Global equities have defied expectations and experienced a remarkable decoupling from the worsening economic backdrop, showing a substantial 13% rise in 2023. However, amidst this apparent market resilience, concerns are mounting over corporate profit warnings, hawkish central bank rhetoric, and a series of profit alerts that have dampened optimism for a soft economic landing. These factors cast a shadow on a market that has already withstood a regional banking crisis and a significant tech sector boom fuelled by the hype surrounding AI.
One prevailing theme expected to persist throughout the year is the rising interest rates. Initially, there were expectations of a Federal Reserve rate cut, but they have now been pushed back to 2024. On the other hand, the European Central Bank anticipates an extended cycle of rate hikes. The implications of higher interest rates could significantly impact the tech sector, which has experienced a surge driven by advancements in AI-related technologies.
Amidst the most rapid Fed hiking cycle witnessed in four decades, there is a growing concern that a recession within the next 12 months may be unavoidable. Despite the economy displaying more momentum than anticipated at mid-year, we now believe the downturn will possibly begin later in the year’s second half rather than earlier.
Another area of worry revolves around the elevated valuations within the tech sector, which raises concerns about a potential correction. The impressive growth driven by AI-driven innovations has led to rich valuations, increasing the vulnerability of this sector to adverse market developments. Moreover, the concentration of the market rally in just a few mega-cap tech stocks amplifies the risks. Any negative news affecting these companies could have a cascading effect on broader equity indices, potentially exacerbating declines across the market.
Federal Reserve Chair Jerome Powell has emphasised the lack of progress in core personal consumption expenditures (PCE) disinflation. Despite the implemented rate hikes, inflation has not responded significantly, indicating the need for persistent efforts to address the issue. In this regard, Powell draws inspiration from former Fed Chair Paul Volcker, who successfully tackled inflation despite facing opposition. Powell highlights positive developments in key components of inflation, such as goods, housing, and the labour market, although progress is occurring at a slower pace than initially anticipated.
The tech sector’s valuation concerns serve as a cause for caution among investors and strategists. While the impressive growth driven by AI-related innovations has propelled the sector, it has also resulted in rich valuations. Consequently, it becomes more vulnerable to adverse market developments, potentially triggering a correction. The concentration of the market rally in just a few mega-cap tech stocks further amplifies the risks. Any negative news or changes impacting these companies could be significant to broader equity indices, leading to widespread declines.
The vulnerability arising from elevated valuations raises caution among investors, as any negative news impacting mega-cap tech stocks could profoundly affect broader equity indices. As the year progresses, it is crucial for market participants to closely monitor these factors and adapt their strategies accordingly to navigate the evolving landscape of the global equities market.
Fullerton Markets Research Team
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