The Tesla-Meta Paradox

Commentary

Market Recap

• The S&P 500 added 2.7% this week, with broad-based gains led by Technology, Consumer Discretionary and Banks. Energy underperformed but continues to be among the top sectors year-to-date.
• The S&P/TSX followed roughly the same pattern, but on a much more muted scale, finishing up just 0.7%. On a sector basis, Consumer Staples led the way, while Industrials lagged the pack.
• Equity performance around the globe largely mirrored the moves in North America. European bourses overcame a mid-week lull, with the major indices finishing broadly in the black, led by a solid 3.1% gain in the UK’s FTSE 100.

Earnings

Last week, earnings announcements from Tech giants Tesla and Meta prompted big movements in markets. It’s no surprise that when companies deliver poor results, they typically get hit hard. Likewise, if they outperform, markets generally act positively. The cases of Tesla and Meta, however, showed that companies’ outlook on future earnings is arguably as important as the reported earnings themselves. Meta reported positive results, but lowered guidance and indicated that capital expenditures might rise. As a result, they were punished by markets to the tune of a nearly 13% decline in stock price overnight. Tesla, on the other hand, reported bad results, having previously lowered prices and failed to meet growth expectations. But their outlook was more positive, including a comment about being able to build affordable cars faster. That caused their stock price to surge 14%. The takeaway from these market reactions? Inflation is not the only thing that matters. Earnings announcements—including forward guidance—do matter. Outside of the Tech sector, we’re still monitoring Consumer Discretionary spending for clues as to whether it will continue to erode as the middle class trades down and spending shifts to Consumer Staples. Lululemon’s poor results were a strong datapoint, but the big bellwethers—Walmart and Target—are still to come.

Bottom Line: Earnings matter, and Tesla and Meta’s results are an indication that markets will penalize companies if their outlook isn’t positive.

Inflation

We’re seeing more and more concern about sticky inflation, as investors worry that it may not come down as fast as markets were expecting, or that it might even go up a little from here. The longer higher inflation persists, the tougher a situation it becomes for the U.S. Federal Reserve (Fed), which has already said that the most recent data doesn’t justify interest rate cuts. If we see further data indicating that inflation might stay elevated, that could easily delay rate cuts until 2025. Recently, there’s also been discussion about potential interest rate hikes. While we don’t expect that to occur unless we get an inflation spike that is more than transitory, it’s nonetheless a possibility, and one that markets thought was off the table. Our expectation remains that we’ll see at least one rate cut from the Fed this year or, if not, early in 2025. But as we’ve said previously, it’s the last mile that’s the hardest, and we expect inflation to remain around current levels for a while. Going forward, everyone—including us and the Fed—will be closely monitoring the job numbers and CPI and Personal Consumption Expenditures (PCE) data for signs of a weakening (or strengthening) economy. In the meantime, expect volatility, which has popped up recently, to continue to rear its ugly head.

Bottom Line: As we expected, inflation is likely to remain higher for longer, which could push rate cuts to later this year or early next.

Equity Rotation

Within the last month, we’ve seen some evidence of a rotation in equity markets from higher-value names to other areas of the market, and we expect this trend to continue. If interest rates remain relatively elevated, that would likely cause higher-valuation companies like the Magnificent Seven to come down somewhat. At the same time, we’re seeing money move to less volatile sectors that have lagged behind recently, including Financials, Health Care, and Energy, as well as gold. We’re certainly not giving up on Technology or the artificial intelligence (A.I.) theme—we continue to like many of those names. But this is a ‘near-term vs. long-term’ story. In the short run, we could continue to see some pressure on market leaders, with Nvidia and Meta already having come down a bit from their peaks. That’s why Nvidia’s forthcoming earnings (to be announced on May 21) are so important—after three phenomenal quarters in a row, the bar for outperformance is exceptionally high, and the stock has already come off. The question is—what is a reasonable expectation, and what is the price point aligned to that? At this stage, there is no clear answer.

Bottom Line: A rotation in equity markets already appears to be underway, and we expect it to continue as long as inflation remains sticky and rates stay higher for longer.

Positioning

Speaking of Nvidia: previously, we’d sold call options on our Nvidia position and took those proceeds to provide some protection with some puts. After a pullback not too long ago, we closed off the calls, collecting a majority of the premiums. This means that we can now continue to benefit from any further upside surprises through our long position, while effectively having protection in place for free. It was a great call by our team, enabling us to crystallize profits when we saw an opportunity. It is another great example of how we continue to look for opportunities to add incremental value for our clients.

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Delayed Again: The Soft Landing that Never Comes.

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Originally Posted April 29, 2024 – The Tesla-Meta Paradox

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