Election Bombshell, Market Jitters and the First of the Mag 7 Report
By David Nelson, CFA
Recent market activity has sparked concerns about the future direction of U.S. equity markets. Last week's sell-off raises the question of whether a significant trend shift is underway, potentially leading to a meaningful correction for U.S. equities throughout the summer.
Bloomberg Data
Key factors influencing the outlook include the following:
Continued rotation from large cap secular growth to small caps.
Federal Reserve Policy
US Elections
Let’s get the election issue out in the open. As I’m writing this on Sunday breaking news flashing across the wires indicates President Biden is dropping out of the race. There is little in the way of details other than an endorsement of Vice President Harris. The news is hardly surprising given the massive drop in support following a troubling debate performance in late June.
The assassination attempt on President Trump last weekend has galvanized the Republican Party which was clearly evident in last week’s RNC Convention. When key democratic donors pulled their funds, it became clear to Democratic leadership that they had to convince President Biden to abandon his bid for a second term. There are any number of scenarios and paths forward and I expect those to be released in the coming days.
Prediction Markets
Last week markets were clearly pricing in a Trump victory. In fact, prediction markets had put the odds at close to 70%. There was even talk of a Red Wave with the GOP taking the Senate and holding onto the House. This of course had definitive implications for how investors would position risk assets.
Now that President Biden has confirmed he is dropping out we could easily see an unwind of some of those bets. The election calculus has shifted from an electoral landslide to a tighter race.
While the election cycle is top of mind the bigger news for investors was the continued rotation out of large cap secular growth shares that have driven the bulk of returns over the last year.
Bloomberg Data
Over the course of one week the rotation from large caps into small caps is one of the biggest on record. At a minimum a reversal in trend this large demands our respect and forces us to seek out answers. Will the trend continue or is it just a reversion to the mean to relieve overbought conditions?
AI Bulls
The nagging concern for bulls like me is the potential for a timing mismatch. Currently the AI trade has centered on the buildout of artificial intelligence infrastructure. The bulk of investment so far has come from the AI hyper scalers including Alphabet (GOOGL), Microsoft (MSFT), Amazon (AMZN), Meta (META), and others. Clear beneficiaries are the semiconductor industry led by Nvidia (NVDA) and the ecosystem that supports it. What could be better for a weapons manufacturer than an arms race? That’s essentially where these AI infrastructure companies find themselves.
However, to justify the buildout we are going to need success stories from companies that adopt the technology;
An industrial giant raises guidance because of increased productivity due to their investments in artificial intelligence.
The military says their investments in AI are bearing fruit, better able to target the enemy while reducing costs at the same time.
A pharma company announces a life saving drug developed in record time with the help of artificial intelligence.
Until we get confirmation investors are left with the science and a story. At some point they will want some food on their plate demanding increased revenue and profitability on the heels of one of the biggest technology investment cycles in a generation.
Bloomberg Data
As a portfolio manager and Chief Strategist, it is important to take in the work of other analysts and build a matrix of information to draw on. Goldman’s research on the Capex and R&D spend by technology firms is an important piece of work. They point to Amazon, Meta, Microsoft, and Alphabet having spent collectively $357 billion over the past four quarters. This represents 23% of the total S&P 500 Capex spend.
Chart - Data Source Goldman Sachs
Here's the mismatch. Earnings estimates have increased by $65 billion but sales forecasts for 2025 and 2026 have only increased by $36 billion, raising concerns about potential margin contraction and the need for improved forward guidance to justify these investments.
Alphabet is the first of the Magnificent Seven to report on Tuesday. Like most quarters the forward guidance will be more important than the headline numbers. I’ve cut my position by about 25% going into the print. Trust me, I’m hoping they prove me wrong.
Disclosure: "At the time of this article I currently hold shares in some of the companies mentioned as part of investment portfolios in funds I manage for Belpointe. Additionally, I may discuss other securities that are under consideration for future investment; however, discussing these securities is not a recommendation to buy, sell, or hold. My mention of these securities reflects my personal opinion and analysis at this moment and may change without notice. Please remember that all investments involve risks, including the possible loss of principal."