How professional investors are playing an interest-rate turnaround
Central banks have signalled that interest rates could fall in 2024. These are the ways the pros hope to profit, writes Sam Benstead.
17th January 2024 09:19
by Sam Benstead from interactive investor
Large investors are buying the “Magnificent Seven” shares and other technology stocks to profit from a change in the interest rate environment in 2024.
Bank of America’s latest survey of professional investors, covering a total of $589 billion (£465 billion) in assets, found that the most crowded trades was owning the Magnificent Seven, with investors also backing “long duration” tech as a means to win from falling interest rates this year.
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The so-called Magnificent Seven counts Amazon, Apple, Tesla, Alphabet, Microsoft, Nvidia and Meta as members. Those shares soared between 50% (Apple) and 240% (Nvidia) in 2023.
The driving force behind the recent returns from the Magnificent Seven has been the boom in AI via software from the likes of Microsoft and Alphabet, alongside demand for computer chips from Nvidia.
Technology stocks that are “long duration” are those where the profits are expected well off into the future. When interest rates fall, this makes “jam tomorrow” stocks more attractive, but rising interest rates leads to lower valuations.
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Long duration tech could include unprofitable stocks working on exciting technology, or biotech firms hoping to find the next miracle medicine.
Bank of America found that one in four investors thought long duration tech would be the biggest beneficiary of US interest rate cuts in the first half of 2024.
Research from interactive investor showed that the central bank “pivot” in November 2023, when rate setters began to signal that they had finished raising rates and could actually cut them in 2024, caused the steepest valuation jump in real assets (such as physical property and renewable energy infrastructure), cryptocurrency, technology, biotech and smaller companies.
Investors are now the most overweight technology than at any point in the last 10 months, according to Bank of America. This has been a reason for the rising valuations of tech winners.
The average price-to-earnings ratio of the Magnificent Seven for the next 12 months of profits for the group is now 44 times, which is more than double the average of the S&P 500 index of America’s largest companies.
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Bank of America adds: “Note that 72% of investors see equities, rather than long duration bonds or the US dollar, as the best way to play a Federal Reserve rate-cutting cycle over the next six months.”
Bank of America found that most respondents (52%) saw the US central bank as the most important driver of equity prices in 2024.
The other popular trades currently among the pros is to short (bet against) Chinese equities, and buy Japanese shares and 30-year US government bonds. Longer bond prices are more sensitive to interest rates than bonds maturing soon.
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