Technology Sector Will ‘Rise Up’ to Increased Valuations: Strategist

Stock markets (^DJI, ^IXIC, ^GSPC) are falling in anticipation of the long-awaited Consumer Price Index (CPI) report and the Federal Reserve’s interest rate decision, scheduled for Wednesday. Despite the uncertainty, Abby Yoder, equity strategist at JPMorgan Private Bank US Equity, maintains positive trends in the markets, supported by the performance of the technology sector.

Yoder notes that earnings growth was solid, driven primarily by technology industry performance. It highlights that all eleven sectors exceeded expectations in the first quarter, with technology companies leading the way thanks to improved margins. Despite slightly elevated valuations, Yoder expects this trend to continue as tech companies “come up to those valuations” as more positive earnings flow in throughout the year.

As for the potential for broader market growth, Yoder says: “That would be a second-half phenomenon.” In addition to her bullishness on the tech sector, she remains overweight in areas such as healthcare, industrials and consumer discretionary, which she thinks will all do well.

For more expert insights and the latest market action, click here to watch the full Catalysts episode.

This post was written by Angel Smith

Video transcription

Stocks are losing ground this morning as tomorrow’s test is too big for investors.

CP I and the Fed decision, even with concerns about higher interest rates in a longer-term interest rate environment, strategists generally expect big tech to lead stock gains throughout the year and be driven by demand for artificial intelligence.

Our next guest is one of these strategists.

We have a private bank, JP Morgan, shares, yes.

Thank you so much for joining us in the studio. You know, you have a pretty optimistic forecast, year-end price target for S and P at 5,500. You see it’s going to go up to 5,750 next year.

What drives it?

So I think that’s important when we think about profit sharing, right?

That’s earnings and multiples.

When we think about both the 5,500 and the 5,700, it’s all driven by earnings growth and it’s between 8 and 10% depending on the calendar year you’re looking at, and most of that is driven by taxes, right?

And what we saw in the first quarter was really, you know, just strong throughout the quarter in terms of earnings. We saw all 11 sectors emerge victorious in the first quarter.

But much of that strength came from technology, and in particular we saw their margins increase.

This is very important to us when we think about the fact that 60% of costs are fixed.

As you see this incremental growth in terms of profit growth, we see it on a technology basis in terms of margin profile.

The story continues

And then in terms of valuation, it’s like we’re actually seeing valuations shrink a little bit.

And this is again driven by technology.

And if you think about it from a natural point of view, yes, their prices are high and their valuations are higher than what is currently in the market.

But where you are, they will grow to that valuation through earnings growth.

So naturally you see this valuation compression from a large cap perspective and that seems to be a key part of why you’re able to achieve the tech rally but also the inherent concentration in the tech part of your book when we have a lot of other guys come in and say rally concentration on technology is a bearish signal for them.

How much variation do you think there is?

Well, there are two things I would look at: earnings, concentration is supported by earnings, right?

So you see concentration not only from a market capitalization perspective, but also from an earnings perspective as they continue to outperform the rest of the market.

You know, at the beginning of the year, we really thought that there would be a broadening of the stock market towards the end of the year.

And we still believe in it.

But what you see is that it was based on a narrowing of the gap in growth rates, right.

So we saw that the rest of, let’s call it, 4 93 4 94 is tight and will catch up with the rest of the seven mag.

But you still see that the pace of technology development remains high, right?

So there was a slight increase in one of the questions.

So it continues to drive the market through the mid-years and EPS growth through the end of the year.

However, you are starting to see that as other sectors recover from the earnings recession, their earnings growth also increases.

So a slight widening, but not to the same amount.

When, if at all, do you expect we will see the same size of expansion and what sectors do you think could benefit from it?

So it would be a second half phenomenon.

And I think if we think about it, we are overweight in the overweight, technology, consumer, discretionary health care and industrial sectors, and I would say that at the forefront of the real recovery from the earnings recession is health care, last year for the first time in service health reported negative annual profit growth. In 2023, a lot of pandemic-related analysis took place in various parts of the sector.

Hmm, they’re about to change from negative.

Therefore, the earnings growth rate on a quarterly or year-on-year basis has been negative, and this will turn positive in the second half of the year.

So you can combine this with really attractive valuations in the industry.

For us, it’s a pretty good deal when it comes to health care.

I also spoke to a healthcare source yesterday who mentioned that their ability to move at higher levels in a longer-term environment and their ability to avoid such capital-intensive expenses on the balance sheet is also a differentiating factor.

How much of this is a mindset and an investment thesis that our investors listening to this should really pay attention to in a long-term hire.

Does this also apply to other sectors?

Yeah, I mean healthcare, yeah, they’re not as dependent on the interest rate environment when you think about large caps, right?

Let’s be clear: small-cap biotech is a completely different story.

It’s riskier, I would say, much more exposed to higher interest rates, and it’s going to be a challenge in this environment.

But yes, from an overall large-cap healthcare standpoint, I mean defensively.

This is usually characterized by positive earnings growth, which we did not see last year.

So I think that’s a nice difference too.

Um, industrial is something that we think would actually benefit from a higher and longer stakes environment.

Normal?

When we think about the cyclical nature of this, we see PM, which we think is bottoming, and then we have structural tailwinds around things like A I.

This is another sector that we like, you know, independent of interest rates in terms of industry and talking about higher for longer. We will update the Fed’s economic forecasts tomorrow, if we see fewer cuts predicted by the Fed, will this be a risk for the market?

What if the Fed doesn’t cut at all?

Yeah, I mean, look, I think the risk with the feds doesn’t necessarily depend on whether they reduce it or not.

Okay, actually we only have one cut at the end of the year.

It’s really a question of what will be the next move and what signal will that send to the market?

And I think if the next move was to suddenly raise prices, it would be a very different story for stocks.

However, at the moment we are still based on the base case scenario, according to which inflation will gradually decline, which will lead to this reduction.

It looks like this will happen later than originally expected at the beginning of the year.

And I think the question really is, OK, what does this mean in terms of valuations?

How can we continue to defend these valuations?

And I think that’s really, and I think that’s where the conversation about equity risk premium comes in when it comes to equity capital.

So how do stocks compare to bonds?

And if you look back over the last 15 years, they look really expensive from an equity risk premium perspective.

However, if you extend this to the period before the global funds crisis and interest rates were not zero, the equity risk premium was more compressed, just as it is today.

Thus, in terms of inflation risk, it remains elevated, but the risk of recession appears to be relatively low.

In this tug of war, I think equities win in terms of ratio to fixed income.

Back to Friday, Abby, when, you know, we’re all heading to our Friday night happy hour to talk about the financial markets as we do.

Do you think the most important factor of the week will be the macro news CP And the Fed or the many technical headlines that we get from Apple from Tesla and as always also in video form. I think we’re in a bit more of a macro vacuum.

Let’s assume that until we start earning season again in mid-July, right?

Like I think most of the rally that we saw when the market bottomed on April 19th through the end of May, and now it’s actually been earnings-driven.

I think it was due to fundamental factors. I think, yes, there were definitely some tailwinds from a macro standpoint, from a milder inflation print that the market really needed.

But I think it’s going to be more macro-based than micro-based at this point.

Happy Yoder JP Morgan, private bank, American equity strategist.

Thank you so much for joining us today.