Q3 2023 Summary AI - The Good the Bad and the Bubble

In this Outlook, our chief focus is on the current market impact of the AI theme across markets and around the world. But Steen’s introductory piece also argues that market participants are making a mistake in believing that the current market cycle will play out like previous ones, as inflation is set to stay higher for longer than the market anticipates, which will eventually register as an enormous surprise, given that yield curves in most markets are pricing significant eventual policy easing starting early next year and a glide path to a soft landing. The complacency surrounding that disinflationary and soft-landing scenario have kept long yield anchored and allowed equity markets, and particularly AI-linked names, to inflate perilously.

Also on the AI theme that has dominated focus over the last quarter:

Equity strategist Peter Garnry argues that the emergence of advanced AI systems such as GPT-4 from OpenAI is by far the most surprising event this year, a phenomenon that has turned everything on its head. Further, he writes that the AI-hyped rally has pushed the US equity market to new extremes, even as the benefits and risks of this new technology are hotly debated. He predicts that we risk seeing US and China engaging in an AI arms race.

Our Greater China strategist, Redmond Wong, points to the challenges China faces in the field of generative AI as it navigates a global order of fragmentation. The success of generative AI breakthroughs in the US, coupled with limited computing power and geopolitical tensions, has threatened to break down China’s virtuous cycle of technology application, productivity enhancement and growth.

Macro strategist Charu Chanana highlights Japan’s expertise in semiconductor manufacturing and robotic integration, suggesting these could be the foundation of a very strong presence in AI. She notes that Japanese equities and artificial intelligence combine the two most powerful market themes of this year.

Cryptocurrency analyst Mads Eberhardt notes that AI fever has stolen the spotlight from blockchain technology and the cryptocurrency market generally, pushing the space further into speculative no man’s land. Despite the contrasting performance between crypto and AI-linked assets, there are striking similarities, especially the risk of bubble-like dynamics.

Investment Coach Hans Oudshoorn outlines in his piece how investors can gain exposure to AI via ETFs that provide considerable diversification, but still noting the risks from valuations that have become very elevated in places.

In addition to the AI focus, this report also delves into the outlook across major asset classes:

In currencies, FX strategist John Hardy notes that USD shorts could be set for a vicious reality check if the US economy remains resilient and core inflation remains sticky, possibly engaging both sides of the "USD smile" that drive USD strength: the Fed remaining on the warpath and market turmoil.  John notes that the stakes are even higher for the Japanese yen if the longer yields of the major sovereign yield curves have to price in a new economic acceleration, as the BoJ will have to eventually capitulate on its yield-curve-control policy.

In commodities, commodity strategist Ole Hansen suggests that the commodity sector looks set to start the third quarter on a firmer footing after months of weakness saw a partial reversal during June. Ole notes that strong gains were at times driven by a weaker US dollar, but specific developments in each sector also weighed. Most concerning for is the risk of higher food prices into the autumn, as several key growing regions battle with hot and dry weather conditions sparked by the first El Niño weather pattern in years.

Fixed income strategist Althea Spinozzi argues that central banks face a troubling dilemma: if they really want to get ahead of inflation, they will need to burst asset bubbles created by a decade of quantitative easing (QE) and trigger a recession. But she asks whether they are willing to take policy tightening that far and ever win the inflation fight.