Lower inflation, tech rally, and Q3 earnings

After eight days of consecutive green rallies by the tech-heavy Nasdaq 100 index, US equities fell on Thursday as investors are digesting disappointing tech earnings. Nasdaq is up 45% in 2023, tremendously outperforming S&P 500 which is up 19%. Canada’s equity indices are providing lackluster performance, with its main benchmark being up 5.7% in 2023. Some firms warned investors of potential underperformance of the Canadian markets and its economic slowdown.

The excitement ignited by Artificial Intelligence and its potential earnings outlook for IT companies created the recent narrow bull market which was pushed by a handful of mega-cap tech stocks. Such rallies are deemed unsustainable, but the recent trend showed stocks have more room to run with a broader group of companies catching up with the rally.

The critical piece is this earnings season which can show that economic recession could be avoided or at least shrugged off if companies on average show their earnings further expanding. The earlier forecast advocating for recession noted that the equities will see earnings contraction in the face of economic slowdown and possible recession but so far companies have delivered better than expected earnings.

With the interest rates at record highs and economic activities slowing down, there could be a disconnect between the capital market and the economy. Companies may be able to pay higher prices to customers and keep their earnings to justify the current or even higher valuations. Customers still have their mass saving from the Covid era and as long as the employment rate is at record highs and the job market is tight, people will keep their jobs and spending will remain high.

Overall, the direction of the market will be determined by the earnings outcome.