Tech sector, company earnings have defied bearish consensus forecasts so far this year, but are we really out of the woods?
Coming into 2023, the majority of investors had plenty of reasons to be bearish: clouds of recession were looming, risk assets had taken a beating, and cost inflation weighed heavy on the near-term outlook for earnings. So far, those fears haven’t come to pass – but is it too soon to breathe easy and go bullish?
The latest monthly commentary from Purpose Investments poses that exact question. Contrary to the numerous bearish consensus forecasts that had been thrown around, it noted how markets entered May with positive momentum on multiple fronts, including a tech-led rally in U.S. stocks.
“This was the most oversold part of the market,” Greg Taylor, chief investment officer at Purpose Investments and author of the note, told Wealth Professional. “I think with the NASDAQ down substantially last year, we were looking for some sort of bounce.”
So far, so good for investors this year
As recent CPI figures on both sides of the U.S.-Canada border point to a slowdown in inflation, markets are already pricing in declines in interest rates, which has been beneficial for longer-duration assets including tech stocks. The recent excitement around AI has also cast a favourable glow on the sector generally, Taylor says, adding that people are starting to see big names with rock-solid balance sheets like Apple and Microsoft as a new safe haven.
“It’s part of the market which I think was highlighted more in March, when we initially started seeing regional bank stresses,” he says. “People started to look up ‘Where can I get areas that are not exposed to this [financial sector stress],’ and that has definitely helped carry some of the gains in tech stocks.”
Company earnings have also been coming in better than expected so far for 2023. A major fear coming into the middle of the year was a contraction in earnings due to recession. So far, that call has not borne out, and company reports to shareholders have surprised to the upside with results buoyed by robust consumer spending.
“The big debate is how long it'll last and whether that'll persist to the second half of the year,” Taylor says. “At least through what we're seeing with Q1 earnings, they've been coming in better than feared, and I think that's causing a bit of relief.”
Amid all this, the volatility index has descended to multi-year lows – a somewhat concerning signal, though he says it also speaks to the degree of defensiveness and how under-invested people are coming into the current period. With footholds in place for markets to potentially climb the wall of worry, the bounce we’ve seen so far might not be so surprising.
Rates, regional banks, and the U.S. debt ceiling pose risks
Still, there remains significant uncertainty ahead for the second half for 2023. In its latest rate announcement, the Federal Reserve signaled a possible pause in its most aggressive tightening campaign since the Volcker-era hikes of the 1980s; the Bank of Canada, meanwhile, has held rates for two consecutive decisions.
As early as now, markets are already anticipating in a victory over inflation – but that might be premature. Both the U.S. and Canadian central banks have said they’ll keep a close eye on incoming information for the economic outlook as they steer monetary policy. Data released last week showed the Canadian economy added far more jobs in April than forecast, while the U.S. snapped a downward trend in labour market growth, giving both the BoC and the Fed additional room to hike as needed.
“Some of the data is showing that the cycle of inflation isn’t over yet,” Taylor says. “Markets are pricing in rate cuts, which I think is something that’s going to happen in the next little bit. But there’s room for disappointment there.”
Notwithstanding the tech sector’s good start for 2023, he stresses the need for investors to be wary as it’s still a narrow market.
The fissures in the U.S. regional banking system, which saw a number of high-profile failures, are also a cause of concern. With tighter financial conditions on tap for U.S. regional banks, small-to-medium businesses and consumers may find it harder to access what’s historically been one of their biggest sources of lending, which could send ripple effects across the economy.
“I don’t think we’re out of the woods yet with the regional banks,” Taylor says.
Given the better-than-feared start of the year and the potential of a stock market rally, some observers are suggesting 2023 could be an exception to the oft-repeated advice of “sell in May and go away.” But with the continuing uncertainties – including the impending debt ceiling issue in the U.S. – Taylor says investors shouldn’t be so quick to dismiss the advice.
“While we’re not advocating to sell in May and go away, it’s definitely something to consider and make sure that you’re not opening yourself up to too much volatility and risk,” he says. “Maybe look at hedging, or adding risk-managed exposure to different asset classes that will give you a little bit of downside protection if we do get some volatility throughout the summer.”
