What Happened: Shares of game engine maker Unity (NYSE:U) fell 5.5% in the morning session after the market took a breather with no obvious reason behind the broad-based weakness. Investors likely took profits following a strong finish to the year. 2023 has been splendid for the market, with the S&P 500 up nearly 25%. The year began with a surge in technological advancements, propelling the tech sector to new heights. Companies pioneering in artificial intelligence experienced a renaissance, capturing the attention of investors and driving substantial gains. Not all sectors, however, flourished equally. Traditional industries like consumer durables faced headwinds as consumers reeled in large expenditures, prompting a wave of restructuring and strategic realignment.
More recently, the market has surged over the last two months. Inflation has come in below expectations, prompting the Federal Reserve to pivot from a hawkish to a doveish stance--it is now projecting interest rate cuts in 2024, a tailwind for stocks as it lowers the discount rate applied to future cash flows. As a reminder, the driver of a stock's value is the sum of its future cash flows discounted back to today. With lower interest rates, investors can apply higher valuations to their stocks. No wonder so many in the investment community are optimistic about 2024. We at StockStory remain cautious, as following the crowd can lead to adverse outcomes. During times like this, it's best to own high-quality, cash-flowing companies that can weather the ups and downs of the market.
The stock market overreacts to news, and big price drops can present good opportunities to buy high-quality stocks. Is now the time to buy Unity? Find out by reading the original article on StockStory.
What is the market telling us: Unity's shares are very volatile and over the last year have had 59 moves greater than 5%. In context of that, today's move is indicating the market considers this news meaningful but not something that would fundamentally change its perception of the business. The previous big move we wrote about was 16 days ago, when the company gained 6.5% on the news that The Federal Reserve maintained its key interest rate for the third consecutive time, holding it within the targeted range of 5.25%-5.5%.
Additionally, committee members signaled a more dovish stance for 2024, anticipating at least three quarter-point rate cuts, roughly aligning with market expectations but more accommodative than Fed officials' previous statements. The market is focusing on this change.
The Fed Chair added that "Inflation has eased from its highs, and this has come without a significant increase in unemployment."
In line with the Fed's assessment, on December 12, 2023, the Bureau of Labor reported a slight decline in inflation, attributed to lower gasoline prices and a general easing of price pressures in the U.S. The consumer price index (CPI) for November showed a 3.1% increase from the previous year (in line with market expectations), down from 3.2% in October, indicating ongoing disinflationary pressures.
As a reminder, lower rates are good for stock valuations, especially for tech companies where the market needs to discount back cash flows further out in the future. When the math is done to discount these cash flows back to today, a lower assumed discount rate leads to higher present values.
Unity is up 50.3% since the beginning of the year, but at $40.48 per share it is still trading 16.5% below its 52-week high of $48.50 from July 2023. Investors who bought $1,000 worth of Unity's shares at the IPO in September 2020 would now be looking at an investment worth $591.81.