Insights into key market performance and economic trends from Dan Kemp, Morningstar’s global chief research and investment officer.
Jobs Data Surprises
US stock prices fell over the week, with the Morningstar US Market Index down nearly 2% following stronger-than-expected employment numbers. The seemingly paradoxical response of investors to positive economic news appears to reflect growing concerns about stickier inflation leading to fewer interest rate cuts in 2025. Preston Caldwell, Morningstar’s senior US economist, remains sanguine about inflation, expecting the Personal Consumption Expenditures Price Index measure of inflation to fall below 2% in 2025. You can read Preston’s take on the latest job report here and download his latest economic outlook here.
Bond Yields Rise, But No Cause for Alarm
Inflation concerns were also evident in Treasury yields which rose 0.17 percentage points over the week with the 10-year bond closing on Friday at 4.77%. While this represents a 4.22 percentage points increase on the yield in July 2020, it is similar to the average yield over the period from the start of the century to the onset of the global financial crisis in 2008. Although shorter-term yields remain above the pre-financial crisis average of 2.77%, the latter included a period of very low interest rates following the technology crash of 2000.
Discount Rates and Stock Returns
With long-term interest rates near normal levels and shorter-term interest rates expected to fall further, it is worth asking why equity prices fell so sharply on the Friday. The most obvious answer is that the largest and most highly priced companies in the market are those in the high growth areas of technology and communications. Despite being highly profitable, most of the earnings of such companies lie in the future because of the impact of compound growth.
The present value of these earnings is determined by the rate at which these future earnings are discounted to reflect the uncertainty of these expectations being realized. Such discount rates are driven partly by long-term interest rates. With high valuations justified by low interest rates, this is why positive economic news can be negative for some investors as prices adjust to reflect higher discount rates.
Value Stocks Could Be Well Placed
When high-growth companies dominate a market, interest rate concerns can have a significant impact on the index and investors who follow it. However, it is worth noting that the valuations of companies that are less reliant on future growth can perform better. These companies tend to be clustered in the value part of the market as evidenced by the fact that the Morningstar US Value Index fared better than Morningstar US Growth Index last week. It would be premature to suggest that this represents a turning point in market sentiment.
Given the size of the valuation gap between value and growth stocks, a change in sentiment may result in large differences in returns. You can see this valuation differential on Morningstar’s markets page. It is also a useful reminder that longer-term bonds are more likely to confer diversification benefits on companies vulnerable to weaker economic conditions that those that are overpriced due to an excess optimism about future growth.
Next Up: Taiwan Semiconductor Earnings
Technology investors will be focused on the latest earnings from Taiwan Semiconductor Manufacturing Co 2330 this week. TSMC is the world’s largest dedicated contract chip manufacturer, with over 60% market share and is a key supplier to Apple AAPL and Nvidia NVDA. Its results are therefore likely to influence the way investors view these US technology giants.
Inflation Data is Due
Inflation will also be back in the news with the latest producer price inflation (PPI) and consumer price inflation (CPI) released on Tuesday and Wednesday respectively. In a busy week for economists, the Federal Reserve will release its ‘Beige Book’ of anecdotal data on Tuesday while we will also receive the latest retail sales numbers on Thursday. Following the surprise of last week, we should expect some volatility as the developing narrative of a strong economy is either reinforced or confounded by these data. You can follow the earnings and economic releases on this calendar.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
