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Friday role reversal charts

It was revenge of the nerds in markets this week, with high-flying AI stocks hitting turbulence and long-suffering value stocks catching a rare bid.

Small caps rose, the Magnificent 7 fell and the Dow Jones Industrial Average — last in vogue when pocket protectors signaled belonging to a particular tribe — re-emerged in the headlines for hitting 40,000.

The proximate cause of this role reversal was a shift in sentiment prompted by Thursday’s CPI data: The market has now officially stopped worrying about inflation — and started worrying about growth instead.

It’s not worried that much, of course. 

Despite all the hand-wringing, the Nasdaq is finishing about unchanged on the week and not far below its all-time highs.

That may be because people now think the Fed could cut by 50 bps at the September FOMC meeting and that would generally be good news for tech stocks.

This time might be different, however, because tech isn’t as “long duration” as it used to be: The tech sector is making money now, and like traditional cyclicals, they’ll make less of it in a downturn. 

The real worry, though, is how much money they’re spending.

The “hyperscalers” (MSFT, GOOD, AMZN, etc.) that have so inflated our 401k accounts are pouring hundreds of billions into AI infrastructure without having much of an idea as to how they are going to make any money on it.

Even in a best-case scenario, that will make them lower-margin businesses and therefore higher-risk investments more vulnerable to cyclical slowdowns like the one people are starting to worry about now.

In a worst-case scenario, however, the tech sector could be about to hit an air pocket reminiscent of when the investment in internet infrastructure came to a sudden halt in the year 2000.

If so, the investing nerds could be taking their revenge for a long while yet — value stocks outperformed tech for nearly a decade after the dotcom bust.

Is it time to dust off the pocket protectors then?

Let’s check the charts to find out.

The good news:

Excluding the shelter component, US prices were up just 1.8% in June vs. a year ago. 

The less good news:

Last week’s labor market data included downward revisions bringing the three-month average of job gains to about 177,000 — sharply lower than the 269,000 seen in the first three months of the year. Openings and quits (above) are also both falling — the theme of “quiet quitting” has given way to “the big stay.”

Jobs are now a greater concern than inflation:

Headline US CPI (blue line) is now 1.1 percentage points below the unemployment rate (red line). When that happens, not cutting interest rates is tantamount to raising them.

Wage growth has plateaued:

US wages are now growing in-line with inflation, removing the Fed’s last reason not to cut rates — fears of a wage-price spiral have proven unfounded.

Prices are getting back to normal:

Used car prices fell 9.5% in June. Adjusted for hourly wages (above), car prices are nearly back to pre-pandemic levels.

Trend change?

If this week’s rotation out of tech and into everything else is the start of a trend, there’d be a long way to go yet. The Magnificent 7 has outperformed small caps by 35 percentage points year-to-date. (And 77 percentage points over the last three years.)

Overdone?

The S&P 500 was trading as much as 15% above its 200-day moving average this week, the biggest such gap in three years. A rotation into value and small caps would be the gentlest way to correct that.

Worse than the dotcom bubble?

As measured by the number of stocks outperforming the index, today’s tech-heavy S&P is even more unbalanced than it was at the height of the dotcom bubble.

Is the AI party over then?

It’s impossible to say, of course, and the last part of market parties are always the best part, so you’d hate to leave too early.

Just make sure you’re not still doing keg stands while the value nerds get the last laugh.

Have a great weekend, pocket-protecting readers.

— Byron Gilliam

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