Head of Equity Strategy
Summary: In today's equity update we acknowledge that we have been wrong on our allocation decision of underweight equities and overweight bonds despite overwhelming evidence of economic activity slowing down. Monetary policies forcing down interest rates are creating strong substitution effects and 'there is no alternative' behaviour which are offsetting the worsening macro. We now have to contemplate a potential melt up scenario in US equities striking a similarity to the 1999-2000 rally.
For more than a year we have been negative on equities relative to bonds as global leading indicators have continuously deteriorated. We have never pulled out the “all out” alarm but encouraged our clients to be defensive on equities gravitating towards high quality and minimum volatility stocks. To be fair our factor tilts have done well against the general equity market with minimum volatility stocks delivering the same return as MSCI World, but quality stocks have delivered 6.4% more in total return this year. In a longer horizon both minimum volatility and quality factors have done even much better. While we have got the equity factor tilts right, we have been totally wrong on our general allocation decision of underweight equities and overweight bonds. As a result, we are now officially positive on equities until the downward dynamics return.
Given the market reaction despite overwhelming data suggesting trouble ahead we now must contemplate a melt up scenario in US equities like the one in 1999-2000. In our equity presentation back in March we did in fact highlight the case for a melt up scenario as the similarities to the 1998 drawdown in equities followed by Greenspan’s panic resemble that of Powell’s panic early this year after the Q4 2018 meltdown. However, as the macro data and the US-China relationship continued to worsen we never materialized the melt up scenario as our base scenario. But for now, we must accept that central bank action pushing down interest rates again is driving strong substitution effects from bonds into equities and creates a strong there is no alternative (‘TINA’) effects offsetting any weakness in macro.
As we highlighted last week S&P 500 is becoming increasingly expensive in long historical context as valuation multiples have risen as technology companies with higher growth and higher return on capital have come to dominate the index. History shows that higher valuation comes with lower returns, so we are currently just borrowing returns from the future. In our monthly equity update published last Friday we are hypothesizing that that one of the key explanations for the disconnect between equities and macro is that equities are discounting a soft patch and a quick return to trend growth. This view is also reflected in current S&P 500 forward EPS estimates which are currently reflecting 14% growth over the next 12 month which in our view is an aggressive estimate for growth. It’s also important to note that S&P 500 estimates are generally too optimistic; the exact figures are 17% above realized earnings the following 12 months since 1991 and 7% in the period since the Great Financial Crisis. In other words, the optimistic view currently baked into forward estimates will not hold pushing up valuation multiples even more over the coming period.
AI: The good, the bad, and the bubble
While a deep recession may not be iminent thanks to central bank policy, interest rates will have to stay high for longer, and this will be accompanied by volatility risk from the unwinding of bubbles, especially within AI.
Steen Jakobsen,
Chief Investment Officer
The emergence of advanced AI systems is by far the most surprising event this year, turning everything upside down, while risks and benefits are debated. AI will also become an arms race between the US and China.
Peter Garnry,
Head of Equity Strategy
While commodities, broadly speaking, have faced some tough months, a partial reversal during June could signal that the asset class is getting back on its feet with energy holding up and precious metals with upside potential.
Ole S. Hansen,
Head of Commodity Strategy
The USD is on its back foot as markets celebrate an eventual Fed rate peak and steady long US yields. The stakes are even higher for the Japanese yen if longer major sovereign yield curves have to price in economic acceleration.
John J. Hardy,
Head of FX Strategy
As inflation remains high central banks face hard decisions about whether they should keep hiking interest rates or stop. Meanwhile, the rise of AI creates bubble-like conditions that only make the decision harder.
Althea Spinozzi,
Senior Fixed Income Strategist
The AI fever has turned the technology into a darling, pushing crypto further into no-man’s-land. There are striking similarities between AI and crypto, and if these are to come full circle, AI won't be spared for bubbles.
Mads Eberhardt,
Cryptocurrency Analyst
Stocks related to artificial intelligence (AI) have appeared on investors' radars. Expectations are high, but it may be necessary to consider how to get exposure to AI in a diversified way.
Hans Oudshoorn,
Trainer Academy
Japan’s expertise in semiconductors and robotic integration could be the foundation of AI dominance. Combining two of this year's themes, Japanese equities and artificial intelligence, brings a wave of opportunities.
Charu Chanana,
Market Strategist
As China navigates global fragmentation, its cycle of technology application, productivity enhancement, and growth is threatened by US breakthroughs in generative AI, limited computing power, and geopolitical tensions.
Redmond Wong,
Market Strategist
