Over the past three months, the global economy and financial markets have been through a lot. First and foremost, of course, because of the conflict between the US/Israel and Iran, which has led to higher prices and lower economic growth, and whose outcome remains uncertain. However, since that conflict has reached an impasse, attention has shifted to the rise of AI. The advent of this technology and the massive investments associated with it are driving economic growth and generating huge increases in profits for companies active in this sector. This combination has caused a great deal of volatility in various financial markets. The chart below shows that the energy sector led the US stock market after the outbreak of the war, but that AI optimism has brought the technology sector back to the forefront over the past two months. Meanwhile, the chart also shows that the financial sector and the bond market are suffering from higher inflation expectations and the increased likelihood of tighter monetary policy caused by the war. The market is thus of two minds and is trying to balance both developments.
Over the past few months, we have repeatedly expressed our concern that it would be difficult to reach a deal that would open the Strait of Hormuz. Iran’s escalation dominance clashes with Trump’s view that he holds the upper hand, making it difficult to find a mutually acceptable compromise. Due to the length of the negotiations and the ongoing blockade of the Strait, the inflation uptick scenario has become more likely. And this is not only visible in the financial markets; the chart below clearly illustrates the increased stress in supply chains.
At the same time, we recognize that the rise of AI is proceeding at a rapid pace and that this development represents the Boom-Boom scenario for certain segments of the stock market. As a reminder, our Boom-Boom scenario describes an environment in which economic growth, inflation, and monetary policy remain within acceptable ranges, while optimism about new technology propels the stock market to new heights. This dynamic is particularly evident in the emerging markets equity market. There, three companies have nearly doubled the entire market’s earnings expectations, with corresponding returns. But in the developed world as well, expectations for corporate earnings have risen sharply, led by the technology sector.
Beyond publicly traded stocks, we are also seeing a lot of boom-boom behavior in the private markets. There, valuations of technology companies are being significantly increased with every funding round. And three mega-IPOs are in the pipeline this year (SpaceX, OpenAI, and Anthropic). Incidentally, the market is torn here as well, as the optimism in private equity stands in stark contrast to the ongoing caution surrounding private credit, where investor confidence remains fragile.
Although there is still considerable uncertainty surrounding the situation in the Middle East, it is important to also keep an eye on the rise of AI and the positive impact it is having. To balance these two perspectives in our portfolios, we use our scenarios as a guide, with the Inflation Uptick and Boom-Boom scenarios as our starting points. This means we have reduced the interest rate sensitivity of our bond portfolio and, in private markets, are relying on the inflation protection offered by infrastructure. In our thematic equity portfolio, we are positioning ourselves for the Boom-Boom scenario.
BY: WOUTER STURKENBOOM, Chief Investment Officer