Santa Claus Is Coming
By Brian Andrew, CFA® – Chief Investment Officer
While the stock market has been rallying since October of 2023, the complexion of the rally continues to change. In particular, what worked post-election, has changed as we enter the Santa rally period between now and the end of December. Yesterday’s Fed announcement that they would cut rates by .25% and approach future cuts more cautiously could cause Santa to get stuck on his way. Bond yields rose after the announcement and the stock market sold off as investors considered the possibility that interest rates won’t fall as much as thought three months ago. The question on investors minds, is whether or not earnings growth can keep pace with stock price appreciation so we need to evaluate what’s on the move and the likelihood that earnings come through.
Post-Election Rally
After the November 5th election, we had a clear winner in President-elect Trump who also secured a Congress aligned with his party, albeit on thin margin. Markets immediately reflected on what this meant for fiscal policy, government trade and regulation.
As a result, financial stocks like banks who benefit from lower short-term interest rates and an easier regulatory environment rallied almost 10% more than the market in November. Next up was the consumer discretionary sector (which includes Amazon and Tesla) outperforming the market by over 9.5%. Investors presume the new administration would be good for consumers and of course Elon Musk’s front and center presence during November didn’t hurt Tesla’s stock price performance. Energy also outperformed the broad market by almost 6% as investors really believe that a deregulatory environment will be good for energy producers.
Santa’s Rally
As we moved into December, the market is flat through today. However, there are winners and it looks like a return to the kind of market we’ve had for most of the year. As an example, Amazon is up 10% since December 1st driving the consumer discretionary sector higher. Tesla has rallied an additional 32%! The technology sector in general has outperformed the broader market by over 2% in December.
These stocks continue to push the market higher and why not. They are producing earnings growth, free cash flow and are at the center of investors excitement regarding artificial intelligence (AI).
We’re often asked how people should think about investing in AI. We remind them that the largest holdings in our index investments include Amazon, Nvidia, Microsoft, Alphabet and Apple. These companies are racing to develop the infrastructure and capability to monetize the tools their creating and they each have a different role to play. In the case of Nvidia, they are selling the computer chips that can do the work of AI based servers. Amazon and Microsoft have spent years developing successful cloud computing businesses and it is there that AI will live, work and play. Alphabet dominates the search business and the monetization of search through advertising. Between them and Amazon, they account for over 70% of online marketing spend.
They will use AI to power their search engines to provide smarter results and move well beyond offering links to pages of information. I’m sure you’ve seen the commercials for their Android driven phones where people are having conversations with them.
These companies have increased their capital expenditures many fold. As an example, Microsoft will spend almost $50 billion in 2024. That is more than 3 times the $15.4 billion they spent in 2020. Amazon will spend $75 billion this year! Combined these companies are set to spend almost $200 billion if you add Oracle and Meta Platforms.
Because they are trading at high valuations relative to their long-term history, we’ll have to watch how they balance this spending with earnings growth. When these stocks are priced for perfection, as they are now, any slip-up in earnings growth won’t be overlooked for long and even the excitement over their AI capabilities could wane.
Still, the capital expenditures for 2024 give you an idea of just how important this new trend will be.
It is worth noting that utilities were one of the other sectors benefitting from the election. They outperformed the broad market by almost 6% in November. The perceived reduction in energy regulation and opportunity to develop generation with an easier permitting process caused stocks to rise. In addition, these companies benefit from a reduction in interest rates as they are generally heavy borrowers. There is also some excitement about the need for additional development as the power needs for AI are well stated.
The Santa Clause rally may continue, and the secular AI theme will be with us well beyond 2025.
We hope that you enjoy the Holidays and have an opportunity to spend time with those that matter most to you!