AI hype, lower inflation, and no landing
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.
[1] The tendency for investors to be driven by emotions and thus adopt a herd mentality.