The JSE All Share Index has followed its American counterparts, the S&P 500 and the Nasdaq, in rallying this year due to expectations that central banks will slow their rate hikes and may even implement rate cuts towards the end of the year.
The performance of these indices alludes to what has been driving the rapid rally in share prices in 2023 – tech stocks.
“The upside has surprised a lot of veteran traders”, according to UBS’ floor director at the NYSE, Art Cashin. A Wells Fargo analyst added that “the optimism in the market was odd to see”.
Both pointed to the rising expectations that inflation has peaked, which is fuelling the market rally.
Cooling inflation in the world’s largest economy will allow the Federal Reserve and other central banks to pull back on their rate hikes and even cut rates towards the end of the year.
This sentiment is not unique to the American market. It is also apparent in the South African market as inflation is fundamentally a global phenomenon.
The JSE’s performance is primarily dictated by global phenomena as its largest companies, such as Prosus, BHP Billiton, AB InBev, Richemont, BAT, and Glencore, earn the majority of their profits outside of South Africa.
However, the rally in American tech stocks also emphasises the unique characteristics of the tech sector and how its companies are valued.
Tech stocks tend to bounce back quickly after a period of poor performance, with every ‘bad’ year for tech stocks since 1970 being followed by a significant rally the next year.
The decrease in tech stocks’ value in 2022 also made them relatively cheap, with their sector P/E ratio dropping below 24x. Historically, the S&P 500 tech index has had a P/E ratio above 30x.
Changes in the operations of technology companies also contributed to the appreciation of their share prices.
Towards the end of 2022 and early 2023, big tech companies have laid off substantial numbers of staff, dramatically reducing their overheads.
It has resulted in them becoming leaner and more free cash flow generative, increasing their earnings and thus potential returns to shareholders.
But, analysts warn that this rally may be short-lived due to high volatility in the markets and contrasting economic data being reported.
Oanda’s Senior Markets Analyst, Craig Erlam, saidthe “enormous optimism” in early 2023 is beginning to be tempered by the release of economic data indicating that central banks may need to keep rates higher for longer.
While “the worst days are behind them…the fog has not yet cleared”, according to Erlam.
No one is immune to interest rate changes, and higher rates will weigh on asset prices and economic growth.