(Bloomberg) — A new meme-stock craze took center stage on Wall Street this week after the world’s biggest stock market finished another strong quarter.
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But behind the scenes, slowing economic growth is testing the beliefs of bullish investors and widening the gulf between the strong and the weak across corporate America.
A depressing trend that has been evident for months now has been exposed once again with the enthusiasm for Big Tech stocks and private credit. Companies with shaky balance sheets again underperformed in June. Equal-weighted equity benchmarks (where disruptive AI market leaders have the same weighting as industry pioneers) again lagged.
Positive news about consumer prices initially boosted market sentiment in early trading on Friday, helping the S&P 500 end the week little changed, and in the process raising warnings that the Federal Reserve is taking too long to ease the economy out of its inflation-fighting measures.
Adding to the anxiety is a flurry of dark data: Reports on consumer spending, jobless claims and home sales, as well as disappointing results from companies like Micron Technology Inc. and Nike Inc., are raising questions about the durability of the soft-landing euphoria. All of these are new variables for institutional trading professionals who have been on the sidelines recently during the day-trading frenzy and escalating presidential election cycle.
“We’re seeing cracks in individual companies and sectors,” said Chris Atkinson, a portfolio manager at Fidelity International, who has reduced risk in his corporate-bond fund by buying up higher-quality debt. “We expect this to continue, and companies with highly leveraged balance sheets, cyclical earnings and weak competitive positions look vulnerable.”
The S&P 500 is up nearly 15% in the first half of the year and more than 50% since the bottom of the bear market, while the risk premium on global corporate bonds has fallen to its narrowest in three years over the past two weeks.The margin of error in markets is getting slimmer.The danger was made clear on Wednesday when stock traders were dealt a double blow by Micron and Nike, who lost a combined $40 billion in share value after their sales forecasts fell short of analysts’ expectations.
A sense of calm prevailed, stock market volatility remained close to pre-pandemic levels, and the US dollar ended the week on another strong note despite a selloff on Friday.
Apart from the S&P 500 Index’s fifth drop in six weeks, there was brief euphoria in the market sector dominated by retail investors. Shares of Chewy Inc. and Petco Health & Wellness Inc. briefly surged Thursday after Keith Gill, known online as “Roaring Kitty,” posted a cartoon image of a dog on X. Nearly all of the gains were reversed by the close of trading.
Meanwhile, a Goldman Sachs Group Inc. index that tracks companies with weak balance sheets by combining leverage and profitability in the S&P 500 stock index has underperformed stocks with strong balance sheets by about 12 percentage points in the first half of the year.Among large-cap U.S. stocks, those with strong balance sheets have outperformed the opposite by 10 percentage points this year, according to an analysis by Societe Generale SA.
ETF investors have most favored investment-grade bonds over higher-yield ones this year: A-rated and above funds drew $15.7 billion in inflows in the first half of June, compared with just $1.3 billion into junk-bond funds, according to Bloomberg Intelligence.
“Credit spreads have tightened due to low equity market volatility, creating the impression that rising interest rates are not impacting companies with weaker balance sheets,” said Andrew Lapthorne, head of quantitative research at Societe Generale SA. “Our strong balance sheet strategy, which has been profitable since the end of March, is now starting to recover.”
While inflation showed signs of moderating, the economy also slowed, highlighting the Fed’s challenge in containing prices without triggering a recession. The U.S. Pending Home Sales Index unexpectedly hit a record low in May while mortgage rates hovered around 7%. Continuing claims for U.S. unemployment benefits rose to the highest level since 2021 and the government revised down consumer spending.
A string of weaker-than-expected data releases pushed Citigroup’s U.S. Economic Surprise Index to its lowest since August 2022. It all highlights how high interest rates are raising the cost of borrowing for everything from consumer goods and home purchases to business equipment, slowly but surely squelching demand.
“The market is signaling that investors are becoming increasingly concerned about credit quality,” said Marty Fridson of Lehman Livian Fridson Advisors. “This comes amid fading hopes of a Fed rate cut that was expected to halt the economic softening.”
–With assistance from Cecile Gutscher.
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