DeGroote MarketWatch

DeGroote Marketwatch is a student-generated weekly report on the financial markets.

Trader in Residence has concluded for the semester.

Week of June 9, 2017

Canadian stocks were marginally higher, U.S. large-cap stocks were mixed, and small-cap stocks rose by more than 1% in a week where divergences in sector performance and political news drove market sentiment. Helping small-cap stocks’ relative performance, compared with their large-cap counterparts, was both their greater exposure to the financial services sector, which outperformed as long-term Treasury yields rose, and their relatively small exposure to the technology sector, which lagged. Small-cap stocks recorded most of their outperformance following the testimony of former U.S. FBI Director James Comey Thursday morning, and they continued their rally even after the United Kingdom’s general election results showed that Theresa May’s party fell short of gaining the majority in Britain’s Parliament.

The major benchmarks ended mixed for the week. Friday brought about an abrupt change in market dynamics, as market-leading stocks such as Amazon, Facebook, and Apple sold off, while a rally early in the day helped the smaller-cap benchmarks outperform and manage to join the other indexes in record territory. Nevertheless, small-caps ...

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Tech Stocks May Be Both Cheap and Risky

As a sign of vulnerability in the (so far) high-flying technology sector, many of the biggest names tumbled towards earth on Friday. Among the so-called FAANG five, the declines for the day were: Facebook Inc, Apple Inc, Inc. Netflix Inc, 4.7%, and the parent of Google, Alphabet Inc. The tech-heavy Nasdaq 100 Index shed 2.4% of its value on Friday, per data from Nasdaq, while the tech stocks in the Nasdaq 100 were off by 3.6%, also per Nasdaq. As a point of comparison, the S&P 500 Index (SPX) dipped by less than 0.1%.

Eggs in One Basket

On Thursday, Bank of America Merrill Lynch, a division of Bank of America Corp, released a report indicating that the tech sector offers both risks and opportunities for investors. In May, tech was both the best-performing S&P 500 sector and the one whose price-earnings (P/E) ratio increased the most, according to Merrill Lynch. At approximately 19x as of the report’s issuance, Merrill notes that this is the tech sector’s highest valuation since the financial crisis.

Moreover, tech is more overweight than it ever has been, among large cap actively-managed funds surveyed by Merrill since 2008. In their May 30 Active Managers’ Holdings Update, Merrill notes that survey respondents are 24% overweight in tech, almost two standard deviations above average. Yet more striking is the fact that fund managers are 71% overweight in FANG stocks (Merrill excludes Apple), though this weight has been flat for a year. The bigger picture is that funds have made a record shift from value to growth sectors over the past 12 months, leading Merrill to prefer value to growth right now.

Conflicting Valuation Signals

Nonetheless, Merrill says, “But although Tech’s 8% premium to the S&P 500 P/E is the biggest premium we have paid since 2010, it is still low relative to history, even excluding the Tech Bubble.” Moreover, Merrill finds that all industries within the tech sector are sporting P/E ratios that are lower than or in line with their “historical average relative P/E multiples.” Closing out the positives, Merrill says that tech screens as most attractive according to their quant models.

On the other hand, based on its enterprise value (EV) to sales ratio, tech is trading at its highest relative multiple since the tech bubble. Exclude the bubble period, and tech currently is still valued well above the average for this metric, Merrill says. Additionally, Merrill finds that inconsistent accounting treatment of stock-based compensation, which is a large expense for most tech companies, might cause tech’s P/E to be understated by as much as 10%. Bottom line: Merrill is marketweight in tech, based on these conflicting valuation signals.

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World Market Performance

IndexLevelChangeCAD % Change
INDU-DOW JONES INDUS. AVG21,206.29+ 126.01+ 0.77%
SPX-S&P 5002,439.07+ 23.25+ 1.13%
NDX-NASDAQ 100 STOCK6305.80 95.61 –
SPTSX-S&P/TSX COMPOSITE15,442.75+ 25.82+ 0.17%
UKX-FTSE 1007,547.630.00+ 0.86%
DAX-GERMAN STOCK12,822.94+ 220.76+2.77%
NKY-NIKKEI 22520,177.28+ 490.44+ 3.49%
HSI-HONG KONG HONG SENG25,924.05+ 284.78+ 1.31%
Currency Returns US$1.3494+ 0.0048+ 0.36%

Market at a Glance *

* Click image to see full size version

Economic Calendar

Date  ReleaseActualConsensusPrior
MonMemorial Day
ECB President Draghi’s SpeechUK
TueCurrent Account (Q1)
RBNZ Governor Wheeler Speech
`WedGross Domestic Product Annualized (QoQ) (Q1)3.7%3.9%2.7%
Real Retail Sales (YoY)
ThurBOE Interest Rate Decision
Fed’s Beige Book –
FriG7 Meeting


DeGroote MarketWatch is a weekly financial newsletter prepared primarily by students. It is designed to inform and educate the community. It is an educational tool. The DeGroote School of Business is not responsible for the consequences of actions taken based on DeGroote MarketWatch.
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