Navigating the Economic Landscape: The Shift from FAANG to MANNA and Beyond

The narrative in the financial sphere continues to revolve around the term “narrow market,” a phrase referring to how a handful of stocks have been driving market performance. This narrow rally might be hinting that an improvement in economic growth isn’t in the near-term cards. With sticky inflation concerns and the unstoppable rise of artificial intelligence, market analysis is increasingly becoming a complex web of interwoven variables.

One thing is clear, however: we need a new acronym for the driving forces in the market. Let’s bid farewell to the “FAANG” (Facebook, Amazon, Apple, Netflix, and Google) era. Today, our focus shifts towards “MANNA”—Microsoft, Apple, NVIDIA, Alphabet. We could add Netflix to complete the acronym, given its recent rally. The name “MANNA” is a nod to the Biblical sustenance for the Israelites during their 40 years in the desert. Similarly, these stocks seem to be providing an oasis for investors in an economy that’s otherwise showing signs of slowing down and amidst a Federal Reserve still keen on tightening policy.

Where Are We Headed?

By keeping things simple, we can gain clarity through a series of fundamental questions:

1. Where are we in the cycle?The US economy continues to display a semblance of resilience, but the obsession with a looming recession remains. Various indicators are sending warning signals—an inverted yield curve, tighter credit conditions, to name a few. Although the recession seems unlikely this year, we must acknowledge that every cycle has an end. However, not all recessions result in disaster. The crises of 2008 and 2020 were outliers, not the norm. Interestingly, markets seem to have already priced in a mild recession.
2. What’s the market telling us about the direction of the economy?The narrow market performance, driven by a small cluster of high-quality, mega-cap names, suggests that an uptick in economic growth isn’t in the immediate forecast. The market suffers from bad breath, and only improved economic activity coupled with easier policy could serve as the needed mouthwash.
3. What will be the policy response?The Federal Reserve hints at more rate hikes in the pipeline even as US inflation moves closer to policy targets. Whether these rate hikes are meritorious is open to debate. For now, it seems unwise to fight against the Fed’s inclinations. Our preference remains for higher-quality stocks and bonds as we see the economy slowing and the Fed preparing for further rate hikes.

Stickiness of Inflation

Contrary to popular belief, I am skeptical about the stickiness of inflation. The Atlanta Fed’s core sticky inflation, when we discount shelter costs, stands below 4% and is on a declining trend. Why exclude shelter costs? The current elevated prices seem unsustainable, and the US apartment rental market is as soft as it has been in a while. As shelter costs likely moderate, the core inflation numbers, currently causing concern at the Fed, should become less alarming.

The Ghosts of the Late 1990s

Today’s concentrated markets eerily echo the late 1990s bubble. But is the current environment preparing us for another crash?

• Concentration: The S&P 500 Index is more concentrated in the top 10 holdings now than it was at the peak of the 2000 equity market bubble.
• Fundamentals: However, the gap between the market share and earnings share of the top 10 companies is currently only one-third of what it was in 2000, suggesting stronger fundamentals for today’s mega-caps.
• Valuation: The valuations of the top 10 holdingsin the S&P 500 Index are far from the bubble levels seen in the 1999 Nasdaq frenzy. Back then, the median price-to-sales of the top 10 largest NASDAQ Composite Index companies stood at a staggering 21.9x. Presently, for the S&P 500 Index, it sits at a more reasonable 5.8x.

The AI Revolution

Artificial Intelligence (AI) has been making quite a buzz lately. Why is it coming into focus now, and what are the potential implications? Ashley Oerth, Senior Investment Strategy Analyst at Invesco, offered her thoughts: AI is not new, and it’s already been reshaping real-world applications for over a decade. We aren’t at the onset of an AI revolution; instead, we are at an inflection point that could lead to accelerating changes driven by three factors:

1. Increasing amounts of captured and available data.
2. More accessible and affordable computing power, supplemented by intelligent systems like cloud computing.
3. More sophisticated and effective models.

AI is expected to significantly enhance productivity across various sectors. It is not a job-killer, as feared, but a toolset for improving efficiency. The winners will likely come from these three categories:

1. Enablers: These are the creators of AI tools and the related infrastructure, including data operations, computing hardware and solutions, and companies creating the models.
2. Adopters: AI could drive productivity increases across many workstreams, leading to broad applications. In finance, for example, AI could provide automated summaries of policymaker speeches.
3. Responders: As AI progresses, new challenges will arise, such as deepfakes, advanced phishing attempts, and the increased potential for coding malicious software. As such, cybersecurity will become ever more crucial.

In a recent exchange with the AI-driven chatbot, ChatGPT, I asked, “Why are people afraid of artificial intelligence?” The fears generally revolve around job displacement, loss of control, ethical implications, security, and privacy. The takeaway? While initial reactions to new technology often include fear, it’s important to remember that these advancements typically lead to significant improvements in the standard of living. AI will likely follow a similar trajectory.

The Federal Reserve’s Tightening Policy

In the words of Jerome Powell, “We have been seeing the effects of our policy tightening on demand in the most interest rate-sensitive sectors of the economy, particularly housing and investment.” Yet, the Federal Reserve is projecting two more rake hikes this year. Shouldn’t we assess the impacts of the unprecedented tightening thus far before considering future rate hikes?

Regardless of our views, the Federal Open Market Committee is on its course. The key takeaway? We probably won’t see a new market cycle until the tightening concludes. The current narrow market rally, driven by “MANNA,” indicates that investors are preparing for a potential slowdown. However, we should remember that the resilience of the US economy, the potential moderating influence of AI, and the less sticky inflation than believed, provide a layer of optimism to navigate these complex times.

Conclusion:

In the end, while the financial markets may present us with complex and intertwined variables, taking a simplified approach by focusing on the key driving factors can give us a clearer perspective. We’ve witnessed the shift from the FAANG era to the current MANNA epoch, which suggests investors are focusing their attention on resilient mega-cap names as economic indicators predict a potential slowdown. However, this is far from a signal for panic.

Contrary to the rising fears, inflation appears to be less sticky than believed, and AI’s adoption could have significant benefits across various sectors, propelling productivity and potentially cushioning the impact of any economic slowdown. The broader picture points to a market that may already be bracing for a mild recession, yet simultaneously recognizing the robust fundamentals of the top market players.

Although the Federal Reserve’s persistent tightening policy may seem challenging, we must remember that the US economy has proven its resilience repeatedly. Therefore, as we move forward, we should approach the markets with cautious optimism, placing our trust in the sectors displaying robust fundamentals, and being adaptable to evolving technological shifts. Ultimately, understanding these market trends and financial indicators can help us steer our investments wisely in the journey ahead.