Thought of the day

US stocks recorded their strongest daily rally since February on the last day of July, with the S&P 500 index climbing 1.6%. A recovery in growth stocks and mounting confidence that Federal Reserve rate cuts are on the way buoyed equities and sentiment. The tech sector led the rally, with AI chipmaker NVIDIA advancing 13% and Meta shares up 7% in after-hours trading. The rebound follows a period of investor caution over how swiftly leading tech companies would be able to monetize heavy investments into AI—contributing to a near 5% fall in the S&P 500 index from an all-time high in mid-July. At the time of writing, S&P 500 futures point to a 0.4% rise at the open.

The gain in NVIDIA reflected news of rising capital spending on AI from other mega-cap tech firms. Microsoft announced AI capex had reached USD 19bn in the second quarter, 80% higher than the same period a year ago. Analysts raised capex spending estimates on the heels of the results. Meta's results also boosted investor confidence, following better-than-expected second-quarter earnings and revenues (including in advertising) and guiding for third-quarter revenues that surpassed prior consensus expectations.

Beyond corporate results, investors were also heartened by a more dovish message from the Federal Reserve's latest policy meeting. Despite keeping rates on hold as expected, Fed Chair Jerome Powell said that “a reduction in our policy rate could be on the table as soon as the next meeting in September.” Recent data had added to “confidence” that inflation is returning sustainably to the central bank’s 2% target, he said. Most notably, Chair Powell and the committee focused comments on the labor market side of their dual mandate, noting in their statement that "job gains had moderated" and becoming more sensitive to risks that the jobs market is cooling excessively rather than overheating. Recent data support this thesis, with JOLTS data showed the hiring rate and quits rate falling to new lows for the cycle in June, the ADP’s report of private payrolls falling to a six-month low in July, and the Employment Cost Index—a measure of labor costs closely scrutinized by the Fed—slowing to 0.9% in the second quarter and its joint-lowest level in three years.

At the time of writing, markets were pricing around 30bps of rate cuts for the September Fed meeting, while the US 10-year Treasury yield stood at 4.06%, still 8 basis points lower than prior to the Fed's decision.

What do we think?

Despite the market pullback in mid-July, and without taking any single-name views, Wednesday’s rally underscores our positive outlook on the technology sector amid strong AI capex and demand. Though we are in the middle of earnings season, with more leading companies set to report in the coming days, profits for S&P 500 companies remain on track to grow 10-12% for the second quarter. Companies accounting for more than 60% of the S&P 500 market cap have now reported, and the results have been generally positive overall as 60% of companies beat sales estimates, and 75% beat earnings estimates, both in line with historical averages. Guidance by US companies for the third quarter has also been in line with normal seasonal patterns.

The outcome of the Fed meeting also supports our view that rate cuts are imminent. Chair Powell’s comments suggest that he sees the US economy headed for a soft landing, in line with our base case. He also indicated that the Fed was becoming more attentive to the risks to the job market from keeping rates high for too long—though he said recent evidence pointed to only a gradual cooling. Overall, we continue to see a favorable backdrop for US equities and advise investors to maintain a full allocation to the US market.

How do we invest?

The revival in markets highlights our view that investors should stick to their long-term plans through periods of volatility to avoid missing out on rebounds. Market sentiment and positioning had become extended earlier this month—making a pullback more likely. But market fundamentals remain positive, and we continue to expect the S&P 500 to recover and end the year higher at 5,900 versus the current 5,522. Against this backdrop, we advise investors to consider several strategies:

Seize the opportunity from AI. The market potential of AI is vast, and we expect it to be a key driver of equity market returns over the coming years. We think it is important that investors hold sufficient long-term exposure to AI. For now, we see the best opportunities in the enabling layer of the AI value chain—which is benefiting from significant investment in AI capabilities—and in vertically integrated mega-caps. We also think investors should look beyond the US for ways to capture AI growth, including in China’s tech monoliths.

Seek quality growth. We believe seeking quality growth should apply broadly to investors’ equity holdings. Recent earnings growth has been largely driven by firms with competitive advantages and exposure to structural drivers that have enabled them to grow and reinvest earnings consistently. We think that trend will continue, and investors should tilt toward quality growth to benefit. But with ongoing geopolitical tensions and likely differences in the timing and extent of major central banks' rate cuts, we think diversification across quality growth equity ideas—whether by region, sector, or theme—makes increasing sense.

Position for lower rates. With economic growth and inflation slowing, and central banks starting to cut interest rates, we see significant opportunities in the fixed income market. We believe investors should invest cash and money market holdings into high-quality corporate and government bonds, where we expect price appreciation as markets start to anticipate a deeper rate-cutting cycle. We also expect broadly diversified fixed income strategies to perform well in the months ahead. In addition, we have identified select ideas within Europe that can benefit from lower rates.