Return of the Ka-Ching
The markets have enjoyed a healthy broadening so far this year, as a solid underlying economy and productivity benefits stemming from AI have boosted revenue growth, margin expansion and earnings growth. Accordingly, this has been another good year so far for markets, with most major indices having advanced by double digits.
When earnings growth is relatively abundant, such as it is right now, we ordinarily see value stocks (relatively inexpensive stocks compared to their earnings prospects) outperform their more expensive growth brethren. After all, why pay a premium for strong earnings when earnings growth is not scarce? That’s what we have seen so far this year, with value indices outperforming growth indices. Furthermore, the rising tide has lifted all ships, small and large, but as one might expect, in this growth-abundant environment, small caps have been outperforming large caps.
Sometimes, however, earnings growth is too powerful to ignore, and the big dogs are going to get their bones. That’s what happened during August, as much-needed evidence emerged that AI investment could have positive economic returns in the near-term. While tech giants have lagged this year amid concerns that the sheer magnitude of the required investments needed in AI would dramatically impair returns on capital, hyperscaler results reported in late July and August provided a bit of counternarrative. Reports from Microsoft and Alphabet suggested that cloud growth was strengthening and that the ginormous capital expenditures into AI were starting to translate into revenue. Shares of Microsoft have climbed about 30% since its July 29 earnings report, as Azure growth and backlog showed that the company’s massive investment in data centers was beginning to support actual cloud-consumption revenue growth. As a bookend, Nvidia’s strong earnings report on August 26 confirmed that the outlook for hardware demand was still extremely strong. Lastly, results from companies such as CoreWeave and Super Micro reignited demand for semiconductors, data-center infrastructure and software, broadening the rally beyond just the tech giants.
Major Equity Indices
Return of the bond vigilante?
Historically powerful earnings growth has fueled another good year for stocks so far, but persistent inflation and a growing sense that the political will to address the federal budget deficit does not exist anywhere are stoking interest rates. Fortunately, the most recent headline CPI climbed just 0.1% for the month and eased to 3.4% year over year. That did not establish a new disinflationary trend, but it temporarily reduced fears of an imminent rate increase. The combination of strong earnings and slightly slower inflation was particularly favorable for long-duration growth stocks, but if interest rates continue their climb, it will create headwinds. Small caps, which have enjoyed a 20% surge so far this year (Russell 2000), could be especially susceptible, given their increased reliance on debt funding.
Bond prices move in the opposite direction of interest rates, so recent fixed income performance has been subdued. However, credit spreads remain tight, and lending conditions remain healthy; after all, interest rates have climbed, but they have not skyrocketed. The magnitude of interest rate changes in the coming months will be worth watching very carefully.
Remembering 9/11
As I was settling onto my couch a few nights ago to watch the new season of Ted Lasso, I found myself instead watching interviews with New York City firefighters and other first responders and looking at images of lower Manhattan from 25 years ago. I thought to myself, “Well, I guess it’s September,” but it soon dawned on me that I was seeing this special because September 11, 2001, was 25 years ago. That is difficult for me to believe. So much has changed since then in our country and in the world, and certainly in financial markets. In 2001, the dotcom bubble was still in the process of bursting and taking the rest of the market with it for three years. ETFs were still something of a novelty. Hedge funds were still seen as something relatively new, private equity was still considered fairly niche and private credit was not even a thing. On the other hand, some things are remarkably the same; the U.S. is facing a willful foe in the Middle East and running a massive federal deficit, technology is changing our lives in real time and markets are allocating and sometimes misallocating capital. The good news is that what worked back then- resisting the urge to go all in on any one sector at any price, maintaining discipline and some international diversification- works now. We cannot predict what will happen on any particular morning. Sometimes the most brilliant mornings and bluest skies contain unimaginable horrors. However, having systems—and VALUES—in place to protect us not just from others but from ourselves will continue to serve us, individually and collectively, well over time.
We thank you for your continued confidence.
Download the PDF
For more information, please reach out to:
Burke Koonce III
Chief Investment Strategist
bkoonce@trustcompanyofthesouth.com
Daniel L. Tolomay, CFA
Chief Investment Officer
dtolomay@trustcompanyofthesouth.com
This communication is for informational purposes only and should not be used for any other purpose, as it does not constitute a recommendation or solicitation of the purchase or sale of any security or of any investment services. Some information referenced in this memo is generated by independent, third parties that are believed but not guaranteed to be reliable. Opinions expressed herein are subject to change without notice. These materials are not intended to be tax or legal advice, and readers are encouraged to consult with their own legal, tax, and investment advisors before implementing any financial strategy.
