US stocks march higher, as US GDP, Tech earnings and central banks in focus

It’s a fairly quiet start to the week for markets, with few data releases on Monday. So far, futures markets are pointing to a positive open for stock markets in the UK and Europe, and US e-mini futures are also pointing to a positive open. Share prices in Asia have been mixed. Japan continues its march towards its record high of 38,915 from December 1989, momentum appears to be on its side and it rose by 1.65% on Monday. However, there are two stories going on in Asian stocks indices. Japan’s index is looking towards fresh record highs, however, share prices in Hong Kong and China are tanking.

The Hang Seng fell by 2.15% on Monday, bringing its losses over the last month to more than 8.5%. This index is now at its lowest level since 2009. The Shanghai Composite is at its lowest level since March 2020, the peak of the pandemic. Nasdaq’s golden dragon index is also at its lowest level since 2013. The contrast with the US could not be more stark. The S&P 500 reached a record high last week, and futures markets are predicting an extension of those gains at the start of this week. The Nasdaq rose by more than 2.3% last week, led higher by tech giants and chip makers. There are three reasons for the contrasting performance between China and US shares: 1, the economic outlook in China remains weak. 2, central bank policy divergence, the Fed is talking about cutting interest rates, while China’s PBOC seems to stand by and watch its country’s economy struggle. Added to this, because Chinese interest rates are lower than levels in the West, the PBOC actually have less room to cut rates than their Western peers. 3, Geopolitics plays into the underperformance of China’s shares.

Why a potential Trump presidency is weighing on Chinese shares

The latter point is worth stressing. There are still restrictions on chip exports from the US to China, and later on Monday the EU is set to unveil a proposal to implement rules that would boost its powers to screen and block foreign investment in sensitive industries. This is an attempt to protect the EU from coercive actions from Russia, China etc, but it could also pave the way to limit exports to and imports from China, which may further hurt its economy.

The prospect of a Donald Trump presidency could also be weighing on Chinese stocks. Trump was critical of China and imposed trade restrictions during his first term as President. There are no signs that he would not pursue the same path if he were to win a second term later this year. The second Republican party primary takes place on Tuesday. With Ron de Santis now out of the race and endorsing Trump, the onus is on Nikki Haley to try and steal Trump’s crown. This will be an uphill batter for her. Although she technically stands a decent chance in New Hampshire, Trump is still favoured to win 50% of the vote, vs. Haley’s 39%. Added to this, even if she does win New Hampshire, the next primary in South Carolina is even more pro-Trump, which makes her chances of an overall victory slim.

Geopolitics, economics and politics are a perfect storm for Chinese equities right now, and we don’t expect them to play catch up with the US any time soon.

US stock market dominance continues

At this early stage of the year, US stocks and the dollar appear to be dominating. Big tech will start to release earnings from this week, and Q4 US GDP will also be watched closely on Thursday. As we move into a new week investors are trying to assess: 1, the US’s economic strength, 2, when the Fed will cut rates and 3, how big tech will fare during earnings season.

Big tech powering earnings expectations for the S&P 500

Looking at earnings season first. Big tech profit growth dominance is a major driver of the S&P 500 so far this year. The magnificent 7 are expected to deliver earnings growth of 46% in Q4, according to Bloomberg. This is down from Q3’s 53%, however, it is still significantly higher than other sectors in the S&P 500. The chart below shows the performance between the S&P 500, the IT sector within the S&P 500 and the equal-weighted S&P 500, which strips out the over-sized impact of the mega-cap tech stocks in the index. The chart has been normalised to show how they move together. As you can see, the IT sector is racing ahead, and the equal weighted S&P 500 is lagging the overall index. Tech is still a major driver of the S&P 500 as we move through January.

Chart 1:

Source: Bloomberg

The S&P 500’s equal weighted index is similar to the European indices, that are also low on tech stocks. When you see this chart, it is understandable why Europe is lagging behind the US in terms of equity performance. Nvidia, who reports earnings for Q4 next month, is expected to report profits of $10 bn, which is more than 7 times what they reported in Q4 2022! These numbers are tremendous, and a strong tech earnings season could lead to another rally in the S&P 500. However, the dominant profit growth for the S&P 500 is coming from big tech, if they disappoint in the coming weeks then there’s a risk that this will hit market sentiment.

Interestingly, there has been some differentiation between performers in the Magnificent 7, with Tesla and Apple lagging behind Microsoft and Nvidia. Microsoft, like Nvidia, is expected to show that its AI-infused products will fuel big profits later this year. In contrast, Apple is yet to materially move into the AI space, and its earnings report could be disappointing to investors. We shall have to wait and see if this leads to greater differentiation in the share price performance of the magnificent 7, which is a theme that we have already touched on in previous notes. 

ECB watch and rate cut recalibrations

Elsewhere, the focus is also on interest rate cuts and when they will happen. No change is expected at the ECB or BOJ meetings this week. At the ECB meeting on Thursday, all eyes will be on Christine Lagarde’s press conference. Last week at Davos, she, uncharacteristically seemed to commit to a summer rate cut. Will she maintain this message at Thursday’s meeting? The market thinks that the ECB will be forced to cut rates in April, with just over 5 rate cuts priced in for 2024. For the UK, the market is pricing in just over 4 rate cuts this year and for the BOE to start cutting rates in May. In the US, the market expects 5.5 rate cuts this year, however, expectations for a March rate cut have dropped dramatically, and the market now expects the Fed to start cutting rates in May. There is only a 46% chance of a Fed rate cut for March, last week the market had priced in an 80% probability of the first rate cut coming in March. This rapid re-pricing of US interest rate cuts has driven the dollar. The dollar was higher against all of the G10 currencies last week. It was particularly strong vs. the yen and the Swiss franc, as risk sentiment improved and safe havens sunk.

Overall, the markets are in a fairly upbeat mood as we start the new week. The oil price has pared gains, and is back below $78.50, as the market focuses on more supply coming on board from Libya, which cancels out the continued strikes from Houthis rebels on commercial vessels on the Red Sea.