Is The Ride Over?
A trader on the floor of the NYSE, October 19, 1987. Photo: NBC News
After a first quarter of the year marked by optimism, with jubilant celebrations over the bright future of the tech industry, reality takes hold. Recent statements by Fed leaders and recent developments on the world stage have reminded overly excited investors that there is still high inflation and a war in the Middle East.
The effects of the recent arms exchange between Iran and Israel, in which Israel largely blocked an attack by Iran with assistance from the U.S. and the U.K., has set off significantly increased tensions between two of the strongest powers in the Middle East. This makes a war increasingly likely, though Iran and Israel have seemed to have backed off for now.
The pressures from the Fed and foreign wars have increasingly weighed on the markets. The prices of many overbought stocks - Nvidia, Super Micro Computers, and Palantir-fell back down to Earth. The Nasdaq has dropped 7% in 7 trading days, more than any other major index, falling below its 100-day moving average.
Israel launching missiles towards Iran. Photo: Business Standard
The decline in Nvidia is especially noteworthy, but perhaps not too surprising, because many analysts treated it as basically the engine of the entire market and expected that it would rise to above $1,000. A UBS analyst rose its price target for Nvidia after the GTC conference that it held in March to $1,100 from $800. Even with its strong increase in earnings as of late, Nvidia remains at an extremely high valuation of more than 60 times earnings. For many recent valuations to be justified, it would need a roughly 19% average growth rate over the next 9 years, which even analysts right now are not seeing.
(Source: Seeking Alpha)
Recently, the IMF has warned that rising U.S. national debt poses a threat to global financial stability by increasing the borrowing costs of other nations around the world in addition to its own. Yet there remains no significant political will in the United States to take significant action to reduce national debt even though the U.S. debt is increasing by $1 trillion every 100 days. In an environment where interest rate expectations are already rising due to a decline in expectations or rate cuts, this matters even more because investors will be demanding more to lend to the United States, not only because of the higher interest rates but also because of the perceived risk attributed to American debt, which has been exasperated by debt ceiling battles over disagreements on government spending.
The depreciation in public equities also reflects a broader shift by major funds away from public equities and into bonds. As treasury rates reach their highest levels in six months, and levels rarely seen anywhere in the past 20 years, and as an increasingly unfavorable interest rate environment and increasingly volatile international situation creates more uncertainty in the public equities market, investors of all sizes are looking to de-risk and protect their gains from the past year. California’s pension fund is planning to move $25 billion out of public equities and into bonds, as part of a 5-percentage-point cut in the share of its funds invested in stocks. Pension funds in New York and Alaska are also reducing their share of funds that are invested in equities. So are many corporate pension plans. In total, pension funds are expected to unload about $325 billion in stocks this year, up from $191 billion in 2023.
With major funds exiting equities at an ever-increasing rate, it is likely that a major correction in equities markets is on the way, which could prove particularly devastating to companies like NVIDIA and super-microcomputers that were the disproportionate beneficiaries of the AI rally. The perils of investing in tech are clear because of the industry’s general interest rate sensitivity-it is clear that the exit from equities will disproportionately affect tech stocks just like how the equities boom of last year disproportionately benefited them.