At Monday’s opening bell, U.S. equities are attempting to regain some of the significant decline from the previous session. Concerns that more weakening was imminent were aroused by the S&P 500’s 1.6% dip on Friday, which was its largest percentage drop since May 21 and followed by dismal jobs data and a revival of tariff worry.
Nevertheless, despite the possibility of short-term challenges, many of the market’s more bullish analysts maintain their optimism.
A window of about seven weeks will now exist, according to Jefferies’ equity strategy team, “during which the economy may have to contend with a weakening labor market and limited support from the Fed.” It is generally anticipated that the Fed would reduce official borrowing costs by 25 basis points to a range of 4.00% to 4.25% at its next rate-setting meeting, which ends on September 17.
“It’s a view that may seem tougher to pitch after this week, but we continue to believe the path for equities remains higher,” Jefferies adds in a note released over the weekend.
Importantly, they believe that the second-quarter statistics indicate “the backdrop has been strong and stable enough to beat tepid expectations,” which will allay worries about a slowing economy.
They point out that 85% of the S&P 500 companies that have reported have surpassed Wall Street’s forecasts. As a result, earnings prediction adjustments have increased, and stocks often follow suit.
Big Tech, which now accounts for 44% of the S&P 500 by weight—by far the largest ever and surpassing the previous high of 40.6% set in February 2000—is causing the Jefferies team to become concerned.
A “bastion of consistent performance amidst an uncertain backdrop,” the industry is still producing the best outcomes, but they “are starting to be concerned with how much longer it can sustainably continue.”
Jefferies clarifies that it does not imply that large tech is in a bubble. In fact, it views the industry as a defensive one with the greatest potential for profit growth in an uncertain economic climate.
For two reasons, though, Jefferies does not believe that large tech is currently the best option. The first is that the trade is “long in the tooth” with stretched valuations; at the moment, it displays a spread compared to the 87th percentile of the least expensive stocks (going back through 2010).
According to Jefferies, the second problem is that Friday’s jobs data made the market price in a higher likelihood of Fed rate reduction, which is generally better for the remaining S&P 500 even when the whole market is down.
“[M]ost of the bouts of significant SPX equalweight outperformance come when Fed funds is falling,” they claim.
According to their chart below, the equalweight S&P 500 has outperformed the broader benchmark on multiple occasions over the last 35 years when Fed funds have begun to decline.
“Now, we’re not attempting to make the case for a big tech selloff or a slump. Regardless of whether the overall benchmark is higher or lower, a dovish Fed has a tendency to incite regime change. Therefore, if Friday’s payrolls have shown us anything, it’s that it could be time to start moving away from large-cap technology,” Jefferies says.
