Saxo Bank
Global equities gained 6.8% in June, adding to the positive first half of 2023, which has returned 15.1% in USD terms. The year started with animal spirits{1] in technology stocks due to optimism about AI and high hopes for the reopening of China’s economy.
Back in March, we observed a brewing banking crisis, but the AI hype accelerated with OpenAI’s introduction of GPT-4 on 14 March, which took the new AI systems to a level of performance that shocked everyone. The AI race was on, and just a week after the introduction of GPT-4, Google introduced their competing AI system called Bard. Technology stocks related to AI, software, data storage, and semiconductors took off. On 24 May, Nvidia announced strong earnings and guidance that was significantly above expectations, resulting in a subsequent 24% single day return increasing the market value by USD 184 billion, the biggest single day increase in market value ever recorded.
The AI hype and economic data indicate the global economy remains robust. In Q2, this caused the market to second-guess its own wager on Fed cuts this year. In fact, as of 13 July, the market is pricing in more rate hikes. Current pricing indicates one more Fed rate hike this year to a policy rate range of 5.25-5.50%. Financial conditions and higher equity markets are indications that the significantly higher policy rates have failed to tame the economy and/or to plunge it into a recession. With the AI hype unleashed and the economy remaining strong, the Fed will likely be compelled to keep the policy rate higher for longer. But inflation in the US for June (reported on 12 July) indicated that while the economy is not slipping into a recession, inflationary pressures are easing. The combination of AI hype, lower inflation, and no recession is the closest to nirvana for equities, and there’s an increasing probability that we could witness a surge in global equities in Q3 if the Q2 earnings season proves to be stronger than expected.
Whilst the US economy is not showing signs of slipping into a recession, the European economy has experienced a decline in economic activity over the past three months with Germany in a technical recession. The catalysts of this slowdown are:
If China succeeds in stimulating its economy, then the global manufacturing sector could see higher growth over the coming six months. And if a global recession proves an illusion then the de-stocking cycle will transition to a re-stocking cycle in the latter half of this year.
Financials conditions have significantly eased over the past three months, which should have a positive impact on risky assets and economic activity and can potentially compel the Fed to signal higher policy rates for longer. The global composite PMI reading remains well above 50 due to a strong services sector and remarkable improvement of South Korean exports over the past three months, suggesting a global growth resurgence is under way.
The US inflation rate declined from 5% y/y at the end of Q1 to 3% y/y by the end of Q2, while the total unemployment rate (full-time and part-time workers) in the US rose a bit to 6.9%, but still well below the long-term structural level in the US economy. The effective Fed Funds Rate rose to 5.08% compared to 4.83% as per our last market update in April.
The AI hype has propelled US equities to their highest equity market concentration ever recorded, which inherently makes US equities riskier as market moves will increasingly be driven by fewer and fewer companies. In the case of the US, it also comes down to sentiment on technology stocks. Equity valuations are now the highest ever on semiconductor stocks. The overall US equity market valuation is now more than one standard deviation expensive again. Our view is that the US equity market is dangerously decoupling from the rest of the global equity market, and that investors should consider being underweight on US equities.
While US equities were on fire in Q2 and European and Chinese equities were more muted, the commodity market had a less positive vibe. The absent rebound in Chinese industrial production had a significant negative impact on commodities with industrial metals down 5.3% and energy prices down 2.3%. In agriculture, the decline was even more intense and was down 11% over the past three months. The declining commodity prices added substantially to the decline in headline inflation, while core inflation remains stubborn. A renewed energy crisis in Europe over the winter months, or China bouncing back, would quickly reverse the dynamics in global commodities reviving the fears of inflation, making the second half of the year a key test for markets.
The USD spot index extended its decline, down 1.7%, while the US 10-year yield rose 22 basis points over the past three months with a brief moment soaring above 4% in early July. Long-term US inflation swaps are still well anchored around the 2.5% level, and the 5Y/30Y yield spread declined 17 basis points over the past three months, reflecting the bond market’s worry over the economy despite the galloping equity market sending entirely different signals.
The excessive expectations around AI caused the global semiconductor industry to rally almost 20% in Q2 and the electric vehicles (EV) boom helped the global car industry to become the second-best performing industry group, up 17% in Q2. Both groups have now entered dangerous valuation levels reflecting unprecedented expectations for earnings growth, dramatically raising the stakes for the Q2 earnings season. If EV stocks and AI stocks fail to deliver on those expectations, equity markets could experience a hard reset lower.
The worst performing industry groups were telecommunication, materials, and food, beverage and tobacco. Telecommunication is experiencing a greater churn among customers due to inflation and the negative impact of higher interest rate expectations during Q2 on industries with a high debt leverage. Materials were impacted by lower commodity prices and several guidance cuts from European chemical companies during Q2. The food, beverage and tobacco industry group was impacted by growing earnings pain as these companies have reached the limit of their ability to raise prices, and several restructurings also dented sentiment in this industry group during Q2.
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
