Market fears are overblown
Investors should avoid overreacting to weak US labour numbers and consider the bigger picture
AT THE start of the month, the US equity market saw a sharp decline due to fears of a tech bubble and a potential recession. We, however, think that these fears are overblown.
Rather than panic selling, we recommend that investors view this as an opportunity to buy the dip.
Tech bubble fears
Concerns about tech stocks have been growing as investors worry that their prices may have risen beyond their earnings potential. This fear intensified after a mixed earnings season, where substantial artificial intelligence (AI) investments by large-cap companies led investors to question the potential returns.
As for chip stocks, there have been reports that US regulators might introduce stricter rules to further limit chip exports to China. Although some restrictions are already in place, the Biden administration is said to be considering more stringent measures, such as the Foreign Direct Product Rule, which would restrict the export of semiconductor products containing even the tiniest amount of US technology used in their production.
We believe the recent market downturn is largely due to negative sentiment rather than any material deterioration in fundamentals. For instance, Alphabet’s stock fell post-earnings despite strong results, and Microsoft’s decline followed a cloud service outage.
With several tech companies’ stock prices near their all-time highs before the sell-off, investors might be quick to take profits at the slightest hint of bad news. While there are concerns about a tech bubble fuelled by excessive AI investment, we consider these worries to be exaggerated. Hyperscalers investing heavily in AI are seeing strong demand for their services.
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Additionally, incumbents have access to substantial capital at low costs, and massive distribution networks and customer bases. This allows them to experiment with AI investments to eventually earn a return. Despite the uncertainty of outcomes, the opportunity cost of pursuing these strategies appears small compared with the potential of building the foundation for the next major computing architecture.
US tech and chip stocks would benefit from the increasing demand for AI and as businesses get increasingly digitalised. Looking ahead, all of the Magnificent Seven companies excluding Tesla have provided higher earnings guidance. Moreover, analysts are expecting US tech firms to continue delivering strong earnings growth in the coming years. As earnings continue their upward trajectory, this would potentially drive share prices up.
Recession fears
In addition to the sell-off driven by tech bubble fears, concerns over a potential recession have further rattled the markets. The main trigger for this was the weak US labour report for July, which fell short of expectations and raised concerns about a potential recession.
Consumer spending accounts for about 70 per cent of the US economy, making it closely tied to the health of the labour market. In July, employers added just 114,000 jobs, compared to the consensus estimates of 175,000. This number is the lowest level in three months, below the average monthly gain of 215,000 over the past 12 months.
Wage growth also slowed in July with average hourly earnings up 3.6 per cent year on year (3.8 per cent year on year in June), marking the weakest annual rate since May 2021. Moreover, the unemployment rate in July spiked up to 4.3 per cent, the highest since October 2021.
Furthermore, geopolitical tensions have heightened after the assassination of top Hamas leader Ismail Haniyeh. As a result, oil prices are likely to stay elevated, contributing to higher energy inflation and potentially increasing global trade costs in the event of supply chain disruptions. This could hinder economic growth and increase the risk of a recession.
Consider the bigger picture
Despite the weak US July labour report and the rising geopolitical tensions, we expect the US economy to remain resilient. The US labour numbers are more in line with a slowdown rather than a recession. While we recognise that the unemployment rate has been increasing, it is driven not by layoffs (akin to past recessions) but attributed more to an immigration-driven increase in labour supply.
Severe conditions in several Latin American and Caribbean countries have led the US government to broaden humanitarian parole programmes. Many migrants look to escape harsh conditions and seek entry to the US under these humanitarian provisions.
Additionally, the availability of jobs and rising wages are significant factors. After the pandemic, the US labour market was tight, with record-high job vacancies in sectors reliant on immigrant labour. Wages in these industries rose faster compared to others. Research has shown that the US labour market conditions have also driven the rise of illegal immigrants.
We believe illegal immigrants have driven strong labour numbers post-pandemic. With US President Joe Biden’s border security and immigration reduction measures in June 2024, monthly border crossings have slowed. Hence, this may have caused weaker non-farm payrolls and slower wage growth in recent months.
Based on the latest Federal Open Market Committee Press Conference held on Jul 31, 2024, Federal Reserve chair Jerome Powell shared that recent data indicates that economic activity has continued to grow steadily.
Gross domestic product in the US continued to grow at 3.1 per cent year on year in the second quarter of 2024, stronger than the previous quarter’s 2.9 per cent.
Private domestic final purchases, which exclude inventory investment, government spending and net exports, and often provide a clearer picture of underlying demand, increased by 2.6 per cent year on year for the first half of this year. Although consumer spending has decelerated from last year’s robust rate, it remains solid.
Moreover, the US Conference Board Consumer Confidence, which serves as a leading indicator of consumer spending, came at 100.3 in July, above market estimates of 99.7 and the prior month’s 97.8, signalling potential increases in consumer spending in the coming months.
In summary, we remain optimistic about the digital economy, especially Big Tech companies and chip stocks, which appear highly attractive given their strong earnings potential.
Despite recession fears, investors should avoid overreacting to weak US labour numbers and consider the bigger picture. With ongoing expansion and robust consumer confidence, we anticipate continued resilience in the US economy that should support corporate earnings.
The writer is a research analyst with the research and portfolio management team of FSMOne.com, a Singapore subsidiary of iFast Corporation
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