2023: The Year That Proved Everyone Wrong (So Far)

Tech to the Moon, Recession Taking Longer to Materialize

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Who had the Nasdaq 100 up 26% in H1 on their 2023 scorecard? 

No one.

Many projected a weak H1 and a recovery in H2. The opposite occurred in the first half.

Hedge funds have also found themselves underperforming, with YTD returns of 5.58% ending April vs the S&P's 8.6% gain.

When investors realized there is an alternative to earning 0.01% in a savings account, capital fled to money market funds yielding ~5%.

This wasn't the only stampede of funds though. Money has piled into Tech stocks as the new defensives, riding the AI hype train.

Famous money managers are proclaiming AI is "better than the internet," and when asked how to play the theme, the default is the Megacaps.

We've had a massive run in Tech - but for how long? Will the winners continue to win or is it time to jump ship?

This week, in <5 minutes, we’ll cover the YTD Tech Stocks Run Up:

• Setting the Table 👉 Gangbuster 2020 + 2021, Hangover of 2022

• Catalyst #1 👉 Q1 2023 Earnings

• Catalyst #2 👉 Artificial Intelligence

• Relative Valuation 👉 Getting Back to Froth

Let’s get started!

1. Setting the Table 👉 Gangbuster 2020 + 2021, Hangover of 2022

The tale of the tape that drove Tech stock performance post-GFC, was monetary policy and liquidity. 

With interest rates near zero, capital flooded into growth equities. There were no alternatives.

Covid added fuel to the fire. By injecting more money into the system, Tech stocks moved higher post the Covid-bottom, and a massive rally took place into the end of 2021. 

Between March 2020 - December 2021, it wasn’t uncommon to hear things like: 

“Even though this Tech stock trades at 72x EV/Revenue, the growth rate is higher than the revenue multiple, so it can grow into its valuation.”

The eventual liquidity-tightening that hit 2022 hard, had something else to say about that. 

The hangover that followed for Tech names felt as bad as waking up as a 35 year old after partying like you’re 20 the night before. 

As inflation spiked and proved to not be “transitory”, the Fed responded with one of the most aggressive hiking campaigns in history. We all know how that went…

Just like how easing worked one way, it also worked the other.

This is why 2023 is so interesting though. Despite tight monetary policy, Tech stocks are putting up the middle finger to JPOW and rocketing to the upside.

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2. Catalyst #1 👉 Q1 2023 Earnings

The most recent earnings season can be summed up in three words from every sell-side analyst report: "Better than feared".

Have you ever heard of "under promise, over-deliver"? That's what these names did. 

In Q3 and Q4 of 2022, we saw a big reset in Tech companies adjusting growth forecasts downward. Going into earnings, most of the growth deceleration looked priced in.

What does "priced in" even mean though? If earnings growth is slowing, and fundamentals are deteriorating, shouldn’t stocks go down? Not so fast. 

Since growth forecast adjustments were already in, and rates were moving higher, Tech stocks had headwinds into earnings. 

This earnings season became a matter of clearing a much lower bar - and that happened.

Tech has gotten good at shifting from "move fast and break things" to "grow slower and fix things (like profitability)". As Tech continues to lay off workers, earnings are maintained and in some cases improved, despite lower growth.

In a higher rate environment, you want less duration (i.e., pull cash flows forward), and Megacap Tech is managing their duration risk well. They have a lot of operating leverage.

Check out what’s happening with Nvidia.

Nvidia was experiencing massive YoY growth in the quarters ending 2022 and beginning 2023, but was expected to contract in the coming quarters. There’s some funky stuff going on here with the pull-forward demand from the pandemic and comps overhang, but the reality is that revenue growth is sharply decelerating.

Oh look, the stock is up 113% YTD. That makes sense right?

This leads to my next point. New information and new narratives drive short-term performance. Not fundamentals like growth rates.

3. Catalyst #2 👉 Artificial Intelligence

AI has entered the hype cycle and rightfully so. 

It’s upending lots of business models, and investors are trying to find ways to get a piece. 

The default names to play in the space so far are Microsoft (OpenAI), Nvidia, Google, Amazon, and Meta. There are other direct plays on the infrastructure, like Snowflake, MongoDB, and Crowdstrike.

As I'll make my case in the monthly newsletter, AI is not the "new new thing". It is the "new permanent thing" that many believe will have productivity enhancements similar to the invention of the internet.

When big fund managers start paying attention - so should you. They dictate the flow of funds around the edges, which drives price performance.

Speaking at the Sohn conference, Stan Druckenmiller highlighted, "AI is very, very real and could be every bit as impactful as the internet." He plowed $220M into Nvidia and $210M into Microsoft.

Another big money manager, Steve Cohen, says that focusing too much on a looming recession could make you miss out on the "big wave" of AI opportunities.

The billionaire added he's worried about the "types of jobs that will be displaced," but expects profit margins to improve. 

Weaker employment might finally make the Fed chill out and with higher margins, markets could rip. As stated by Cohen, "I'm actually pretty bullish."

Here's a fun stat. Without the AI-related boom in Tech, the S&P 500 would be meaningfully down vs the rally we've had. 

Check out this widely circulated chart:

I’ll be releasing this month's paid newsletter to my subscribers with a deep-dive on the state of AI that you don't want to miss!

4. Relative Valuation 👉 Getting Back to Froth

Another highly circulated chart this week was the relative performance of Tech vs. everything else.

We're now back to levels from the peak Tech run in 2021, right in line with the dotcom bubble. That comparison scares people.

Let's remember the most infamous words in finance are "this time is different." and while the business models are certainly different, and cloud infrastructure will be more enduring than website URLs, things are starting to look frothy.

It might be time to fade the rally.

Wrapping Up…

Previous tech market-ups have all been fueled by eras of low interest rates, liquidity and nothing else to put capital in. This time around, it’s a different story. We continue to have tightening and a recession on the horizon, yet the "AI" and "safety" narratives dominate.

We're through April 2022 levels despite this challenging backdrop. 

While I don't believe this rally is sustainable, I also don't believe it’s smart to bet against momentum.

Until next time. Always Yours. Incessantly Chasing ROI,

-Genevieve Roch-Decter, CFA

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