Welcome back to our latest edition of Market Insights with Sanjeev Kaushik.
In this edition, we explore how the Fed rate cuts might impact stocks. We also take a closer look at the dominance of AI in S&P 500 earnings calls, highlighting its growing influence on corporate performance and stock valuations.
Finally, if you missed our webinar, you can catch up now to learn the basics of options trading.
So let’s dive right into it..
Today at a glance:
- Which Stocks Will Benefit From Rate Cuts?
- AI Dominates S&P 500 Earnings Calls
- Is Options Trading Right For You?
1. The Winner of Fed Rate Cuts
Long-term performance of mid-caps, large-caps, and small-caps as of September 9, 2024.
On September 18, 2024, the Federal Reserve implemented a 50-basis-point interest rate cut, bringing the federal funds rate to a range of 4.75%–5.00%. This decisive action marks the beginning of the Fed’s easing cycle, aiming to support economic growth and stabilize the labor market.
Historically, mid-cap stocks have demonstrated impressive resilience and often outperformed both large-cap and small-cap stocks during the 12 months following the first Federal Reserve rate cut in an easing cycle.
With the Fed’s recent 50-basis-point reduction, investors might anticipate a similar pattern, where mid-cap stocks could experience enhanced performance. However, the actual outcome will largely depend on the strength of economic growth and the trajectory of the Fed’s easing cycle.
1.1 Why Mid-Cap Stocks Could Outperform?
One of the most significant factors influencing mid-cap returns is their current valuation.
Historically, low starting valuations have been a strong predictor of forward returns for mid-cap stocks, particularly at extreme levels. As of now, the S&P 400 index, which tracks mid-cap stocks, trades at 15 times next-twelve-month (NTM) price-to-earnings (P/E), placing it in the 25th percentile of valuations since 1995.
This low valuation could be a key driver of returns, as the beginning of a Fed rate-cutting cycle often brings incremental equity demand and a boost to investor risk sentiment.
Since 1984, the S&P 400 mid-cap index has outperformed both the S&P 500 (large-cap stocks) and the Russell 2000 (small-cap stocks) in the 3 and 12 months following the first rate cut. This trend suggests that mid-caps are poised to benefit from a potential shift in market dynamics.
1.2 Here are the Expected Returns:
MID typically outperforms SPX and RUT following the first Fed rate cut.
Given the low valuations and Goldman Sachs’ forecast for continued economic expansion, the S&P 400 mid-cap index is expected to deliver a 13% return over the next 12 months.
This return would place mid-caps in the 50th percentile of historical 12-month returns since 1995, signaling that investors could still capture significant upside despite concerns over market volatility.
1.3 Key Risks to Watch
While mid-cap stocks are positioned for solid gains, potential risks remain. The most pressing concern is a deterioration in economic growth, which could derail the recovery. However, even if economic conditions worsen, mid-cap stocks may still find support from their lower valuations compared to large-caps and stronger fundamentals relative to small-caps.
Moreover, mid-cap returns tend to be closely correlated with the performance of cyclical stocks versus defensive stocks. The S&P 400 index has a heavy weighting in the Industrials and Financials sectors, making it vulnerable to economic cycles.
A weak July labor report recently heightened investor concerns about a potential US recession, contributing to a sharp selloff in equities. During this period, mid-caps underperformed the equal-weight S&P 500, further emphasizing their sensitivity to economic data.
2. AI Dominates S&P 500 Earnings Calls
Artificial intelligence (AI) has captured the market’s attention, and this is clearly reflected in the recent earnings calls of S&P 500 companies.
The buzz surrounding AI is undeniable, but just how many companies are mentioning AI in their discussions with investors?
According to data from FactSet’s Document Search, more than 40% of S&P 500 companies cited “AI” during their Q2 earnings calls—a significant uptick compared to historical trends.
2.1 AI Mentions Surge in Q2 Earnings Calls
From June 15 to September 13, a total of 210 S&P 500 companies mentioned AI during their earnings calls for the second quarter of 2024. This marks a steep rise from the 5-year average of 88 companies and the 10-year average of 55.
In fact, this is the second-highest number of companies citing AI on record, surpassed only by Q1 2024, when 211 companies brought up the term. This quarter also represents the second consecutive period in which more than 200 S&P 500 companies have mentioned AI.
2.2 Information Technology Leads the Way
Unsurprisingly, the Information Technology sector had the most companies citing AI during their Q2 earnings calls.
A staggering 59 companies from this sector mentioned AI, representing 91% of all companies in the sector. The high engagement with AI in this sector is expected, given its technological focus and leadership in driving AI innovations and applications.
2.3 AI Mentions and Stock Price Performance
Interestingly, companies mentioning AI on their Q2 earnings calls have seen mixed stock price performance compared to those that didn’t reference the technology.
Since the beginning of the third quarter (June 30), companies citing AI have experienced an average price change of 4.1%. Meanwhile, those that didn’t mention AI have outperformed slightly, with an average price change of 6.1%.
However, the story shifts when looking at stock performance since the start of the year.
Companies that mentioned AI have posted an average gain of 12.2% since December 31, 2023, compared to an 8.6% increase for companies that did not mention AI.
This indicates that while AI discussions might not have provided a short-term boost, they have been associated with stronger long-term stock performance in 2024.
