LVMH Pops The Bubbly

Last week saw the first GDP report of the year coming out of the US and it wasn’t great, with growth in the world’s biggest economy slowing down by more than expected. Elsewhere, French luxury goods company LVMH became the first European company to exceed a market value of $500 billion last week. Firms in the luxury goods sector are benefitting from large and stable profit margins as well as growing sales in China. That’s in sharp contrast with mega-cap US tech stocks, which have been dubbed as the most crowded trade in the latest Bank of America monthly Global Fund Manager Survey. That crowding has pushed tech stocks’ valuations to extreme levels relative to the wider market, causing options traders to grow more suspicious of the sector’s strong year-to-date rally. In the commodity world, oil prices plunged last week, erasing all of the gains made since the surprise OPEC+ output cut a month ago. Finally, some crypto analysts are making bullish calls on bitcoin ahead of the coin’s “halving” next year. Find out more in this week’s review.

Macro

Data out last week showed US economic growth decelerated much more than expected during the first three months of the year, downshifting under the weight of interest-rate hikes and elevated inflation. GDP in the world’s biggest economy rose at a 1.1% annualized pace in the first quarter, as weak business investment and a decline in inventories offset a pickup in consumer spending. That marked a significant slowdown from the 2.6% pace registered in the final three months of last year, and came in well below economists’ expectations for a 2% increase. The GDP report doesn’t capture the full extent of the damage done by the mini-banking crisis, which only began to unfold from mid-March onwards. Many economists expect the turmoil to accelerate the withdrawal of credit, which is the lifeblood of the economy (tightening credit conditions cause consumer spending and business investment to plunge, derailing economic growth).

Stocks

After reporting strong first-quarter results, French luxury goods company LVMH became the first European company to surpass a market value of $500 billion last week, powered by booming sales of luxury goods in China and a strengthening euro. After all, China’s abandonment of its strict zero-Covid policies is fueling growth across the entire luxury goods industry, and that view was further reinforced after rival firm Hermes reported its own set of strong results last week. However, LVMH did caution that it’s seeing a pullback in US growth, and some investors fret that the stock will inevitably be hurt should the economic slowdown worsen, especially considering the stock’s rich valuation.

To put LVMH’s rich valuation in numbers, its forward P/E ratio is twice that of the CAC 40 Index (the stock market index made up of the biggest 40 French publicly traded companies). But you can also understand why investors are willing to pay up for LVMH’s stock. After all, global demand for LVMH’s products has held up, even as rising inflation and interest rates threaten to tip the world into recession. In fact, the entire luxury goods sector is arguably in a good place to be right now, offering exposure 1) to Chinese consumption, which continues to surprise to the upside; and 2) to firms with large and stable profit margins thanks to their strong pricing power. 

Contrast those two qualities with mega-cap tech stocks, which have been dubbed as the most crowded trade in the latest Bank of America monthly Global Fund Manager Survey. Given that China restricts foreign competitors and tightly controls its tech industry, US tech firms have limited exposure to the country. And unlike luxury stocks, Big Tech has been contending with shrinking profit margins for several quarters already.

Investors crowding into Big Tech have pushed the S&P 500 Information Technology Index up 20% in 2023 compared with an 8% gain for the S&P 500 Index. That’s the tech sector’s strongest start to a year relative to the wider market since 2009. But this outperformance has nothing to do with earnings expectations. After all, analysts estimate that US tech earnings plunged 15% in the three months through March – the third-biggest decline among the S&P 500’s 11 industry groups – as the sector contends with higher costs and slowing demand. Instead, the rally is being driven by hopes that the Fed will soon start cutting interest rates, boosting tech stocks’ valuations.

But one valuation model, conducted by Bloomberg Intelligence, shows that the euphoria has gone too far. Tech stocks in the S&P 500 are trading at a forward P/E of more than 25x – but to justify such a multiple, the Fed would need to cut rates by at least 300 basis points, according to Bloomberg Intelligence’s calculations. That’s more than five times what the futures market is pricing in for rate cuts this year. Not only is the sector's valuation high in absolute terms, but it is also relatively high compared to the broader market. Tech stocks' forward P/E is trading at approximately a 35% premium to the S&P 500, which is 2 standard deviations above the five-year average.

Options traders, however, do not seem to share the same level of optimism as equity investors, and are growing more suspicious of the tech sector’s recent outperformance. Case in point: options contracts hedging against a 10% drop in the Invesco QQQ Trust, the biggest ETF tracking the tech-heavy Nasdaq 100 Index, now cost 1.7 times more than options that profit from a 10% rally – a level of pessimism not seen in over a year.

Commodities

Oil prices have erased all of the gains made since the surprise OPEC+ output cut a month ago. Brent crude dropped below $78 a barrel last week as falling refining margins and worries over China's economy, coupled with fears of an economic slowdown and issues in the US banking system, all contributed to the bearish sentiment in the oil market. Those concerns overshadowed an otherwise bullish US stockpile report last week that showed shrinking crude inventories in the world’s largest oil-consuming nation.

Crypto

Bitcoin has gained over 70% year-to-date and has been trading in a range of $28,000-$30,000 for the past six weeks. But the rebound is just the beginning of a rally that’s expected to push bitcoin past $50,000 next year thanks to a process known as "halving”, according to new projections from crypto analysts. The bitcoin halving is an event that occurs approximately every four years, reducing the reward for mining new bitcoin blocks by half. This process is a part of bitcoin's monetary policy, designed to control supply inflation by decreasing the rate at which new bitcoins are created, ultimately leading to a fixed total supply of 21 million coins in 2140. As a result, the next halving event, due in April 2024, is expected to have a big influence on bitcoin’s price.

So as the supply of new coins slows, the laws of supply and demand imply that the price should trend higher (all else being equal). What’s more, the hype and anticipation around the next halving event can drive investors to buy in, which in turn causes the expected bull run to materialize, creating a self-fulfilling prophecy. Just look at the chart below, which shows how bitcoin tends to bottom around 12-18 months prior to each halving before going on to hit new record highs. And according to some crypto watchers, the upcoming halving is currently only about 50% priced in based on previous cycles. Put differently, the analysts reckon that bitcoin has a lot more room to run and could hit $50,000 by April next year.

This week

• Monday: US ISM manufacturing index (April). Earnings: MicroStrategy.
• Tuesday: Reserve Bank of Australia interest rate announcement, eurozone flash inflation (April), US factory orders (March). Earnings: Pfizer, AMD, Airbnb, Ford, Starbucks.
• Wednesday: Fed interest rate announcement, eurozone unemployment rate (March). Earnings: Uber Technologies, Qualcomm, The Kraft Heinz Co.
• Thursday: European Central Bank interest rate announcement, global PMIs (April). Earnings: Apple, Moderna, Novo Nordisk, Shopify, Block.
• Friday: Eurozone retail sales (March), US labor market report (April). Earnings: AMC Entertainment.