The Big Tech Apples May Have Further to Fall

Until now, shares of the iPhone-maker had fallen roughly 17% for the year, in step with the broader market rout. The announcement undercut the market, with other big “FANG” internet platforms such as Alphabet Inc. and Microsoft Corp. also falling. The tech stalwart had been among the companies that beat Wall Street expectations throughout the pandemic, and had come to be seen as a defensive stock, so any negative news was bound to hurt sentiment across the market. 

The development was particularly unwelcome as it came just as the tech sector appeared ready to rally. The Nasdaq 100, down 27% for the year so far, had briefly managed to get above its 50-day moving average on Monday, suggesting that the relentless downward trend was over — but the index failed to stay there, thanks in large part to Apple. 

There have been hopes that valuation is at last looking favorable for the tech sector once more — although this gets a little harder to sustain on closer examination. The spread between the prospective earnings multiples of the S&P 500 Information Technology Sector and the benchmark S&P 500 started this year at the highest it had been since 2004. A “healthy correction” was in order, and what looks like some seriously unhealthy speculative excess has now been wrung out of the market. However, it’s worth noting that from the Great Financial Crisis through to about 2018, tech basically traded at the same multiple as the rest of the market. Tech’s premium could easily fall further from here:

There is a similar message from the tech index’s P/E ratio judged in its own right. It has slipped to 20.6 on Monday, having peaked above 30 in the first year of the pandemic. But 20 appears to be the level at which it hit a plateau in 2017 and 2018 — again while it looks like the excess has been blown off the top, there’s no particular reason to think that the multiple can rebound.  

Investors will get more clarity this week when more tech heavyweights report earnings following mixed results from major banks. Netflix Inc., savagely punished for disappointing results so far this year, will kick off the FANG stocks Tuesday evening. This is the season for all companies to get bad news off their chests, so the chances of a durable rebound should be much stronger once investors believe they know the worst. 

Nicholas Colas, co-founder of DataTrek Research, would “prefer to get bullish” on US large-cap tech once he sees second-quarter earnings season, which will include third-quarter guidance. This, even as Wall Street’s forecast still remains relatively optimistic. “Even still, the return math says the Nasdaq is pretty washed out here on a relative basis,” he said.

• While the surge in US tech stocks just after the March 2020 stock market lows was statistically remarkable, it was nothing like the dot com bubble. The peak in post-Pandemic Crisis NASDAQ outperformance was 21 points in August 2020. That is just over two standard deviations (18.4 points, as calculated above). By contrast, the 2000 dot com bubble saw the NASDAQ outperform the S&P 500 by 77 points, which is nine standard deviations.

• The NASDAQ rarely underperforms the S&P 500 by much more than 6.8 points over 100 days, which is one standard deviation from the relative return mean… It exceeded those levels in late May 2022, at 11 points of relative underperformance.

• The NASDAQ has underperformed the S&P 500 by 4.3 points over the last 100 days, well within one standard deviation.

All of this suggests that the sector could have further to fall if the news is bad. Still, if earnings of tech companies prove profitable, or traders can be convinced that the worst news is known, it may solidify its status as the new defensive play, at least for now.

Colas is not alone in suggesting that the conditions for a bottom are not in place, despite the recent signs of life in the tech sector. Tom Essaye, a former Merrill Lynch trader who founded The Sevens Report, continues to suggest that some broader macro landmarks need to be passed before the market can make a durable bottom. His list is as follows:

1. Chinese Lockdowns Ease and Growth Recovers — The Chinese economy has largely reopened, but this week’s shutdown in Macau and mass testing in Shanghai and other regions show that “Zero COVID” remains partially in effect and as a result, the threat of lockdowns will continue to weigh on Chinese stocks and the outlook for the global economy.

2. Inflation Peaks and Declines and the Fed Eases Off the Hawkish Rhetoric — Obviously we’re not close on this yet. The June CPI printed above 9% and it’s essentially a “toss up” as to whether we get a 75bps hike or a 100bps hike.

3. Geopolitical Tensions Decline — Certain commodities like wheat and corn have declined to pre-invasion levels, as markets are hopeful that grain shipments from Ukraine will start again soon. But energy commodities, despite large drops, remain above pre-invasion levels (oil and natural gas). Additionally, the drops have been driven by fears of a global recession crimping demand and lack of export capacity in the US (for natural gas), not on some geopolitical improvement.

Until these macroeconomic factors are resolved, and it could take a while, Essaye does not think the June low in equities is the bottom, while the market remains vulnerable to any disappointments. Apple delivered just such a disappointment on Monday; now the question is whether further ones lie ahead.

Politics Is About Economics Again

The fight for the leadership of the UK’s Conservative Party is for the most part demoralizing and depressing. It’s true of all of the candidates that until now they’ve done a better job of attacking each other than putting forward any kind of new political vision. Boris Johnson’s ouster had almost nothing to do with ideology or policy, and all to do with his perceived dishonesty, so perhaps this shouldn’t be surprising.

But something intriguing is going on. The economy is back at the center of the Conservatives’ internal debate for the first time since the early days of Margaret Thatcher four decades ago. Since Thatcherite reforms succeeded in revitalizing the UK’s economy, internal Tory politics has been dominated by Europe and culture war issues. But with inflation back, so is an intense debate over how to guide the economy. 

It’s healthy that economic policy is now going to have to respond to the democratic will. But it’s very unhealthy that the debate seems badly uninformed. Liz Truss, the current foreign secretary, looks now as though she has a good chance of confronting Rishi Sunak, who recently resigned as chancellor, in a head-to-head ballot that goes to the party membership. Sunak is the candidate of fiscal prudence and austerity, preferring tax rises to more debt.

Truss is arguing for something more expansive. That in itself makes some sense. If austerity isn’t producing results, try spending some money. There’s always a case for tax cuts.

The problem came when Truss detailed how she would deal with inflation. “We need to look at the best practice around the world. The countries who have been most successful at controlling inflation,” she said. “We need to look at the mandates they have, for example the Bank of Japan.”

This is terrifying. The BoJ has been trying to raise inflation for a quarter of a century now, and failed. In the process, it has flooded the system with money. There is no greater example of monetary incontinence. And yet Truss also wants to move to a system of targeting money supply: “We have inflation because of our monetary policy. We have not been tough enough on monetary supply. That’s the way I would address that issue.”

There is a strong argument that loose monetary policy has a lot to do with the UK’s economic problems. But regular readers will know that quite a lot of other factors are involved, too. Any hint of changing the Bank of England’s mandate (which unlike the Federal Reserve’s is focused solely on controlling inflation), will go down like a lead balloon on markets. And her suggestion that the Bank should start targeting money supply, using the BoJ as a positive example, suggests that she doesn’t know what she’s talking about. 

It’s perfectly possible to be a good prime minister without being an expert in economics (although as Truss, like Sunak, has a degree in philosophy, politics and economics from Oxford, it would seem reasonable to think she knew something about it). But taken as a whole, the Truss package is alarming. She should at least be getting good advice and understanding it, and she isn’t. I agree with a startlingly critical report that came out from Citigroup Inc.’s chief UK economist Ben Nabarro:

Truss’s policy platform still poses the greatest risk from an economic perspective in our view with an unseemly combination of pro-cyclical tax cuts and institutional disruption… Scapegoating the [Bank of England] bank for the cost of living squeeze is neither correct nor constructive. More worrying here though are efforts to muddy operational independence, which poses fundamental questions surrounding institutional credibility.

Attacking Truss on this is not to side with the powers that be, or to come out in favor of inequality, or insist on the status quo. Rather, it is to recoil with alarm at the realization that someone who could very soon be in charge of a major economy has some weirdly confused ideas about basic economics, and seems to have half-understood some extremely bad ideas. It’s obvious that economic policy is not working well for people in the UK or in most other developed countries. It’s vital to try to improve it. But it would be good not to make it worse.

That is one of the greatest current risks. Economics is back as the pivot of political competition for the first time in a generation, and the results are impossible to predict. Well-meaning attempts to reform institutions such as central banks could lead to uncertainty and financial accidents. Predicting the outcomes is made all the harder by the fact that parties of both the right (like Britain’s Conservatives) and the left are divided over what to do next.  

There’s Something About Vlad…

It’s almost been possible to forget about Vladimir Putin and the Russian invasion of Ukraine of late. The war drags on. With few big headlines any longer, it looks as though Russia is steadily and brutally winning a patient war of attrition to establish a hold over more or less the entire of the Donbas region in eastern Ukraine. What happens next, though, is critical.

If Russia basically holds on to what it has gained, and tries to institutionalize those gains, then the situation begins to resemble the status quo from 2014 until the invasion earlier this year. Russia had grabbed some territory in the Donbas, a low-intensity war continued with almost no fanfare in the west, and Russian relations with the west were broadly unaffected. This would be an awful outcome in many ways, but it wouldn’t be so bad for the markets. One way or another, western Europeans would return to buying Russian oil and natural gas. Arguably the greatest single force pressing upward on global inflation while also dragging Europe into recession would be neutralized.

To be clear, this is a cynical point of view, but it’s one that will move markets, and help them move in a direction that makes a lot of people more hopeful. The Ukraine conflict and the risk of a European energy crisis it creates has everything to do with the weakness of the euro. As Marko Papic of Clocktower Group points out, the euro never dropped below parity with the dollar when its very existence was in question — but it fell below parity last week. That’s an indicator of how serious the crisis is perceived to be. Unfortunately, as the price of natural gas in the Netherlands makes clear, the crisis isn’t over:

The week has started with an ugly combination of bad news on the energy front. Gazprom PSJC, the giant Russian gas supplier, is declaring force majeure and stopping supplies to Europe; Saudi Arabia’s unwillingness or inability to boost oil production prompted a sharp rise in crude oil prices; an EU report suggests that a Russian cessation of supply and a cold winter could on their own knock 1.5 percentage points off European gross domestic product; and  maintenance of the vital Nord Stream pipeline continues to provoke anxiety.

Papic sketches an optimistic version of events in which Russia sticks with its gains in the Donbas, and then returns to providing energy to western Europe as the European powers seize the opportunity to accept. The technological difficulties of building pipelines to alternative potential customers in India or China make this by far Russia’s preferred option; Putin’s position remains weak.

The pessimistic version of events would begin to unfold if Russia instead decides to press on and try to capture more Ukrainian territory, or force some form of Ukrainian capitulation. Such a decision might well be disastrous for Russia in the longer term. In the short term, Europe would have no choice but to deny itself Russian energy imports. The effect on inflation and growth would be horrible. 

Will Putin be satisfied with Donbas, or will he try to get more? It’s an imponderable question, and the latest convulsion in the energy markets shows that the answer remains unclear. 

First, survival is easier if you’re unashamed to ask for help. The eagle-eyed will note that the Apple note is bylined by my colleague Isabelle Lee, who did the research for it. My thanks to her, and I’m looking forward to her ongoing contribution to Points of Return. With luck, she’ll help make this a better newsletter.

And now some podcast recommendations. If you want to bone up on inflation, try this chat from The New Bazaar between Cardiff Garcia and Matthew Klein; they know what they’re talking about, and they can actually express themselves. As a huge fan of BBC Radio 4’s Desert Island Discs, I’d recommend two compilations, of seven of the funniest castaways (Simon Cowell’s one luxury was a mirror), and the nine most moving (including both the cellist Jacqueline Du Pre on what it was like to be dying of multiple sclerosis, and her widower Daniel Barenboim, decades later describing what it was like to watch his wife dying). And on a more contemporary note, I recently recommended Patrick Radden Keefe’s book “Empire of Pain” on the Sackler family’s role in the opioid crisis. For a podcast inspired by it, try this episode of Malcolm Gladwell’s Revisionist History, which finds that the states that made it obvious to doctors through extra bureaucracy that their prescriptions were being monitored suffered far less severely than the rest. It might be the most successful example of a behavioral “nudge” I’ve ever heard. Worth listening. 

More From Other Writers at Bloomberg:

• Inflation Beast Won’t Lie Quietly Again: Allison Schrager

• The Big, Fat $200 Billion European Energy Bailout: Javier Blas

• China’s Labor Force Is About to Get Much Smaller: Justin Fox

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

John Authers is a senior editor for markets and Bloomberg Opinion columnist. A former chief markets commentator and editor of the Lex column at the Financial Times, he is author of “The Fearful Rise of Markets.”

More stories like this are available on bloomberg.com/opinion