The tech sector now accounts for a major share of the entire US market and earnings growth, and investors are becoming uneasy about the heavy reliance on a single sector.
Price volatility in the investment markets has intensified in recent weeks. For example, the S&P 500 index, which represents the US stock market, has fallen about four per cent from its peak at the end of October. The key force behind this is the decline in tech stocks, but unusually high price volatility has also been seen in small caps. At the same time, the US dollar has strengthened slightly, which has softened the impacts of falling stock prices for euro investors.
There have been fewer movements in the fixed income markets, although company-specific differences are significant. Credit spreads have shifted slightly upward in the USA, particularly in higher-risk high-yield bonds.
The price volatility in recent weeks has been particularly influenced by investors’ increasing scepticism over the profitability of massive investments in artificial intelligence.
The Q3 earnings season ended in the USA with average earnings growth of 13 per cent. However, the growth is primarily based on the earnings growth of tech companies, which is partly explained by major investments in AI. If these investments were to decrease, earnings growth would also be expected to weaken.
Tech companies account for a significant share of the entire market and thus boost its performance through their strong weighting. Since the markets are now very concentrated on one sector and a handful of companies, and potential replacements do not seem to be available in other market segments, investors’ anxiety is understandable. The cooling of the labour market is not yet reflected in the tech sector, but if it were to quiet down, there are currently no other pillars in sight on which earnings growth could lean on in the future.
The federal government shutdown, one of the longest in US history, ended on 12 November, after which the long-awaited economic data has started to flow into the markets again. The end of the shutdown was not enough, however, to turn investor sentiment. Only NVIDIA’s strong results released last week managed to momentarily turn the market, but the gloomy sentiment returned again the next day.
The shutdown has most likely had negative effects on consumer confidence and consumption. Consumer confidence, measured by the University of Michigan, weakened close to the lows recorded in the summer of 2022, and similar figures were not seen during the Covid-19 pandemic or the Global Financial Crisis. However, that is just one index measuring consumer confidence, and for example, another key indicator measured by the Conference Board has painted a brighter picture. Presumably, however, the government shutdown, the cooling of the labour market and the lacklustre performance of the stock market have affected consumer confidence.
Thanks to the end of the shutdown, the labour market report for October, which had been postponed several times, was published last week. The reported figures were strong enough to maintain confidence in positive economic development, and more jobs were created than expected. The published report, however, was not too strong, which could have led the Fed to start slowing down its interest rate cuts.
The markets have recently begun to price in a slightly higher probability that the Fed will lower its key interest rate at its December meeting. There have also been comments from the Fed suggesting that interest rate cuts may be possible in the near future. According to market estimates, a rate cut in December is far from certain, with the probability currently being just over 60 per cent according to the markets.
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