July 15, 2024

Stocks’ Resistance to Record-High Interest Rates and What It Means for Investors

As interest rates stayed high and all major market averages climbed to or near all-time highs last week, the rise in U.S. equities continued.

For the week, the S&P 500 rose 1.60% to 5,303.27, the Dow Jones gained 1.25% to 40,003, and the tech-heavy Nasdaq gained 2.10% to 16,685.97.

In the past twelve months, the Nasdaq index has climbed 31.50%, the Dow Jones has climbed 19.30%, and the S&P 500 has climbed 26.30%. Even if interest rates have gone up, the popular stock market indices have been climbing to new records.

After peaking at 5% in October, the benchmark 10-year Treasury bond yields have risen steadily from 3.70% in May to 4.42% last week. This “loathed” stock market bounce is mostly due to strong profit growth at a few tech businesses that have a significant impact on stock market index performance.

FactSet tracks the popular equity index’s earnings and predicts an increase of more than 8% in the S&P 500 in Q1 2024, excluding Bristol Myers Squibb’s earnings.

Microsoft, NVIDIA, Alphabet, Amazon.com, and Meta Platforms are among the “Magnificent 7” firms that have contributed the most to the increase in the S&P 500’s earnings. According to John Butters, VP of FactSet, the exclusion of these five companies would have resulted in a year-over-year decrease of -2.4% for the S&P 500 instead of the 5.4% growth in earnings for Q1.

Despite rising Treasury bond yields, the Magnificent 5 group managed to increase their earnings for multiple reasons.

These businesses are financially stable; they have more cash than debt. Take Alphabet as an example; they have $108 billion in cash on hand and $28 billion in debt. Meta, on the other hand, has $58 billion in cash and $37 billion in debt.

High interest rates, then, help their bottom lines rather than hurt them.

Second, the United States is currently experiencing a virtuous growth cycle thanks to robust economic growth and a stable labor market. A robust economy creates jobs, which in turn generates money. Consumer spending, which is a direct result of income, boosts economic growth as well as company profits.

Third, the Magnificent 5 protects its supremacy with several “moats,” or obstacles to admission. For example, thanks to networking economies, Microsoft has built a strong global brand. There are more than a billion Windows users across the globe, giving Windows a market share of 76.33 percent. Competition has a very hard time breaking into its market because of economies of scale and “lock-in” agreements with customers.

The “moats” have played an important role in the Magnificent 5’s delivery of high EVA. That is the result of dividing the invested capital by the weighted average cost of capital (WACC), which is itself a function of the return on invested capital (ROIC).

Investors can earn what economists call the “normal profit” of investing (WACC) if they put their money into stock and debt funds that track the performance of prominent market indices. So, EVA is a way to quantify returns that are better than the opportunity cost of capital, or returns in the market.

The Magnificent Five have delivered strong EVA numbers. The EVA for Microsoft has increased by 640% over the last five years, whereas the EVA for Nvidia has increased by 743 percent. These profits have outpaced the two companies’ market gains during the same time span, suggesting that their stock might be undervalued even now.

Fourth, when it comes to artificial intelligence, the Magnificent 5 are at the vanguard. They may be able to maintain their competitive advantage, strong profitability, and EVA gains, which might propel market averages to new heights.

Unsubscribe whenever you want. Your agreement to our privacy policy and terms of service is implicit in your registration.
“We are living through the fourth innovation boom since the 1960s tied to AI, automation, and profitability,” stated Scott Helfstein, SVP and Head of Investment Strategy at Global X. “In the past, those booms worked out well for companies and stocks.”

There is still a long way to go before the present surge ends, according to Helfstein. “Expansion to new highs usually lasts two years and delivers returns of 50%,” he remarked, as he added, “This market broke out to a new all-time low just a few months ago.” More new peaks and landmarks should appear. Companies have recently produced twelve consecutive quarters of 12% margins. If it becomes the standard, investors will have to shell out more money.

Refrence: Ibtimes

Leave a Reply

Your email address will not be published. Required fields are marked *