts this past week, with stock prices plummeting 13.6%. The decline marked the steepest drop for Nvidia since September 2022, resulting in nearly $300 billion evaporating from its market value.

Market analysts on Wall Street remain skeptical, suggesting that the correction is far from over. The S&P 500 is on a downward trajectory, dropping into the vicinity of the 100-day simple moving average at approximately 4,940, before rebounding slightly above 5,000. Analysts stress that buyers will likely strive to push prices above this level, while testing the previous low of 5,050 from March. Still, they note that ultimately, this may not succeed.

Looking ahead, the upcoming week’s focus will pivot towards U.S. GDP data and the Core Personal Consumption Expenditures (PCE) index, a critical inflation gauge for the Federal Reserve. A robust economy coupled with rising inflation could reignite questions regarding the Fed’s ability to lower interest rates. In tandem with these macroeconomic indicators, earnings season is also upon us, with Tesla slated to release its first-quarter earnings report on April 23, following market close. The electric car manufacturer finds itself in turbulent waters, as the juggernaut's delivery numbers declined to 386,810 units in the first quarter, down 8.5% year-on-year.

Steeped in these complexities, Schroders expressed to the press that U.S. equity valuations rest at a price-to-earnings ratio of 31, which is considerably higher than the historical average since 1990. This elevates concerns about diminished returns in the future for American equities. In contrast, regions outside the U.S. may encounter fewer impediments due to comparatively lower valuations. Some market commentators have queried the ramifications of U.S. technology sector setbacks potentially spilling over into the global financial architecture. It's worth noting that, unlike 25 years ago, the present strength in the technological sector’s fundamentals renders its influence over the financial markets substantial.

The Asia-Pacific markets are also facing pressure from capital outflows, exacerbated by rising U.S. dollar valuations and interest rates. This has led to a staggering $82 billion in sell-offs throughout the Asia-Pacific regions, with notable declines reflected in the Nikkei 225.

In summary, global equity funds witnessed an outflow of $9 billion last week, with significant capital withdrawals observed across developed markets — the U.S. losing $4 billion, Japan $6 billion, and Europe sustaining $17 billion in withdrawals. However, the Chinese stock market has been relatively insulated from the sell-off due to its low valuation; overall, the A-share market has rebounded nearly 13% since its low in January.

Goldman Sachs identifies ongoing policy easing as a support factor, driving Chinese economic growth to outpace expectations in the first quarter. Another indicator of stability is the estimated $200 billion in index ETF products from the "national team,” which have bolstered investor confidence. With the stabilization of U.S.-China relations, Goldman also asserts that it has prompted investors to reassess their stance in the Chinese market.

Kinger Lau, a strategist for Goldman Sachs in China, noted that nominal exposures among global mutual funds and hedge funds have hit a ten-year low, yet hedge funds are increasing their stakes. Although investors remain cautious regarding underlying issues such as real estate and local government debt, they are adjusting their underweight strategies concerning China, reducing their underweight band from 400 basis points last year to 350 basis points currently to manage tracking error risks effectively.

At the same time, perspectives from Morgan Stanley reflect tempered expectations in the near term. They anticipate continued pressure on first-quarter earnings, attributing this to relative weaknesses in overarching policy support. Nevertheless, with price indicators such as the Producer Price Index (PPI) potentially stabilizing, the second quarter may see improved performance driven by underlying structural advantages aligning with fundamental trends.