S&P 500 Rides Megacap Tech to Fourth Straight Quarterly Advance

  • The benchmark rises 3.3 percent over the three-month period
  • Tech-heavy Nasdaq 100 hit record highs within last two weeks

Low-volatility shares have been a market obsession for most of 2016. But the rewards of owning a few stocks with the potential to swing was on display in the third quarter.

After barely budging through the first six months, technology companies have roared upward since June, beating the S&P 500 Index by the biggest margin since the bull market began. Their influence lifted the broader market to the fourth straight quarterly gain and its biggest of 2016, with the benchmark gauge rallying 3.3 percent in the three months ended Friday.

Apple Inc., Alphabet Inc. and Microsoft Corp. surged at least 12 percent in the third quarter while the Nasdaq 100 Index jumped 10 percent, the most since 2013. When all was said and done, tech companies in the index beat the S&P 500 by 9.1 percentage points, according to data compiled by Bloomberg.

Part of the allure was valuation. Computer and software stocks began the quarter with lower price-earnings ratios than their counterparts in the utility, telecommunication and consumer staples industries. Signs the Federal Reserve wasn’t rushing into further interest-rate increases whipped up risk appetites, sending the Nasdaq 100 to seven straight weekly gains to start the quarter.

“There were a lot of value tech names that were attracting interest at the beginning of the quarter,” said John Carey, a Boston-based fund manager at Pioneer Investment Management Inc., which oversees about $230 billion. “It was part of a more general move back into names that appeared to be attractively priced, while still offering growth potential. The more defensive stocks had maybe gotten ahead of themselves.”

Hedge funds were one beneficiary of tech’s third-quarter surge. Of the top 20 stock holdings at the 150 largest hedge funds, half were tech companies, according to a report by Bank of America Corp. analysts led by Jue Xiong. That led to the group of so-called core holdings beating the S&P 500 by 6.4 percent, the most for any quarter since the firm started compiling data in 2011, they said.

The equity rotation into riskier assets since June has spread out gains among stocks. In mid-September, that pushed a version of the S&P 500 that strips out market-value biases to its best performance versus the standard gauge since 2013.

The switch is occurring amid a growing valuation gap that made losers too cheap to pass up in a market where the S&P 500 is trading at one of the highest multiples since the dot-come era. At their peak in July, utilities fetched 19 times forecast earnings, compared with a ratio of 18 for the broader benchmark. At that point they were 13 percent more expensive than tech stocks -- now they’re 17 percent cheaper.

“The growth side of the market is where the money is going to start heading, and that of course would focus on technology,” said Terry Morris, a senior equity manager who helps oversee about $3.2 billion at Wyomissing, Pennsylvania-based National Penn Investors Trust Co. “Investors are trying to buy forward growth as opposed to value, and then hope for a catalyst.”

Investors will turn attention to the corporate earnings season that gets underway in about two weeks, with technology companies expected to report profits 3.3 percent higher than a year ago, according to analysts surveyed by Bloomberg. The broader S&P 500 is forecast to see profit contraction of 1.5 percent, which would be its sixth straight quarter without earnings growth.

The Fed’s decision to hold rates steady also stoked risk appetites, though investors may lose that tailwind in the coming quarter. The odds for December hike have climbed to 57 percent, according to fed funds futures. That’s up from the start of the third quarter, when economists saw only a 12 percent chance of higher rates.

Further expectations of a hike were fueled last week by multiple Fed officers. On Thursday, Fed Bank of Atlanta President Dennis Lockhart said the central bank is nearing its goals of maximum employment and steady inflation near 2 percent, a day after Chair Janet Yellen testified that jobs growth will likely soon warrant tighter policy.

They’ll also be closely watching for any developments relating to Deutsche Bank AG, which roiled markets in the final week of the quarter. The lender tumbled to a record low on Thursday after a Bloomberg News report signaled growing concern among some of the bank’s clients after the Department of Justice earlier in the month said it would seek a $14 billion fine for issues dating back to the financial crisis. The stock rebounded Friday on reports that the U.S. would settle for a penalty of less than half of what it sought.

“Going forward, the first overhang is what’s the resolution of Deutsche Bank is going to be,” said Andrew Brenner, the head of international fixed income for National Alliance Capital Markets. “But at the end of the day, we’re still central bank dependent for the next six months.”

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