Markets changed in July. Following an almost uninterrupted rise since 2022 lows, the so-called “Magnificent 7” stocks dramatically underperformed in the month. These largest capitalisation stocks (Microsoft, Nvidia, Alphabet (Google), Apple, Meta, Tesla and Amazon), have outperformed the rest of the market to trade on high valuations, often accompanied by exceptional fundamental business performance. However, the market called time on their run mid-July, selling off larger cap technology names and buying smaller cap stocks. Over the last two weeks, the impact has been sharp and persistent. While most of the attention has been focused on the rotation in US markets, more broadly, recently outperforming assets have fallen, and underperformers have risen.
The rotation was given further momentum by the first of the Magnificent 7’s quarterly earnings releases, all of which disappointed. Tesla, Alphabet and Microsoft reported towards the end of the month, with shares in each falling over 5% on the announcements, causing contagion to the others. In general, this has been less that company fundamentals have been weak, but rather, that market expectations had become over-stretched and increasingly challenging for companies to meet. Such high valuations make these shares particularly susceptible to earnings misses. On balance, the broadening of market performance should be seen as healthy, as a market driven by a narrow group will lack longevity. It is too early to tell if this is a blip or starting a longer trend. However, given the number of market participants that have been anticipating such a rotation, we would be inclined to believe that the last few weeks’ trend will persist.
July was rounded off by a Federal Reserve interest rate decision, with rates held at 5.5%, as expected. Since inflation is still above target, the jobs market and economy robust, policymakers remain happy to wait for further evidence before cutting. However, comments following the meeting suggested that the first reductions may be made shortly. The rhythm of monetary policy continues to diverge geographically, impacting currency valuations and money flows. The clearest example is between the US and Japan, where the Japanese Yen has been weak on the back of loose policy, contrasting with tighter positioning from the Federal Reserve. However, recent weeks saw a sharp reversal, as the Bank of Japan raised rates from 0.1% to 0.25% and reduced QE. The influence of changes in interest rate differentials can be powerful and enduring, potentially overwhelming other currency valuation metrics. Such divergences in monetary policy therefore become an area to watch for investors going forward.
