By Rebecca Ellis
WED, JULY 05 2023-theGBJournal |Last Friday marked the end of Q2, with the Nasdaq’s top seven companies continuing to outpace the broader marked by a wide margin. The icing on the cake was Apple, which became the first company to hit $3 trillion in market capitalisation.
The continued rise in the top 7 “mega caps” begs the question: is this froth or substance?
As the main components in the Index, these companies have driven Nasdaq Composite gains of almost 33% this year, far outstripping a still impressive 10.9 % for the MSCI World Index in 2023.
But there are clouds on the horizon.
The U.S. Federal Reserve has made clear its intention to continue ratcheting up interest rates if inflation remains at elevated levels.
Interest rates set at levels higher than most companies have anticipated could plunge the economy into a recession and effectively put a lid on market frothiness in the latter half of 2023.
Market exuberance has been driven by improving sentiment according to UBS Director Art Cashin. “I can’t overstate how strongly sentiment has taken over. I think, short of going absolutely parabolic, this has been some dramatic, pyrotechnic run…” the UBS executive told CNBC on June 30.
According to the Cashin, company fundamentals are temporarily out of fashion among investors, making the extended market climb extremely fragile.
Can the U.S. markets continue their ascent in the face of sustained, robust central bank action?
In historical terms, since the end of World War II, there have been two U.S. recessions arguably triggered by central bank action aimed at taming inflation.
The first was the era of Arthur Burns and G. William Miller in the 1970s, when both Fed chairmen raised rates sharply to curb inflation. The resulting recession lasted two years, causing much unemployment and economic hardship.
The second came in the early 1980s and is generally referred to as the Volcker recession. Fed Chairman Paul Volcker’s monetary policy had short-term negative effects on the economy, driving stock prices sharply lower. The recession that followed lasted a year and a half.
Investors should consider the impact of further interest rate increases on their portfolios and stick with companies whose balance sheets and cash flows will best protect them from a rising cost of capital.
What else can an investor do in these times?
While FOMO is hard to resist, the key to managing portfolio volatility is careful planning. It is important to consider fundamentals such as growth potential and pricing levels while also taking account of thematic disruptors.
Considering this, we would recommend that investors reinforce their defences through broad diversification. Within the equity sector of a portfolio, there should be a focus on health care, materials and energy. They should seek safety in large cap companies with sound balance sheets to ride out the tech downturn which is due.
Keeping a toe in tech may offer solid upside in any recovery phase; however loading up tech stocks with high price-to-earnings multiples after an already steep rise is always a dangerous plan.
Rebecca Ellis, Family office advisor, www.aktspartners.ch| Co-author Martin de Sa Pinto, Martin de Sa Pinto Research-Switzerland
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