Economic Indicators Signal Strength, but Risks Remain
The Stock Market Isn’t All About AI Anymore
Tech Stocks Lose Steam, Market Broadens
AI's grip on the stock market has significantly loosened, as investors shift their focus to a broader range of sectors. The first half of 2024 saw AI hype drive stock prices upward, even as inflation remained stubbornly high and dashed hopes of Federal Reserve rate cuts. However, the third quarter introduced a new dynamic, as big tech's aggressive spending on AI came under scrutiny. This shift allowed other sectors, such as utilities, industrials, and financials, to outperform the previously dominant tech sector.
During this period, value stocks outperformed growth stocks, and small-cap stocks surged ahead of large-cap stocks. The S&P 500 gained 5.5% for the quarter, bringing its 2024 total gain to 21% — its best first three-quarters performance since 1997. Investors are increasingly optimistic that the Federal Reserve's efforts to control inflation without triggering a recession are succeeding, paving the way for more sustainable growth across various sectors.
Tech Stocks Lose Steam, Market Broadens
The third quarter saw divergence among the so-called "Magnificent Seven" tech stocks. Nvidia, Alphabet, Microsoft, and Amazon experienced declines after their meteoric rise earlier in the year, while Apple, Meta Platforms, and Tesla posted gains. Concerns about tech companies' heavy AI-related expenditures weighed on investors, with Alphabet and Amazon's stocks falling 8.9% and 3.6%, respectively, due to increased spending and softer-than-expected growth.
Many investors are now questioning whether these companies will see meaningful returns on their AI investments. Jim Polk, head of equity investments at Homestead Advisers, noted that while AI's long-term potential remains intact, the market may have been overly optimistic in the short term.
Bond Market and Dividend Plays Shine
The bond market also saw gains in the third quarter, as the Federal Reserve finally began cutting interest rates. The yield on the 10-year U.S. Treasury note fell to 3.798% from 4.342% at the end of June. This drop in yields supported sectors like utilities and real estate, which are seen as bond proxies due to their strong dividend payments. The utilities sector was the top performer, with an 18% gain, while the real-estate sector climbed 16%.
A key development in the bond market was the end of the inverted yield curve, where short-term bonds had higher yields than long-term ones, a classic recession indicator. Although the yield curve returned to normal, many investors remain optimistic that a recession is not imminent, with more than half of respondents in Bank of America’s September global fund-manager survey predicting no U.S. recession within the next 18 months.
Economic Indicators Signal Strength, but Risks Remain
Data from August showed inflation cooling for the fifth consecutive month, reaching a three-year low, while job growth rebounded. Consumer sentiment also improved, and household spending remained strong. This has boosted confidence that the U.S. economy is weathering inflationary pressures and avoiding a severe downturn.
However, not all indicators are positive. The unemployment rate has edged up, and lower-income consumers are facing difficulties, as reflected in Dollar General’s downgraded sales outlook. Additionally, restaurants have been offering more deals to entice budget-conscious customers. Some, like Josh Emanuel, chief investment officer at Wilshire, caution that the recent rate cuts reflect underlying economic deterioration, which may not be fully priced into the stock market yet.
Conclusion
As AI hype cools and other sectors rise to prominence, the stock market is displaying broader-based strength. Tech stocks are no longer the sole drivers of growth, as investors turn to value and small-cap stocks. With inflation easing and the Fed cutting rates, optimism remains, but risks such as rising unemployment and consumer strain warrant caution. The economy's trajectory will continue to influence market movements, with a more diversified rally offering potential for sustained growth.