Stock markets around the world finished the second quarter on a strong note, enjoying a June rally in equity prices spurred by a recovery in corporate profit margins, encouraging economic data, and expectations that interest rates would level off. However, the rise in the S&P 500 has been narrow in scope, with just the ten largest stocks accounting for 95% of the gains year-to-date. This lack of market breadth is a cause for investor concern, especially with the overall market selling at an expensive valuation of 20x next year’s corporate earnings (higher than the historical average).
With all the recent excitement about artificial intelligence (AI), investors have enjoyed record strength in computer chip and cloud technology stocks. In fact, the NASDAQ index of technology companies had its strongest first half rise since 1983, increasing 32% year to date. Cloud computing and developments around AI are the latest examples of companies innovating and creating new business opportunities. From an investment perspective, technology stocks have not just survived the pandemic years but have flourished. New business models will continue to evolve as these technologies are deployed into other industries like healthcare and global trade (logistics).
Similar to the stock market, the broader U.S. economy has prospered, driven by a strong job market and better than expected GDP growth. From the perspective of Federal Reserve Chairman Jerome Powell, it is indeed possible to avoid a painful recession later in the year, although Powell’s ongoing fight with inflation has a ways to go. Our central bank, along with its international banking counterparts, are planning for multiple interest rate hikes in the months to come, while also suggesting that any eventual cut in rates would be delayed well into 2024.
Looking ahead, the next test for financial markets will be the second quarter corporate earnings reports being released later this month. Analysts at FactSet Research are forecasting a 6.4% decline in company profits, which would be the largest decline in three years, and third straight quarterly decline. On a brighter note, positive business momentum in the U.S. will continue to dictate the direction of global financial markets. Economic strength in the U.S. is particularly important at this juncture, with China’s economy still sputtering from its COVID-19 lockdowns and Germany, Europe’s largest economy, mired in recession.
