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October 30, 2023 - All eyes on the "Magnificent Seven" .



The "Magnificent 7" is the term that the investment community coined after the famous western movie, to group seven Technology related companies, whose performance had contributed to all gains of the S&P500 this year. We had mentioned a couple of months ago the dangers of this over-concentration or "lack of breadth" as it is formally called in our profession. We had shown that if we took out these seven stocks (Apple, Microsoft, Nvidia, Google, Tesla, Nvidia, Facebook) from the S&P500's performance calculation, there is no positive return for the rest of the index in 2023 ! And that was before the recent big correction. Their expensive valuations demanded actual results and a short-term guidance that could justify the stocks to keep rallying. These names had been correcting along with the broader markets since the end of July, but it was their corporate results and their guidance for next quarter which was scrutinized by already fearful investors and led to their significant weekly losses.


Especially in a world of high interest rates and slowing growth, valuations came back to "haunt" the expensive parts of the market. To mention just a few examples, shares of Tesla are now almost 30% lower than at the end of July and even Nvidia is down 20% from its peak, the company which is actually responsible for the May-July rally, due to its announcements about the very strong demand in AI-related semiconductors. At last, valuations are coming back to earth, as it is usually the case when a frenzy (AI this time) makes investors flock into a handful of stocks related to this theme. We claim neither that AI is not a true, multi-year structural theme nor that Technology shares will keep falling. On the contrary, the recent company news are starting to paint a clearer picture of what is overvalued and what not and who can be really the winner in the new AI-impacted world.


And finally, we should not "cry over spilled milk" and look forward. It is natural that when the seven pillars of the S&P500 performance start to crack to send shockwaves to the broader market and to investor psychology. However, the markets can still stabilize and recover as investors will look at so many other sectors and individual stocks that have performed so poorly this year, without their fundamentals warranting such a negative move. Shares in the Consumer Staples industries, Biotechnology, Healthcare are waiting their turn to move to higher valuations again (higher stock prices, that is) after falling to multi-year lows, as investors were all chasing those seven stocks. Technology will also heal and move higher, but this does not necessarily mean that it will be the leader again for the next few weeks/months. And of course within that sector there are names, like Microsoft, which has corrected but announced superb results, which offer reassurance for its above-average growth potential.


The ECB maintained its interest rates unchanged. We copy here some sentences of the most interesting part of the announcement (the underlining is ours): "... inflation dropped markedly in September, including due to strong base effects, and most measures of underlying inflation have continued to ease. The Governing Council’s past interest rate increases continue to be transmitted forcefully into financing conditions. This is increasingly dampening demand and thereby helps push down inflation...Based on its current assessment, the Governing Council considers that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to this goal".


The tone of the announcement and the press conference can be characterized, at the margin, dovish. The mention of the big drop in inflation but also the acknowledgement that demand is slowing and interest rates are having a forceful impact give us reassurance that the ECB is done with interest rates hikes. Mrs. Lagarde was careful at the press conference not to offer such explicit guidance, but all the signs were there. The ECB made special mention to the fact that credit growth has significantly slowed down in the last three months, which does not bode well for economic growth. The next step to seal such a view is the December meeting when the 2024 forecasts for growth and inflation will be updated. We expect those they will be revised downwards, a fact that does not give the bank any ground to raise interest rates again in the next 1-6 months at least.


The FED has its own monetary policy meeting this week. Wednesday is the big day and they could chose to be slightly more hawkish than their European peers. Recent macro economic data in the US have been much better than in the Eurozone and the FED's official forecast is for one more rate hike until year end. As no rate hike is expected to be announced this week, all eyes and ears will be if there is any hint for what happens in December, the last meeting of the year. Of course the military conflict which seems to be escalating can be a great excuse or reason for the FED to alter the message at this meeting and provide some new guidance of no more rate hikes.


The Eurozone October Composite PMI dropped by 0.7 points to a three-year low of 46.5, the fifth consecutive reading below the neutral level of 50, thus indicating that after a weak Q3, the Eurozone had an even weaker start to Q4. The decline was led by a 0.9 point fall in the Services PMI (to 47.8), the weakest level since late 2020 and a ten-year low outside of the pandemic. Looking into the country level, Germany exhibited weaker Services PMI (-2.3 pts to 48) but saw a small increase in the Manufacturing PMI to a still depressed 40.7. The French Composite PMI rose to 45.3, driven by an increase in the Services PMI (+1.7 pts to 46.1) which offset a decline in the Manufacturing PMI (-1.6 pts) to a four year low of 42.6.


The 3rd quarter US GDP number was announced at an impressive 4.9% (q-o-q annualized rate), better than the consensus expectations of 4.5%. Some of the increase in real GDP was due to noisy components like inventory's contribution, but real personal consumption expenditures climbed 4.0% in Q3, continuing to show a resilient US consumer who keeps on spending.


Equities had a rough week, characterized by the fall of Nasdaq index by almost 3%. Europe performed again better than the US, with Eurozone equities down about 0.4% on average, while weakness in banks and energy stocks impacted the UK's FTSE 100 index (-1.5%). Surprisingly, China showed a remarkable resilience last week, moving higher by 1.5%. Reports about interventions by the state to curb the sell-off and more stimulus measures to come, as well as "dirt-cheap" valuations have given the signal to buyers to re-emerge.


Bonds had a positive week, as investors are attracted by the highest yields in more than a decade and the safety of high quality government or corporate bonds, as the conflict in the Middle East might start to escalate. The 10-year US Treasury finished the week at 4.85%, after failing to stay above the 5% "Maginot line". Renowned hedge fund managers publicly announced that they have closed their short on the US Treasuries, creating a mini rally in bond prices, as we had described in our "Bond Vigilantes" weekly review. German yields also remained subdued, especially after the slightly dovish ECB meeting. The 10-year German yield is around 2.80%, after failing to overtake the 3% level.


As already mentioned, the earnings week belonged to the big-Tech in the US, with booms and busts along the way. Microsoft was the clear winner as it presented clear evidence that it's benefiting from a shift in enterprise spending toward AI, expects its cloud business to grow more than 25% and sees a rising enterprise adoption of its AI products. The company said its GitHub Copilot now had over one million paid users with 37,000 organizations also subscribing to GitHub CoPilot for Business---up 40% from the prior quarter. Expectations were high going into Alphabet's earnings report, since the Google parent has boasted about its cloud unit's prowess in AI tools and AI frameworks. But Google's cloud revenue disappointed, sending its shares almost 15% lower in just two days. Amazon posted better results than expected and a decent growth for its own cloud business, but nothing to match Microsoft's growth. Shares rose by more than 5% on Friday, in a relief rally. Apple is set to report on Thursday of this week.


Chart of the Week : "The clash of the Titans".



The above chart shows the evolution of the market value of Microsoft (blue line) and Apple (green line) in the last 5 years. The two companies have been "fighting" for the crown of the most valuable company in the world (leaving aside the case of Saudi Arabian Aramco). One can observe that up to middle 2020 when the pandemic broke, the two companies were almost going hand-in-hand. In the pandemic, Apple managed to surpass Microsoft, as consumers staying at home had more need for playing around with their phones or buy new phones, than using Microsoft's services. In 2022 the companies fell about the same, and Apple became the first to reach a 3 trillion USD market value, just a few months ago. But in recent weeks, the gap has been shrinking again, as shares of Microsoft have been more resilient during the correction, due to the fact that the company is a much clearer beneficiary of the explosion of artificial intelligence, than Apple. Microsoft's Q3 earnings results confirmed that. It remains to be seen whether Microsoft will take back the crown from Apple in the coming months and the upcoming results of Apple will be a good test for the "competition" for the gold medal.


Disclaimer

• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Chart of the Week : Factset . Photo: https://movies.fandom.com/wiki/The_Magnificent_Seven

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