Equities

Investors are still cautious and have significant cash that needs to be put to work. Trickle-down of it into the US equity market may extend the rally. Overly bearish futures positioning is also a strong contrarian indicator. Disinflation is good for real earnings growth, and imminent earnings rebound may add support for equities.

The S&P 500 performance was flat in May if not for the strong performance of a small cohort of mega-caps, aided by exposure to AI. Earnings and sales growth are contracting but analysts expect a rebound into a yearend, which is already priced in. Yet, inflation is still elevated, and the job market is stubbornly tight – rates will stay much higher for longer, eventually ending the party. Until then, the lopsided equity rally may continue.

The semiconductor industry is at the epicenter of the AI frenzy, which even with all the hallmarks of a bubble, may last for months. There are also early signs of a turnaround in demand for more conventional chips. As such, it no longer pays to be underweight in the sector. But the sector is too expansive to shift our positioning to an overweight. This is not a trade to “be a hero” - we upgrade the sector positioning to neutral.

Special Report

The aerospace and defense industry faces several short-term headwinds such as the defense budget standoff, supply chain disruptions, and labor shortages. But most of these will clear in the near term, and a relief rally is likely. Ensuing global geopolitical risks and rivalry will remain a long-term tailwind, bolstering the industry over a long-term horizon. Remain overweight.

The Q1-2023 earnings season has surprised as companies’ results point to the end of the earnings recession. However, the good news is already priced in – the market has barely budged over the past six weeks. Earnings rebound may continue as long as the economy avoids a recession. However, inevitably, tighter monetary policy will weigh on demand, and recovery will come to a halt.

Special Report

The conventional economic thinking about the likely impact of AI is misguided because it extrapolates linearly from what AI can do today to what it can do tomorrow. Just as the investment community and the broader public were blindsided by the exponential rise in Covid cases during the early days of the pandemic, they will be blindsided by how quickly AI transforms society and the economy.

The S&P 500 was up through 1Q23 and in April, despite the prevailing banking crisis, recession fears, and rising rates. The market is still not adequately pricing tighter monetary conditions, slowing growth, and economic uncertainty. Disappointment may be in store. We remain defensively positioned.

The Fed increased interest rates by 0.25% during its May FOMC meeting, a hike that was both well-telegraphed and widely anticipated. However, the FOMC statement and post-meeting press conference of Chairman Powell had enough for both bulls and bears to stay entrenched in their respective positions. A few bullet points below are what we heard and our take in the context of US equities.

Special Report

Drug development is a challenging business. Yet, the market is growing, and areas such as oncology and obesity present tremendous long-term opportunities. AI will accelerate drug development and reduce its costs. From a macroeconomic standpoint, Pharma tends to outperform the market when economic growth slows. While the industry group is hardly cheap, we will stay overweight thanks to its defensive characteristics, and long-term earnings potential.

In this Strategic Insight, we will summarize earnings and sales expectations, corporate guidance, and what is priced in.