Tech Valuation Premium Is Vanishing

1.) TECH – Tech is always an important part of a bull market. Lots of people are worried that this market turns into a “reset” year like I mentioned yesterday. While any year in market space can turn out to be a down/reset year, I think it’s important to remember that just because an index might be down for a particular year, it doesn’t mean our models will be. Let me know if you want to see the historical tests that we have on our models so you can see how they did in those other “reset” years. Hint…they did fine. Anyway, tech's premium over the S&P 500 has all but vanished: now at the lowest since early 2019. Tech valuations are already reasonable: NVDA (~16x, 8% of QQQ), META (~17.3x, 4% of QQQ), AVGO (~18x, 2.5% of QQQ), MSFT (~19.5x, 9% of QQQ), and GOOGL (~21.5x, 5% of QQQ). These are on a forward Price/Earnings basis, so this lowers the probability of an aggressive selloff in QQQ (this is the Nasdaq 100). These companies are also big parts of the S&P 500, which is why I’m pointing them out. Importantly, the profit outlook for S&P 500 companies has been improving even as share prices have fallen. This is a dynamic rarely seen during episodes of geopolitical uncertainty. This is also a setup that has historically rewarded investors willing to look through near-term pain. Another important reminder is that there have been various days where the VIX (S&P 500 volatility) is down and markets are down too. I’ve pointed those out and what they’ve meant historically...that it tends to signal that the market is trying to bottom.

2.) HEDGES – Look at the chart below. The red line shows how much downside people are preparing for, while the black line is what the market is actually doing. That’s a big gap pointing out that investors are already hedged, so there’s no real rush to sell stocks. The hedge transfers risk, but it also removes urgency. If you’re already protected, you don’t need to dump your stocks on bad news. The selling tends to get spread out and absorbed, instead of turning into panic. That’s why markets can stay more stable while heavy hedging is happening/in place even when that hedging is expensive.

3.) INFLATION – Rates have been telling us for a while now that inflation is still a problem and it is reaccelerating, mostly due to oil caused by the Iran issue. Here are the OECD inflation projections. They updated their outlook this morning, which sharply increased their inflation forecasts for major economies and now sees the average rate for the Group of 20 this year jumping to 4% — with an even higher pace in the US — rather than the 2.8% they predicted in December. Guess what… this is not “new news.” Just ask the bond market where, over just the last month, the 2 YR Yield – the Fed Front-Runner, has gone from 3.38% to 3.93% this morning. That is telling us the Fed is on a pause and may even raise rates. The 10YR yield has been saying the same thing – inflation. Over the last month, the 10YR Yield has moved from 3.95% to 4.38% this morning. So, again, markets are not surprised by any inflation “updates” that are coming out. It’s not an “unknown, unknown.”