Markets Brief: Tax Reprieve Boosts Big Tech Stocks

Be Selective When Picking Stocks

The Morningstar US Market Index gained 3.4% last week, with the median company rising above our estimate of its fair value for the first time since February. As large growth stocks continue to lead overall market gains, the gulf in valuation (and likely future returns) grows between these stocks and those of smaller companies in more traditional industries.

Opportunities remain for investors who are prepared to be both selective and patient. For some tips on how to use valuation as a guide when investing, check out this article by Ricky Williamson, Morningstar Wealth’s head of investments.

Canada Scraps Tech Tax

The communications sector (up 6.1%) was the highest gainer over the week, and it received a further boost after Canada scrapped a tax on big US technology firms just hours before it was due to come into force. On Friday, US President Donald Trump suspended trade negotiations with Canada due to the imminent implementation of a retroactive 3% levy on the tech giants.

The Canadian digital services tax, announced a year ago, would have been backdated to January 2022. The first payments were due on June 30, but the Canadian government rescinded the tax over the weekend in the hope of restarting talks and securing a lasting trade deal. Index heavyweights Alphabet GOOG and Meta Platforms META were the key beneficiaries over the week, rising 7.1% and 7.5%, respectively. Amazon AMZN, up 6.4%, also benefited, boosting the consumer cyclical sector.

Energy Stocks Now Below Fair Value

At the other end of the spectrum, energy companies fell 3.3% following the announcement of a ceasefire between Israel and Iran and the resulting 14.8% decline in the price of crude oil. Superficially dramatic, this merely returns the price to where it started the month, while energy stocks remain 4.3% higher over June and are now priced a little below their fair value.

Overseas Stocks Still Offer Opportunities

The US dollar resumed its decline, falling 1% and boosting the returns of overseas assets. The Morningstar Developed Markets ex US Index rose 2.9% and the Morningstar Emerging Market Index rose 3.4% measured in dollars. Despite the strong returns over the year to date, most overseas markets continue to trade below Morningstar analysts’ estimates of their fair value, providing opportunities for both diversification and potentially higher returns.

Philip Straehl, Morningstar Wealth’s chief investment officer, and Dominic Pappalardo, chief multi-asset strategist, unpacked these opportunities with Ivanna Hampton at Morningstar’s Investment Conference last week.

Bonds’ Diversification Powers in Question

Longer-dated Treasury bond yields continued to fall, with the 10-year yield back to 4.3%. Market observers would typically expect US yields to fall when investors are feeling nervous and seeking safety in lower-risk investments, as was the case in April. The rise in demand for Treasuries when equity prices are rising gives credence to the view that the role of US government bonds as the default risk-free asset of global capital is being undermined.

Although it is far too early to reach this conclusion with any conviction, this reinforces the need for clarity when selecting assets. While Treasuries continue to offer attractive value for lower-risk investors, they may not always provide the diversification benefits they have in the past.

Fed Should Hold Off on a July Rate Cut

The May Personal Consumption Expenditures Price Index, with volatile food and energy costs stripped out, came in slightly above expectations at 2.7% over the last 12 months. This reinforced expectations that the Federal Reserve will maintain interest rates at their current level when it next meets at the end of July.

Expectations of two further quarter-point cuts before the end of the year remain priced in, with the first expected in September. Preston Caldwell, Morningstar’s senior US economist, provides his take here.

All Eyes on NonFarm Payrolls

In a shortened trading week, the key economic news is likely to be the US employment report on Thursday. Unemployment is expected to have risen slightly to 4.3%. Any significant deviation from this outcome is likely to create volatility at a time when many investors will be preparing for the July 4 holiday. For those seeking some investment reading over the long weekend, I recommend the “State of Semiliquid Funds” report, which provides a great introduction to these new vehicles.