Around lunchtime Tuesday at FT Alphaville towers a sell-off took hold of equity markets for no apparent reason. By the middle of the afternoon, the S&P 500 was down 1.6 per cent, and the Nasdaq close to 3 per cent.
We weren’t the only ones puzzled as to why. Some speculated that reports a Chinese aircraft had entered Taiwanese airspace triggered the fall, despite this happening 23 times over the past month. Others thought fresh pandemic news from Singapore (new restrictions) and India (the suspension of the Premier League cricket tournament) was wot done it. But, on a relative basis, these headlines again seem minor in the context of a global pandemic.
(For those wondering, Treasury Secretary Janet Yellen’s remarks about interest rates came later in the day.)
Another theory was put forward by Jim Reid’s team at Deutsche Bank this morning in their excellent daily macro note. Here’s the key passage (with our emphasis):
Could the sell-off be as simple as a sign that the pace of US growth is peaking? Regular readers will know that we’ve been flagging DB’s Binky Chadha’s work from last month . . . where he looked at all ISM peaks since WWII and found 37 such occurrences. The S&P 500 fell -8.3% (median) after those growth tops. Given the stretched positioning in this cycle he was/is expecting something at the top end of a 6-10% correction over the next couple of months. So with the ISM falling on Monday from 64.7 to 60.7 (65.0 expected) it’s possible we’ve seen the peak in the rate of change in growth that has previously heralded a correction. As such was some of the sell-off a delayed reaction to Monday’s quite notable fall in the ISM?
In a world of high-frequency trading and aggressive data mining, a delayed reaction to an ISM print seems like an inadequate explanation for the sell-off. However, FT Alphaville does have a thesis we’d like to put forward: a market that is struggling to digest the end of narrow growth.
For the best part of a decade, like a lot of the world, the US’s economic growth has accrued to those who need it the least with the top quintile of American earners taking a larger and larger share of national income since 2010:
That, of course, depressed economic consumption as those at the top of the economic ladder tend to spend far less of their income than those at the bottom. The result for a broad number of businesses? Low revenue growth, which meant investors were happy to pay premium prices for shares of companies that consistently grew at double digit levels — whether it be Visa, Netflix or the bevvy of upstart enterprise software companies.
The Biden administration’s $1.9tn stimulus package, and proposed infrastructure and social care bills, has changed this dynamic by shifting income to those in the engine room of the American economy via direct transfers, child tax credits and a deeper social safety net — some of it paid for by higher marginal tax rates on those who don’t spend.
Moody’s Mark Zandi expects growth to top 6 per cent this year, and 5 per cent in 2022. By 2022-2023, the IMF projected in its latest World Economic Outlook that the US will have closed its lost economic output from Covid faster than any other advanced economy:
Which means not only is the rebound from the pandemic going to be sharp, it’s also going to benefit a much wider set of the population.
For investors starved of inclusive growth for so long, it’s seemingly a message that’s been hard to digest, but you can see it everywhere. For instance, the worst performing stocks on Tuesday were what we would label as narrow growth names (software, tech hardware and semiconductors), while the best performing were those exposed to broad growth. Namely, cyclicals such as banks, telecoms and materials.
This trade isn’t new. Since it became clear Biden’s stimulus bill was arriving in mid-February, the stocks that have sold off have been the most speculative ones. Perhaps the best investment to express the narrow growth trade is ARK Invest’s flagship product, the ARK Innovation ETF. Here’s what its performance looks like compared to the Nasdaq, and old school cyclical index the Dow:
Many have attributed this price action to interest rate expectations, with the focus being the yield on 10-year Treasuries. It does make some sense: as growth not only accelerates but becomes more inclusive, price pressures should become more generalised than those we’ve seen since 2008, and if that happens, interest rates should rise. In turn, discount rates on future cash flows should move up also, which in theory should affect stocks where profitability is in the distant future, rather than the here and now. Yet, with speculative tech continuing to sell off in the past two weeks without the sharp move in yields we saw in March, it feels like that reasoning has lost its mojo.
Whether the impact of the Biden stimulus on redistribution will last is another matter. Many US businesses are struggling to digest that, in a hot economy with a threadbare social safety net, they might have to compete for labour by paying workers more. Still, for some investors, it seems the penny is beginning to drop that the growth-at-any-price market winners of the past decade are no longer so exceptional in an American economy where the gains will be more equally shared.