What kind of rally is this anyway?

Unlock Editor’s Digest for free

FT editor Roula Khalaf selects her favorite stories in this weekly newsletter.

Good morning. Yesterday I said there could be an investment case for Chinese stocks if the Chinese government were to use its fiscal muscle to revive the economy. Just an hour after our letter appeared, Xi Jinping and his team announced that there would indeed be fiscal stimulus. Chinese stock indexes jumped on the news. We’re still not convinced. Few targets or tough policies have been announced, and much fiscal support will be needed to avoid a deflationary trap. Will China put its money where its mouth is? Email us: [email protected] and [email protected].

A slightly strange rally

The S&P 500 hit another all-time high yesterday. The market has risen steadily, if not spectacularly, since September 6. This was the day of the August jobs report. This report is long enough – though not exhaustive – to explain the dynamic market. The report wasn’t terrible at all; the unemployment rate fell from the previous month. But it was weak enough to open the door for the jumbo-sized 50bp cut that followed on September 18. This is, at first glance, an easy landing rally.

The market didn’t just go up in the last three weeks. Its structure has completely changed. Sectors that led the market in the three months before the jobs report are now lagging behind. Over the summer, bearish (real estate, financials and utilities) and defensive (consumer staples and healthcare) plays were the place to be. Technology has lagged behind. This month the opposite happened. Technology is back with a vengeance and cycles (materials and industrial products) are also booming. The only constant between the two periods has been weak profits from energy companies as weak global demand has kept oil prices low.

In the chart below, the light blue lines represent the sector’s performance over the last three weeks, while the dark blue lines show the performance for the previous three months:

In terms of valuation and size factors, growth has decisively outperformed value lately, while large versus small has been a bit of a back-and-forth, with large-caps now leading the way.

If someone had told you a few months ago that the economy would cool only slightly and inflation would almost level off, allowing the Fed to begin its cutting cycle with a bang, that would have been the pattern of sector performance that would you have predicted it? Unhedged must shamefully admit that we saw little of this appearance. The cyclical outperformance blindsided us – this seems like a soft landing, but cyclicals are supposed to work in a recovery, which is something entirely different. And like many others, we would have expected a soft landing to have led to a broader market where gains came from more stocks across the index. But we’re back to where we were this summer: Big Tech delivering most of the market’s gains.

Looking a little closer at what has worked recently helps solve these puzzles. And what performed best are the Magnificent 7 tech stocks, semiconductors and copper:

Mag 7 may do well for reasons that have little to do with inflation and rates. There has been more news recently suggesting that AI investment continues to gain ground, most notably the announcement of a $30 billion AI infrastructure partnership between Microsoft and BlackRock, with support from Nvidia. Now, you might ask: what will be the return on this investment? But the stock market isn’t asking this, at least not yet.

The result is that, in dollar terms, Magnificent 7 tech stocks account for more than half of the S&P 500’s gains over the past three weeks. And in percentage terms, Nvidia, Microsoft, Meta, Tesla, Amazon and Alphabet outperformed the market. Only Apple (a defensive stock, at least for now) has lagged behind.

To some extent, semiconductor stocks – not just Nvidia, but also Broadcom, AMD, Applied Materials and so on – have been sailing in the wake of Mag 7. Micron, which makes memory chips, reported excellent earnings just yesterday, sales data centers being the leader.

Copper also rode the wave. If you think US demand will pick up after a soft landing, or that industrial investment from either green energy or the AI ​​boom is just around the corner, you’ve been looking for a reason to own copper, a critical mineral in both the centers of processing as well as in solar cells. As Unhedged wrote, the copper futures market does not perfectly reflect its long-term outlook, so buying copper spots and copper producers when they are cheap, as they were this summer, is one way to gain exposure.

Copper just got a second wind from China’s promise of economic intervention. It rose another 4 percent after the Politburo announced its intention to increase fiscal stimulus on Thursday. But Hartree Partners’ Ed Morse cautions that this response to the announcement and the prospect of a soft landing is largely speculative:

There is no evidence to date that any of the moves made by China’s central government will actually materialize. . . (and) US GDP growth is quite subject to controversy and interpretation. (Buying copper) is a wait and see, with risk on the downside, more than the upside

Morse is right. Economic data, while solid in the US, does not suggest a re-acceleration in response to the prospect of lower rates – at least not yet. Earnings reports in recent weeks also paint a rather mixed picture. While homebuilder Lennar had a great quarter, FedEx fared terribly as US domestic shipments fell. Darden, owner of Olive Garden and LongHorn Steakhouse, was a mixed bag. Value-conscious consumers seem to have stayed at home rather than enjoy the sorrel at Olive Garden, but the wealthiest have been scratching their bones at the LongHorn. Retail giant Costco and pet supplier Petco were also mixed, with very modest revenue growth. So it makes sense that technology, which is less tied to the consumer economy, is leading the market. We are less sure what is driving the increase in cyclicals, other than somewhat lower interest payments.

A good read

Lunch with the FT celebrates its 30th anniversary with a free newsletter highlighting the best interviews. Please register. And read our favourites: Donald Trump with his polar opposite Martin Dickson (Rob) and General Mark Milley (Aiden).

FT Unhedged Podcast

Can’t get enough of Unhedged? Listen to our new podcast for a 15-minute dive into the latest market news and financial headlines, twice a week. Keep up to date with previous editions of the newsletter here.