The scenario of a soft landing for the U.S. economy is increasingly likely as inflation slows, bond yields decline, and the economy continues to grow. An economic soft landing would be a positive factor for equity markets. However, it may also dim the prospects of the seven megacap tech stocks that rallied sharply this year. With recession fears easing, investors may not continue to pour money into the megacap stocks as a safe haven.
The seven megacap technology stocks, which include Apple (AAPL), Alphabet (GOOGL), Amazon.com (AMZN), Microsoft (MSFT), Meta Platforms (META), Nvidia (NVDA), and Tesla (TSLA) generated nearly two-thirds of the S&P 500 Index’s ($SPX) (SPY) advance this year. With added fuel from the artificial intelligence (AI) craze, the group rose almost 100% through mid-July compared with roughly 20% for the entire S&P 500 Index. However, since the Federal Reserve’s last interest rate hike in July, gains in the megacap stocks have become more muted, rising only 6% while the broad market rose around 4%.
With more and more investors embracing the soft-landing scenario, the rally in equity markets has broadened to include smaller technology stocks and other sectors that had been beaten down for much of this year. Spouting Rock Asset Management believes that the megacap stocks had proven themselves as a safe haven when inflation soared and the Fed aggressively raised interest rates, saying, “From a portfolio-construction point of view, we think they’re good hedges, even if they pause for a while.”
Overall, there’s increasing optimism for additional gains in the overall S&P 500 next year as better-than-expected economic data underscore bets the Fed can cut interest rates without a recession. Oppenheimer Asset Management correctly forecasted this year’s rally and predicts the S&P 500 will climb to 5,200 next year to set a fresh record. Oppenheimer expects the rally to broaden next year and predicts 9% earnings growth and a price-to-earnings ratio multiple of around 21.7 for the S&P 500, in line with the current valuation level.
Some are concerned about the ability of megacap technology stocks to capitalize on AI to achieve higher profits. The valuations of the seven megacap technology stocks are elevated, trading at an average of 32 times earnings. The lofty valuations and the ability of the megacap stocks to deliver profits from AI may weigh on these stocks heading into 2024. Citizens JMP Securities said, “We’re getting closer to the moment when the companies claiming AI-related profits will have to start showing them. We are not calling for an expansion of multiples next year as the returns will have to come from companies actually turning in better profits.”
On the date of publication, Rich Asplund did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
