What kind of rally is this anyway?

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Good morning. Yesterday we said there could be an investment case for Chinese equities, if the Chinese government used its fiscal muscle to revive the economy. Just an hour after our letter came out, Xi Jinping and his team announced that there will, indeed, be fiscal stimulus. Chinese stock indices jumped on the news. We are not yet convinced. Few hard targets or policies were announced, and it will take a lot of fiscal support to avoid a deflationary trap. Will China put its money where its mouth is? Email us: [email protected] and [email protected].   

A slightly weird rally

The S&P 500 hit another all-time high yesterday. The market has been rising steadily, if not spectacularly, since September 6. That was the day of the August jobs report. That report goes quite a long way — though not all the way — to explaining the buoyant market. The report was hardly terrible; the unemployment rate fell from the month before. But it was weak enough to open the door to the jumbo-sized 50bp cut that followed on September 18. This is, on first glance, a soft landing rally. 

The market has not just risen over the past three weeks. Its structure has changed completely. The sectors that led the market for the three months before the jobs report are now the laggards. Through the summer, plays on falling rates (real estate, financials and utilities) and defensives (consumer staples and healthcare) were the place to be. Tech lagged. This month the opposite has been true. Tech is back with a vengeance and cyclicals (materials and industrials) are booming too. The only constant between the two periods was poor returns from energy companies, as soft global demand has kept the oil price low. 

In the chart below, the light blue lines are sector performance over the past three weeks, while the dark blue lines show performance for the three months prior to that:

In terms of the valuation and size factors, growth has outperformed value decisively lately, whereas big versus small has been a bit of a back and forth, with big caps now in the lead.

If someone had told you a few months ago that the economy would cool only gently and inflation would all but subside, allowing the Fed to start off the cutting cycle with a bang, was this the pattern of sector performance you would have predicted? Unhedged must admit, with shame, that we saw little of this coming. The outperformance of the cyclicals has blindsided us — this looks like a soft landing, but cyclicals are supposed to work in a recovery, which is something quite different. And, like many others, we would have expected that a soft landing would have led to a broader market, where gains came from more stocks across the index. But we are back where we were before this summer: with Big Tech providing most of the market’s gains. 

Looking a bit closer at what has worked recently helps solve these puzzles. And what has worked best are the Magnificent 7 tech stocks, semiconductors and copper: 

The Mag 7 may be doing well for reasons that have little to do with inflation and rates. There have been several bits of news recently suggesting the AI investment land grab continues, most prominently the announcement of a $30bn AI infrastructure partnership between Microsoft and BlackRock, with backing by Nvidia. Now, you might ask: what will be the return on all this investment? But the stock market does not ask this, at least not so far. 

The result is that, in dollar terms, the Magnificent 7 tech stocks account for more than half of the gains in the S&P 500 over the past three weeks. And in percentage terms, Nvidia, Microsoft, Meta, Tesla, Amazon and Alphabet have all outperformed the market. Only Apple (a defensive stock, at least for now) has lagged. 

To an extent, the semiconductor stocks — not just Nvidia, but also Broadcom, AMD, Applied Materials and so on — have surfed in the Mag 7’s wake. Micron, which makes memory chips, reported excellent earnings just yesterday, with data centre sales leading the way. 

Copper has also ridden the wave. If you believe that US demand will pick up after a soft landing, or that industrial investments either from green energy or the AI boom are around the corner, you have been looking for a reason to own copper, a mineral critical in both processing centres and solar cells. As Unhedged has written, the futures market for copper is not perfectly reflective of its long-term prospects, so buying spot copper and copper producers when they’re cheap, as they were this summer, is one way to get exposure. 

Copper also just got a second wind from China’s promise of economic intervention. It rose another 4 per cent after the Politburo announced its intent to increase fiscal stimulus on Thursday. But Ed Morse of Hartree Partners warns that this response to the announcement, and the prospect of a soft landing, is basically speculative: 

There is no evidence to date that any of the moves made by the central government in China will actually materialise . . . [and] US GDP growth is quite subject to controversy and interpretation. [Buying copper] is a wait and see, with risk to the downside, more than to the upside

Morse is quite right. The economic data, while solid in the US, does not suggest re-acceleration in response to the prospect of lower rates — at least not yet. Earnings reports in the past few weeks paint a quite mixed picture, too. While home builder Lennar had a great quarter, FedEx did terribly, as US domestic shipping was down. Darden, owner of Olive Garden and LongHorn Steakhouse, was a mixed bag. Value-conscious consumers seem to have stayed at home rather than enjoy all-you-can-eat breadsticks at Olive Garden, but wealthier ones scarfed down T-bones at LongHorn. Retail giant Costco and pet supplier Petco were also mixed, with very modest revenue growth. So it makes sense that tech, which is less tightly bound up with the consumer economy, should lead the market. We’re less sure what is grounding the rally in cyclicals, other than somewhat lower interest payments. 

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