Volatility returned to the markets last week, as cracks showed up in the dominant AI narrative. After a couple of trading halts in Korea, the Kospi ended the week 7% lower and Wall Street’s Nasdaq lost just over 4%. The big question for investors today is how to ride the ongoing wave while protecting the gains already in the bag.
Boom or bubble?
A different version of the same question is whether the AI boom is turning into an AI bubble. One is sustainable, the other will inevitably come to an abrupt end.
It’s a hard question to answer. One key difference with earlier bubbles is that this time around valuations are justified by strongly rising earnings. When you consider how far their share prices have moved, the likes of Nvidia and SK Hynix are not expensive.
And strength in earnings is not just a tech story. As we approach second quarter results season, profit growth forecasts are not just in double digits, but above 20%. That’s keeping the US market trading on around 22 times earnings – higher than the rest of the world but not dot.com bubble crazy.
The threat from bonds
Bull markets do not die of old age. Typically, they are killed off by excessive valuations or by inflation and consequently restrictive interest rates and bond yields. So, if valuations are not the big risk, what about inflation?
A few weeks ago, as the seemingly intractable Gulf crisis pushed oil above $100, this seemed like a real threat. Today, with a fragile truce holding and oil back at $70 a barrel, it seems less of a concern.
At that level, the pressure is off. It’s a helpful backdrop for new Fed chair Kevin Warsh, who has made it clear in his first weeks in the job that inflation is his principal focus. Markets have taken him at his word and inflation expectations have fallen. The bond market is claiming victory. Time will tell.
All quiet on the data front
As investors weigh up the competing tail risks in the market, there’s little on the news front to guide their deliberations. It looks like being another quiet week on the economic and company results front.
Top of the economic agenda will be jobs data for the US on Thursday. The forecast is for a steady-as-she-goes 4.3% unemployment rate with non-farm payrolls rising by 110,000 compared with 172,000 in May. Much of that was a World Cup related one-off so maybe this month’s data will be more reflective of the ongoing health of the market.
A bigger concern than a weak employment number would actually be another strong reading. Too much growth, re-igniting inflation, feels like the greater problem.
The issue in Europe could be the reverse. With oil at $100, the ECB felt it prudent to hike interest rates a quarter point last month. That could look premature if fuel prices tumble and this week’s inflation print comes in at 3% or lower. Expectations a few weeks ago of 4% inflation in the region now look wide of the mark.
Meanwhile, on the corporate front, there will be a handful of trading statements, with retail in focus here in the UK. Sainsbury’s and Primark-owner Associated British Foods are in the spotlight. And there’s some evidence that flotations are picking up. It’s not on the same scale as SpaceX, but this week’s listing of Uber-backed Lime will garner some headlines.
King of the North
On this side of the Atlantic, the big story will continue to be the ‘coronation’ of Andy Burnham, the so-called ‘King of the North’, who came down south last week to be sworn in as the new MP for Makerfield and presumptive recipient of the keys to Downing Street.
With rival bids melting away in the wake of his decisive by-election victory, Burnham could be Prime Minister in three weeks’ time. And then the real work will begin.
First up, he must regain the trust of the same bond market he said he would not be ‘in hock’ to. For now, with 10-year yields down a few basis point to 4.7%, fixed income investors are giving him the benefit of the doubt. They will be watching closely his first speech this week, setting out his 10-year vision for rebuilding the standard of living of everyone in the UK, northerners and southerners alike.
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