Quick Bites | Below the Surface, it’s Pretty Volatile!
The major US stock indexes had a reasonable week, despite uncertainty about US tariffs struck down by the Supreme Court. In a 6-3 decision, the US Supreme Court ruled that the Trump administration exceeded its legal authority last year when it imposed tariffs on imported goods from its trading partners. The ruling didn’t resolve whether the government must repay tariff revenue that it has already collected.
Source: Evans & Partners
A lot of noise, but it probably doesn’t mean much to markets. What is more important are rates and the labour market, corporate profitability and business and consumer sentiment.
While markets have been “consolidating” for a while, beneath the surface individual stocks and sectors have been more volatile than usual. As most readers will know, the benchmark S&P 500 index is a market weight index, and the mega-cap tech companies dominate its movement. Analysts examine the alternative equal weighted index, to get an idea of how “corporate USA” is doing, where each of the 500 companies has an equal allocation.
The equal-weight S&P 500 has been rising to record highs since the beginning of the year, while the market-weight S&P 500 has been consolidating below 7000 over the same period (see chart below). This has been mostly attributable to the stock market’s rotation in the type of outperforming stocks, from high-tech to low-tech industries.
Source: Yardeni Research
Last year, the index was driven by expectations that companies involved in AI were obvious winners, while the latter lagged because investors figured it would take a while before AI benefited them. However, once the hyperscalers like Alphabet, Amazon, Meta and Microsoft began massively increasing their spending on AI infrastructure, investors feared that the investments might not pay off. This uncertainty has triggered a rotation from high-tech industries that had gained much market-cap share in the S&P 500 to low-tech industries with smaller market-cap share.
Investors are shifting capital to “real assets” including commodities, property and non-digital industries where there is greater understanding of prospects, in a world where no-one is quite sure how to best judge the impact of AI on business models. That makes sense because whether AI capex is profitable or not, the AI capital spending boom will boost demand for oil and gas, electricity, materials, capital equipment, and real estate.
Source: E&P
The geopolitical backdrop remains unsettling. A military confrontation between the US and Iran seems increasingly likely, which has sent the price of a barrel of Brent crude oil up by more than $10 since the start of the year. This explains why the S&P 500 Energy sector has been the best-performing S&P 500 sector so far this year. Transportation stocks included in the S&P 500 Industrials sector have continued to rise to record highs. Defense stocks, which are also part of the Industrials sector, have been very strong so far this year. Rising geopolitical risks and uncertainties have been bullish for precious metals, which are included in the Materials sector. Base metal prices are rising amid growing demand driven by booming AI capital spending.
Disaggregating US market returns
Source: Goldman Sachs
Source: GS
For many core macro assets – US rates, major equity indices and currencies – volatility has remained moderate. But that has coincided with extreme volatility “beneath the hood” of the US equity market, and huge moves in non-US indices such as Korea, Japan, and in commodities, especially gold and silver. These moves speak to the sharpness of the shifts in perceptions of the distribution of winners and losers, and the repositioning around those themes.