Key takeaways
- Bull market bias: The bull market continues to deserve the benefit of the doubt.
- Recent weakness = reset: We view the recent market pullback as a reset of stretched short-term prices and elevated expectations following one of the strongest six-month rebounds in history.
- Context on pullback: The S&P 500 has not experienced even a 5% decline since April—a longer-than-average period without a normal correction.
- Tech under pressure, yet fundamentally strong: Despite recent weakness and concerns around rising capital spending and debt, tech still shows the strongest earnings momentum in the market.
- Structural leadership intact: While this pullback may have further to go, we remain positive on tech and see it as a key driver of structural leadership.
What happened
Broad markets have come under pressure amid a mix of factors. The technology (tech) sector has faced notable selling in recent weeks, driven by concerns over rising debt issuance and a surge in capital expenditures—raising questions about whether these investments will translate into future profitability.
On Thursday, tech fell 2.4% and is now down more than 6% below recent highs. Semiconductors led the decline, sliding over 3.5% and are now roughly 9% off peak levels.
This weakness spilled into the broader market, with the S&P 500 down 2.2% from its recent high. Small caps also came under pressure as investors priced in a lower probability of a December Fed rate cut following comments from committee members expressing inflation concerns.
Our take
The bull market continues to deserve the benefit of the doubt. That said, we view the recent market weakness as a reset of stretched short-term prices and elevated expectations following one of the strongest six-month rebounds in history.
For perspective, from the April lows, the S&P 500 rebounded 38%, while the tech sector rallied over 73% and semiconductors gained more than 120%. Indeed, when expectations are high, a little bad news can go a long way.
Moreover, the S&P 500 has not seen so much as a 5% pullback since April—a longer-than-average time without such a pullback.
Importantly, we are not seeing a fundamental deterioration in profits, the north star of this bull market. Indeed, forward 12-month earnings estimates for the S&P 500 have once again risen to record highs, led by tech.
Notably, tech earnings estimates have risen 9% over the past three months, the strongest among all sectors and more than double the S&P 500. While valuations remain elevated at roughly 30x earnings, they are well below the 50x levels seen during the dot-com bubble and appear more reasonable given superior growth prospects.
Debt financing bears watching, but most companies are adding leverage from a position of strength—supported by high credit ratings and robust free cash flow margins (though moderating from elevated levels). Importantly, many large cap tech leaders such as Google, Microsoft, and Amazon generate hundreds of billions of dollars annually, from diverse revenue streams, to help fund the investment.
History offers perspective: in the 1990s, Amazon faced similar skepticism over aggressive spending and lack of profits. Those investments ultimately paved the way for AWS, a major growth engine—though the stock endured a volatile path along the way. While capital misallocation is inevitable and there will be winners and losers, the long-term innovation cycle remains intact.
From a broader perspective, sentiment is resetting quickly, which should eventually set the stage for stocks to reclimb the proverbial wall of worry. Indeed, the latest survey from the American Association of Individual Investors (AAII) showed the percentage of investors with a bearish outlook spiked to 49%—a two month high—which, from a contrarian perspective, can be viewed as a positive.
Bottom line
This bull market still deserves the benefit of the doubt. Yet, a short-term recalibration of stretched prices and sentiment is underway. Pullbacks are never comfortable, but they are the admission price for participating in the potential of stronger long-term stock market returns.
Despite the possibility of further weakness—which, for investors who are underweight, we would lean into—the weight of the evidence suggests the tech sector’s secular growth story remains intact, underpinned by strong earnings momentum.
As always, we will continue to follow the weight of the evidence and keep an open mind.
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