Thought of the day

Gains in tech stocks drove US equities to all-time highs overnight, with the S&P 500 notching another record. The benchmark is now 15% higher than at the start of the year, while the tech-heavy Nasdaq has risen nearly 21%. US Treasuries rallied, with the 10-year yield shedding six basis points to 4.22%. Equity momentum carried through to Asian equities on Wednesday, with the MSCI Asia ex-Japan index rising 0.7% to a three-week-high.

While political uncertainty in Europe created by the snap legislative election in France has contributed to some safe-haven flows for US assets, including the US dollar, we believe the equity rally has also been underpinned by fundamental drivers that should continue to support the market.

The US economy remains on track for a soft landing. Retail sales rose 0.1% month-over-month in May, weaker than the consensus forecast for 0.3%. The headline print was dragged down by soft spending in gas stations and food services. There were downside revisions to the preceding two months. The retail sales control group, which excludes volatile categories and feeds into GDP calculations, rose by 0.4% month-over-month in May, marginally below market consensus forecast for 0.5% growth. These figures are consistent with our view that the US economy is headed for a soft landing, with moderating demand bringing inflation back toward the Federal Reserve's 2% target. However, while the US economy is slowing, we don’t see signs that a recession is on the way. This means the outlook for equities is positive, supported by resilient growth and solid earnings.

Federal Reserve rate cuts are on the horizon. Despite the median “dot” for Federal Reserve rate cuts this year falling from three to one at the FOMC meeting last week, and Philadelphia Fed President Patrick Harker’s comments on Monday suggesting one cut this year, market pricing remains for nearly two cuts by December and about a 60% chance of a cut in September. In addition, Fed Chair Jerome Powell downplayed the dot plot by saying that “these projections are not a committee plan or any kind of decision,” and the US central bank remains data dependent. If inflation over the summer remains modest, following encouraging prints in both April and May, the Fed will have a valid case for making a cut in September, in our view. The start of an easing cycle should provide a tailwind for both growth and small-cap stocks.

Artificial intelligence should continue to drive growth. Recent tech industry events have provided strong catalysts for AI-related names, with the Nasdaq rallying roughly 6% over the past month. While AI capex upgrades for 2024 are now largely behind us, we think the positive momentum will continue as AI continues to offer significant opportunities for growth. We currently like companies that provide the backbone for AI development, ranging from semiconductor production to chip design, cloud and data centers, and companies involved in power supply, as these firms in the “enabling” layer of the AI value chain currently offer the best mix of attractive and visible earnings growth along with reasonable valuations.

So, we maintain our constructive view on US equities, and see opportunities in AI-related tech stocks. Investors can also consider capital preservation strategies to manage sentiment, valuation, and idiosyncratic risks.