ECB and US GDP in focus, as big tech could determine next move for US stocks

The S&P 500 reached a fresh record high on Friday, driven by big tech. The S&P 500’s IT sector rose by more than 2.3% on Friday, and compared to Europe and Asia, where stock indices had weekly losses last week, US stock markets pushed higher. The Nasdaq led the way, rising by 2.75% on the week, the S&P 500 rose by 1.71%, even the more industrial focussed Dow Jones Industrial Average rose by 0.87%. This compared with a 2.14% loss for the FTSE 100, a 1.32% loss for the Cac 40, and a near 1% loss for the Dax. At this early stage of the year, US stocks and the dollar appear to be dominating. Big tech will start to release earnings from this week, and Q4 US GDP will also be watched closely on Thursday. As we move into a new week investors are trying to assess: 1, the US’s economic strength, 2, when the Fed will cut rates and 3, how big tech will fare during earnings season.

Big tech powering earnings expectations for the S&P 500  

Looking at earnings season first. Big tech profit growth dominance is a major driver of the S&P 500 so far this year. The magnificent 7 are expected to deliver earnings growth of 46% in Q4, according to Bloomberg. This is down from Q3’s 53%, however, it is still significantly higher than other sectors in the S&P 500. The chart below shows the performance between the S&P 500, the IT sector within the S&P 500 and the equal-weighted S&P 500, which strips out the over-sized impact of the mega-cap tech stocks in the index. The chart has been normalised to show how they move together. As you can see, the IT sector is racing ahead, and the equal weighted S&P 500 is lagging the overall index. Tech is still a major driver of the S&P 500 as we move through January.

Chart 1:

The S&P 500’s equal weighted index is similar to the European indices, that are also low on tech stocks. When you see this chart, it is understandable why Europe is lagging behind the US in terms of equity performance. Nvidia, who reports earnings for Q4 next month, is expected to report profits of $10 bn, which is more than 7 times what they reported in Q4 2022! These numbers are tremendous, and a strong tech earnings season could lead to another rally in the S&P 500. However, the dominant profit growth for the S&P 500 is coming from big tech, if they disappoint in the coming weeks then there’s a risk that this will hit market sentiment.

Interestingly, there has been some differentiation between performers in the Magnificent 7, with Tesla and Apple lagging behind Microsoft and Nvidia. Microsoft, like Nvidia is expected to show that its AI-infused products will fuel big profits later this year. In contrast, Apple is yet to materially move into the AI space, and its earnings report could be disappointing to investors. We shall have to wait and see if this leads to greater differentiation in the share price performance of the magnificent 7, which is a theme that we have already touched on in previous notes.  

ECB watch and rate cut recalibrations

ewhere, the focus is also on interest rate cuts and when they will happen. No change is expected at the ECB meeting on Thursday; however, all eyes will be on Christine Lagarde’s press conference. Last week at Davos, she, uncharacteristically, seemed to commit to a summer rate cut. Will she maintain this message at Thursday’s meeting? The market thinks that the ECB will be forced to cut rates in April, with just over 5 rate cuts priced in for 2024. For the UK, the market is pricing in just over 4 rate cuts this year and for the BOE to start cutting rates in May. In the US, the market expects 5.5 rate cuts this year, however, expectations for a March rate cut have dropped dramatically, and the market now expects the Fed to start cutting rates in May. There is only a 46% chance of a Fed rate cut for March, last week the market had priced in an 80% probability of the first rate cut coming in March. This rapid re-pricing of US interest rate cuts has driven the dollar. The dollar was higher against all of the G10 currencies last week. It was particularly strong vs. the yen and the Swiss franc. USD/JPY is gaining on the back of diminished expectations for the BOJ to hike rates in the coming months.

Why volatility is receding

The fact the USD made gains vs. the safe haven currencies was also down to the drop in volatility that we witnessed last week. The Vix initially rose on Wednesday, before declining sharply at the end of the week. There are solid reasons for this decline in the Vix index: 1, the US government communicated that its attacks on the Houthis in the Red Sea could continue for months, and that commercial vessels traversing along the Red Sea could still be targets. This has reduced the market’s expectation for a quick fix to this problem and given them more certainty about what to expect in the future. Secondly, the market is expecting decent growth from the US economy in the coming months. Lastly, we are leading up to earnings season for the big US tech firms, and the market is expecting big numbers. The expectation for a strong earnings season for big tech is soothing market nerves right now. This also means that if big tech earnings disappoint, then we could see the Vix turn higher.

Economic data watch: Jan PMIs, Q4 US GDP and PCE in focus

Elsewhere this week, economic data will also be in focus. It could be a quiet start to the week on Monday, however, preliminary PMI reports for January for the UK, US and Europe are released on Wednesday and they should give us a good steer on how these major economies performed at the start of the year. The Q4 US GDP report will be released on Thursday at 1330, the market is expecting a moderation in the growth rate to a 2% annualised rate in Q4, down from a 4.9% rate in Q3. Growth is expected to be driven by personal consumption, which may have been boosted by falling price pressures. On Friday, the Fed’s preferred inflation measure, the Core PCE will be released for December. Economists are expecting a decline to 3% from 3.2% in November, according to Bloomberg. If accurate, this would be the lowest level since April 2021. A stronger than expected core PCE reading, which would be in line with stronger CPI at the end of last year, could strengthen the dollar further as we end the week, and see an even greater reduction in expectations for a March rate cut. US stocks could potentially rally even with rising inflation pressures, as long as the news on economic growth is good, and as long as corporate earnings don’t disappoint, especially for big tech.