Market participants have been struggling with a narrow market led by a few big-cap names leveraged to AI. The gap between these tech giants and the rest of the market continues to grow, but the pressure for some sort of transition is building. The gap between the Fab Five AI names and the rest of the market is becoming too pronounced to accelerate further, but the disparity can continue for quite some time.
There are several macroeconomic factors that are going to have an impact on how the broad market transitions in the next couple of months.
- The first issue that is having an impact this morning is further signs that the Chinese economy is struggling. There was a sharp surge after China ended its Zero Covid policy, but it has deteriorated quickly. Several key Chinese indices have fallen into bear markets. This is not having any impact on the surging AI stocks in the US, but HP, Inc (HPQ) is reporting very weak computer sales, which is part of the issues that are impacting China. Is China a leading indicator of where the US Economy is heading? Interestingly there do not seem to be any significant AI stocks helping the Chinese market.
- A second issue is that inflation remains a significant issue. The likelihood that the Fed will raise rates at its June meeting is close to 70%. A pause was a near certainty after the last hike, but inflation has proven to be sticky, and now the Fed is signally another hike. The good news is that the economy is still strong enough to produce inflation, but the more the Fed hikes, then the greater the likelihood that the lag effect of economic policy will be felt in a few months.
- A third issue is that the debt ceiling deal is likely to be approved, although there is an intense fight over controlling the spin over which side 'won." There is concern that the deal will be a catalyst for a reversal as there will be a surge in new Treasury bond issuance that will soak up the liquidity that has helped to feed the big-cap rally. The Treasury Department needs cash, and they are going to raise it and drain some of it from the stock market.
- The fourth and key issue right now is how the narrow big-cap AI strength transitions from here. They are covering up the underperformance of the rest of the market, and it is building buildings. These big-cap names are not acting as leadership that is helping the rest of the market, although they effectively control the indexes that drive sentiment.
There is a theory that even if a recession hits, these big-cap names will continue to outperform because they are less economically significant and are viewed as safe harbors.
The lopsided action in the market is not likely to be corrected by a sudden crash of the big-cap names. They may see a reduction in relative strength, but the downside is likely to stay limited regardless of what happens in the rest of the market.
We have some early pressure due to the news of the weakness in the Chinese economy. Big-cap AI is seeing some mild profit taking, and there are some poor earnings reports that are causing a little additional pressure.
