While loading up on AI stocks, investors should keep pouring money into US money market funds.
On a trailing 12-month basis, the S&P 500’s “earnings yield”, or earnings per share as a percentage of the index, was 4.77 per cent versus the current US three-month Treasury bill yield of 5.2 per cent.
After an aggressive 500 basis point lift in interest rates by the Fed since March 2022, the “risk free” three-month bill yield recently exceeded the S&P 500 earnings yield, for the first time since 2001.
On a forward 12-month basis, the earnings yield is a touch better, at 5.3 per cent.
But is it worth the risk of potential disappointment on earnings outside of the AI stocks?
“I think there will be some people out there asking: ‘should you be taking earnings risk, if you can basically earn a risk-free yield at about the same rate,” NAB head of market economics Tapas Strickland said.
He sees a chance of weakness in US shares before the end of the month and quarter, as fund managers rebalance their portfolios after a big move up in shares relative to bonds.
The S&P 500 is up 14 per cent on extremely narrow gains so far this year.
The NASDAQ is up 30 per cent, with NVIDIA up 200 per cent, Meta up 136 per cent, Tesla up 123 per cent, Amazon and Oracle up 50 per cent, and Apple, Alphabet and Microsoft up about 40 per cent.
By comparison, Australia’s ASX 200 share index is only up 4 per cent for the year to date.
Tech is by far the largest S&P 500 sector by market capitalisation, making up about 30 per cent of the index. However, tech represents only a paltry 2.4 per cent of the ASX 200.
On a more worrisome note for bears, Goldman Sachs global head of hedge fund sales Tony Pasquariello noted that the NASDAQ rose 20 per cent above its 200 day moving average last week.
He found that this had happened only 15 times since 1983. On 14 of those occasions, the 12-month forward return of the index was positive, with a massive average 12-month gain of 35 per cent.
Another thing he pointed out was that, based on the history of the S&P 500 going back to 1957, the US benchmark was “basically doing exactly what it should be doing” after inflation peaks.
Of course the exception to that strong historical performance of the US share market after inflation peaks as it did in mid-2022, is when the economy enters a recession – but that’s proving elusive now.
Still, the cumulative breadth of gains in the NASDAQ is now showing one of the widest-ever divergences from the index, according to Morgan Stanley chief investment officer Michael Wilson.
“If this bear market rally is really a new bull market, this will need to change in our view,” he said.
Mr Wilson admitted to being “so wrong” about the S&P 500 this year as the “bear market rally” he predicted last October turned into a bull market this month, with a more than 20 per cent rise from the October low. He’s been trying to decide if his earnings model may be misleading.
But he said that actual earnings have been tracking his model perfectly for the past year.
“So the model looks to be performing well even in this higher inflationary regime – something we were concerned about a year ago,” Mr Wilson said.
“In other words, we don’t think this is the time to abandon the model and if it’s right, then price will ultimately follow.
“Second, growth has been better in some areas and the AI theme has provided the narrative for people to believe it can broaden out to drive both top-line growth and productivity increases that will make our earnings forecasts too low.
“To be clear, we believe in the AI theme, too; and believe it will be a big component in the next boom. We just don’t think it will prevent the deceleration that is already in motion for this year.
“Instead, we view AI as mostly a cost in 2023 that will pressure margins further as top line disappoints.”
Interestingly, Mr Wilson expected the faster-than-expected fall in US inflation to have a directly negative impact on top-line growth that was not yet embedded in consensus forecasts.
“While many equity investors were cheering the weaker-than-expected PPI release last week, we would caution to be careful what you wish for as we think these data portend a sharp drop in revenue growth over the next four months,” Mr Wilson said.
“Such a decline in revenue growth would imply that our well below earnings forecast is correct as the negative operating leverage does the heavy lifting.”
“This fits well with our 1940s-’50s boom/bust narrative we have been using since the pandemic.”
