Plus: Large-cap stocks, interest rates, AI and emerging markets.
US stocks continued to climb a wall of worry last week. The Morningstar US Market Index rose 0.6% as the Federal Reserve delivered the expected quarter-point interest rate cut, President Donald Trump claimed victory in his negotiations with China and the majority of the Magnificent Seven stocks revealed better-than-expected results. As a result, the possibility of a sharp upward movement in stock prices remains as we move toward the end of the year.
The situation is more nuanced when we look a little deeper. While Alphabet GOOGL, Amazon AMZN, Apple AAPL, Microsoft MSFT all reported strong results, supported in most cases by growth in AI and cloud computing, Meta META was hit by a $15.93 billion tax charge which the company attributed to President Donald Trump's One Big Beautiful Bill Act. Investors also appear concerned with the planned level of AI investment at the company, precipitating a 12.2% decline over the week.
The sensitivity of the US market to the success of a small number of companies was further illustrated by comparing the price movements of US large-cap companies, which were up 1.2%, with those of mid cap, down 1.1%, and small-cap stocks, down 1.5%. This disparity can also be seen at the sector level as seven of the 11 sectors declined over the week. This is best illustrated by the gap in the performance of US technology stocks which were up 2.6%, and consumer defensives, down 3.9%.
Investors have become familiar with this dispersion in performance and its impact on the relative returns of active strategies. But it's worth remembering that a wide divergence in value cannot persist forever, and consequently creates unusually attractive opportunities for investors who are prepared to think independently and remain invested through the volatility that typically accompanies a change in market leadership.
These valuation anomalies also existing within the largest and most popular stocks as evidenced by the consumer cyclical sector, which rose 2.2% last week driven by Amazon, up 8.9%, following strong results. Together with Tesla TSLA, up 5.3%, these companies account for 49% of value of the sector. However, despite this grouping, they represent very different investment propositions. While Amazon is deemed by Morningstar's analysts to have a competitive advantage that could take decades to fully erode, Tesla's competitive position is robust. Tesla is currently priced at 188 times its expected earnings, while Amazon is priced at a more modest 32 times. Morningstar's analysts expect Amazon to provide reasonable long-term returns, while Tesla is priced to deliver low returns.
The interest rate situation is similarly nuanced as despite the action of the FOMC, the US dollar rose 0.9% over the week on dampening expectations of a further interest rate cut in December. While investors continue to expect a cut, the probability of this outcome fell from 91% to 65% following Jerome Powell's press conference. Treasury bond yields also rose in response, with the 10-year reaching 4.1% at the end of the week.
Amid speculation about the future path of interest rates, there is an ongoing debate among economists seeking to identify a neutral interest rate at which the FOMC is applying neither the accelerator nor the brake to the economy. As Morningstar's senior reporter Sarah Hansen highlights in her article, this rate is fascinating to to experts who are starved of data because of the ongoing government shutdown. However, investors should approach such speculation with care, as the idea of a neutral rate ascribes too much power to the central bank. From this, it is a short leap to believe that interest rates determine term asset prices, an idea which has been the undoing of so many investors.
Outside the US, results were again mixed with developed markets (ex US) down 0.6%, held back by US dollar strength, while emerging markets rose 0.9% in dollar terms. Within this latter group, Korea, up 6.3%, and Taiwan, up 3.1%, were especially strong. Both of them are dominated by semiconductor manufacturers, which again demonstrates the current concentration of returns within the single AI/technology theme.
For an overview of everything that has been happening over the last quarter, the latest Morningstar Markets Observer for Q4 has just been released.
The traditional excitement surrounding "jobs Friday" will again be quashed if the shutdown continues this week. However, the earnings season continues apace. You can follow these releases on this dedicated page and check out forthcoming results and consensus estimates on this calendar.