Strong corporate results have helped fuel the S&P 500′s climb to new highs this year, taking the focus away from the Federal Reserve’s tortuous path towards lower interest rates. As earnings season winds down, some investors believe monetary policy will jump back in the driver’s seat.
Nvidia Corp’s blockbuster earnings results put an exclamation point on the fourth-quarter reporting period, as the AI darling’s surging shares propelled the S&P 500 to fresh record highs in the past week. The benchmark index has gained over 6.7 per cent so far this year.
With the vast majority having reported, S&P 500 companies were on track to increase fourth-quarter earnings by 10 per cent from the year-earlier period, according to LSEG IBES data, which would be the biggest rise since the first quarter of 2022.
As the earnings glow fades in coming weeks, the spotlight could turn back to the macroeconomic picture. One pivotal factor could be the steady rise in bond yields, which has come on the heels of shrinking expectations for how much the Fed can ease monetary policy this year without reigniting inflation.
“The market has been able to ignore the rise in yields because of the strong earnings,” said Angelo Kourkafas, senior investment strategist at Edward Jones. “That focus on the path of rates and yields might come back into the forefront as we move past earnings season.”
Higher yields on Treasuries tend to pressure equity valuations as they increase the appeal of bonds over stocks while raising the cost of capital for companies and households. The benchmark 10-year Treasury yield, which moves inversely to bond prices, hit 4.35 per cent last week, its highest level since late November.
While optimism on earnings and the economy has helped stocks shrug off the climb in yields, this could change if inflation data keeps coming in stickier than expected, forcing the Fed to further delay rate cuts.
Futures tied to the Fed’s main policy rate on Friday showed investors pricing in around 80 basis points of Fed cuts this year, compared to 150 basis points they had priced in early January.
An inflation test arrives Thursday, with the release of January’s personal consumption expenditures price index, which the Fed tracks for its inflation targets. On a monthly basis, the PCE index is expected to increase 0.3 per cent, according to a Reuters poll of economists, up from a 0.2 per cent rise the prior month.
“If inflation renews its downward trend, that is going to be helpful to interest rates and that can provide the next catalyst for an up move” in stocks, said Chuck Carlson, chief executive officer at Horizon Investment Services.
At the same time, many investors believe AI fervor will continue driving stocks for the foreseeable future. Nvidia touched US$2 trillion in market value for the first time on Friday, riding on an insatiable demand for its chips that made the Silicon Valley firm the pioneer of the generative artificial intelligence boom.
“We believe retaining strategic exposure to the US large-cap technology sector is important, and the rise in tech stocks could go further still,” wrote analysts at UBS Global Wealth Management on Friday, adding that they believe generative AI “will prove to be the growth theme of the decade.”
This week will also bring other data including on consumer confidence and durable goods that will give a broader look into the state of the economy. A number of the companies due to report results in the coming week, including Lowe’s and Best Buy, are retailers who will give insight into consumer spending.
Jack Ablin, chief investment officer at Cresset Capital, is among the investors who see benefits if the economy continues walking a fine line to a so-called “soft landing,” in which the Fed is able to cool inflation without upending growth.
“If we can get slowing growth, slowing inflation, create an environment that the Fed can start reducing interest rates... that should help the average stock,” he said.
-- Lewis Krauskopf, Reuters
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The Rundown
The Globe’s Dividend All-Stars 2024
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Ask Globe Investor
Question: What is your opinion of single-stock exchange-traded funds such as those offered by the U.S. company YieldMax ETFs that advertise double-digit distributions? These ETFs seem like a good way to invest in some of the big names like Nvidia Corp., which I can’t afford directly, and kick up my dividend stream.
Answer: With AI chip maker Nvidia soaring to fresh highs this week on the strength of yet another blockbuster earnings report, many investors have come down with a serious case of FOMO. But if you’re itching to get in on the rally in tech stocks, these ETFs aren’t the way to do it.
YieldMax funds generate income by selling call options on individual stocks such as Nvidia, Tesla Inc. TSLA-Q, Microsoft Corp. MSFT-Q and Netflix Inc. NFLX-Q As YieldMax explains on its website, however, its ETFs do not invest directly in these securities. What’s more, because of the options strategy the company employs, any gains in the underlying stocks will be capped for holders of its ETFs.
Consider the YieldMax NVDA Option Income Strategy ETF NVDY-A, which writes options on Nvidia NVDA-Q shares. The ETF posted a total return – from share price gains and distributions – of about 24 per cent for the six months ended Jan. 31. That sounds impressive, until you compare it to the return of about 32 per cent for Nvidia shares over the same period. That’s the problem with many options-driven yield strategies: They often leave money on the table.
Similarly, the YieldMax MSFT Option Income Strategy ETF MSFO-A, which writes options on Microsoft Corp. shares, had a total return of 15 per cent for the three months to Jan. 31. That compares with a total return of 18 per cent for Microsoft shares.
I’m not suggesting that you should invest in Nvidia (or Microsoft) directly, but I don’t understand your comment that you “can’t afford” to do so. Yes, at nearly US$800 a share, buying 100 shares of Nvidia would cost you close to US$80,000. But there’s no reason you couldn’t buy five, 10 or even a smaller number of shares.
However, a more prudent approach would be to purchase a low-cost index ETF that tracks the S&P 500, which has a roughly 30-per-cent weighting in technology stocks, including Nvidia and all the other big-tech names. You won’t get a huge yield – the BMO S&P 500 Index ETF ZSP-T, for instance, currently yields about 1.2 per cent – but you will achieve better diversification and participate in virtually all of the upside if stock prices continue to rise. You’ll also keep your costs low, thanks to a management expense ratio of just 0.09 per cent for ZSP and similar products such as the iShares Core S&P 500 Index ETF XUS-T.
In general, investors are too easily seduced by investments that offer outsized yields. Products like those offered by YieldMax appeal to investors who are looking for a shortcut to build wealth, but the process can’t be hurried. There is no substitute for building a diversified portfolio and letting time and compounding do their work.
-- John Heinzl (E-mail your questions to jheinzl@globeandmail.com)
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Compiled by Globe Investor Staff