Top of the Morning: CIO Strategy Snapshot - Market drivers
The desk sees ongoing market momentum driven by a confluence of corporate earnings, economic data, and technological advancements, particularly in AI. Per the full note source, this is evidenced by a notable 3.6% rally in the S&P 500, while tech stocks related to AI, such as NVIDIA and Microsoft, recorded impressive gains of 11.5% and 8%, respectively. With no high-impact events on the calendar for the next 30 days, the focus remains on how these factors will sustain market activity, particularly in the currency space. Our internal coverage indicates a consensus around a USD weakness outlook against major currencies like the EUR and JPY.
What the desk is arguing
The desk asserts that the persistent strength in equities reflects underlying economic resilience, contrary to typical summer slowdowns. Market participants are reacting to robust corporate earnings and dynamic shifts in technology sectors, suggesting that the current momentum is sustainable. Per the full note source, Jason Draho highlighted that during the recent earnings season, sectors tied to AI have significantly outperformed their peers.
The recent data has shown the S&P 500 experiencing its best weekly performance in four months, up 3.6%, which aligns with broader market trends we are witnessing in foreign exchange, as traders adjust their positioning based on these performance indicators. The notable engagement in small-cap indices further underscores the bullish sentiment across the board.
Where it sits in our coverage
Our consensus target for EUR/USD currently stands at 1.075, with a range between 1.04 and 1.12. Several firms contribute to this outlook, including: - jpmorgan: Target 1.10, Tenor Mar26 - bofa: Target 1.04, Tenor Mar26
This view aligns closely with jpmorgan, suggesting a slightly more bullish interpretation, sitting near the upper bound of the consensus target range.
How other firms see it
Firms like jpmorgan and others are aligned in their optimistic view towards the potential for further USD weakness, supporting a bullish stance on the EUR. Contrarily, bofa holds a more cautious position, advocating for a stronger USD against the Euro.
The anticipated volatility in the EUR/USD pair closely mirrors the ECB’s potential policy adjustments, particularly if economic outcomes steer towards tighter monetary conditions. Watch this space for further developments, as the intersection of technology and monetary policy could influence directional trades significantly.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Equities are experiencing strong momentum, defying typical summer slowdowns.
- 02AI-related tech stocks are leading the market, showcasing significant gains.
- 03Consensus targets suggest a weakness in the USD against major currencies over the foreseeable future.
- 04No high-impact events scheduled may keep market focus on corporate performances.
Market implications
Traders should monitor key levels around 1.075 for EUR/USD, as any break above could confirm further weakness in the USD. Positioning signals from tech stocks could also indicate broader market trends, especially in relation to AI developments.
Risks to this view
A reversal could occur if upcoming economic data unexpectedly suggests stronger-than-forecasted USD resilience, particularly through employment reports or inflation metrics outpacing current expectations.
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. We are in the dog days of August when activity can feel sluggish, but that's certainly not the case for financial markets.
The S&P 500 is coming off of its best week in four months, while bond and forex markets have had no shortage of volatility. With a flurry of economic and earnings data, policy news, and continual developments in AI, there are plenty of factors contributing to these market developments. Joining me here today from the UBS Chief Investment Office within UBS FSI, glad to welcome back Head of Asset Allocation for the Americas, Jason Draho.
Jason, hope you enjoyed some restful time away. It's great to have you back here on the podcast, a lot to catch our listeners up on, so great to be with you on this Monday morning. Welcome back.
Thank you, Dan. Happy Monday. It's good to be back.
Appears during my time off, the markets did well, so maybe that's a sign it should take more time off. We'll see. We'll get more data points on that, but that was a positive development.
So on that note, Jason, let's talk about the markets and the good equity performance as well as the volatility and other asset classes. What has been taking place recently and what are the factors driving this market movement? Well, let's just start with what actually happened, especially over the last week, because for S&P 500, last week, it was up 3.6%.
That was its best week since mid-April when the worst of the Iran-U.S. war was kind of getting over. So it was a strong bounce back, but it was kind of fairly broad-based in small-cap equities measured by the Russell 2000 was up kind of a comparable amount of 3.6%. The NASDAQ index was up just over 5%.
A lot of it was led by AI, kind of tech-related sectors, like NVIDIA was up 11.5%, Microsoft 8%, and other parts of the broader AI-related complex, all up 5% plus. But it was also kind of a more broad-based measure in that cyclical stocks outperformed defensive stocks by roughly 4 percentage points. So why was this?
There's a few factors. One, maybe increasing investor confidence that there would be another sort of period of ceasefire between the U.S. and Iran that contributed to oil prices falling roughly 9%. That helped yields, treasury yields, to decline across the entire yield curve.
So that was sort of kind of beneficial. They were down a little bit last week, and really, if you go back over the past two weeks, expectations for the Fed, hikes have gone down. So this September, that's declined to less than a 50% chance.
Some of it is kind of geopolitical news. Some of it was good earnings. We've had a very strong earnings season, so we'll get into the details a little bit later.
And then also on Friday, it was a jobs data point that was kind of below expectations, but the markets sort of interpret this as perhaps bad news is good news. So some fundamental factors, some factors about policy, just kind of all the kind of driving the markets higher. But there's also the fact that this was coming after a period of time where July was very choppy.
You saw a lot of rotation beneath the surface. So even though the headline index at the S&P 500 was relatively range-bound, it never fell more than about 2.5% at its peak to trough, beneath the surface, there was massive rotations with the momentum factors thawing off very, very significantly. Investor positioning that had been quite engaged or elevated had de-risked a lot.
And what happened last week was signs of investors, especially institutional investors and hedge funds, kind of re-engaging, kind of adding back exposure, maybe even to some extent chasing the upside, because there was more fear of the downsides in the markets that are resuming their grind higher. So just as one data point, last Tuesday, there was record volume on the S&P 100. Investors are buying calls because they anticipate upside, so that's an indication that investors very quickly pivoted to wanting to chase the upside.
So all those things kind of led to a bigger week in early August, even though it is sort of the dog days, the markets are a bit quieter, a lot of people on vacation. Some of that lighter volumes and activity means it's also makes the markets a little more prone to perhaps reacting to sort of views that otherwise would be, and last week was a positive story kind of overall. Quite a number of factors, Jason, you outlined.
You did mention economic data as one of the driving factors. Thinking back to this past Friday, we did receive the July jobs report, and this week we will be receiving July inflation prints. Can you summarize, Jason, the jobs data for us?
What happened and what are you expecting to see in this week's inflation numbers? And what might this all mean for the Fed's monetary policy outlook? Well, starting with the jobs report, it was certainly well below expectations.
The July payrolls number fell by 23,000, and that was well below expectations where consensus was around 50,000. It was also coupled with down revisions to the prior two months for May and June, combined those revised down by 103,000 jobs. So the three-month average of job growth is 20,000.
Prior to the report, the three-month average was 111,000. So this is clearly kind of a big decline. And so what suggests that the job market wasn't quite as strong as the data coming through the second quarter would have indicated, it's not bad.
This is 20,000. It's kind of in the range of what a lot of economists would say is sort of a break-even level for the labor market, meaning how many jobs need to be created every month in order for the unemployment rate to stay stable. These estimates vary.
Some are as low as basically zero. Some might be as high as around 50,000 to 60,000. 20,000 is sort of within that range. That's reflected by the fact that the unemployment rate actually fell 4.1%, and it fell because of a falling participation rate.
This is not entirely unexpected. We have two key structural drivers that would be leading to a falling participation rate. One is just demographics.
As people age, in the population ages, you're going to get fewer people working, and that's one factor. Another is with net immigration, this should be probably negative. You have sort of less supply coming through immigration.
So that's leading to less supply in the labor market, so you just don't need to create as many jobs. So 20,000 a month, that is sort of, perhaps you could say, kind of in the range of sort of the new normal, what it is for the labor market. Some additional details of the labor market report also give a little more coverage than the headline numbers, not as indicative of a real sort of weakening.
A lot of the job loss was in government, but also leisure services. On government, some of those, that's maybe the seasonal statistical quirk of, you know, kind of government layoffs, you know, this year versus, you know, prior years. And in leisure services, you know, there was perhaps hiring related to, you know, the World Cup that took place in June and early July.
As that eased off, perhaps, you know, you could see some of the leisure services pull back a little bit. So, you know, not a good number, but also perhaps not as bad as the headline number would indicate. Another key data point in the jobs report was wage growth.
On a year-over-year basis, the average hourly earnings fell to just over 3.1 percent. The month-for-month level was quite low. This was sort of coupled with another data point last week, which is the quarterly employment cost index.
That's a really broad measure of overall kind of wage costs for employees, whether it's, you know, salary bonuses of that sort. It fell to 3.1 percent in the second quarter. That's the lowest in a number of years.
So, you're seeing definitely some softening of the labor market, sort of less, you know, bargaining power, but not kind of outright weakness. If we look at other data points just on the consumer, that would be tied to the labor market. Spending remains solid, and also investment remains strong.
So, overall, economic activity remains, you know, still relatively solid, despite that jobs number on Friday being disappointing. Looking ahead, you know, the focus this week will be on the inflation data, starting with the CPI data that we'll get on Wednesday, and then the PPI data for July that will come out on Thursday. You know, consensus expectations is that, you know, the headline number will still be, you know, quite low as the benefits of, you know, gas prices, you know, moderated, still kind of flow through, although the benefit won't be quite as strong as in June.
The key focus will really be on the core CPI data. You know, if anything, that's around 0.2 or 25 basis points, it sort of will be in line with the headline or the year-over-year number per core CPI going lower. Consensus has a 2.5% per core CPI year-over-year.
Last month, it was 2.6%. As long as it's moving in the right direction, it's another reason why the Fed should be willing to stay on hold for September. And another factor is, you know, the wage growth being relatively soft.
That is ultimately some factor in kind of the long-term sort of inflation pressures. That's another reason why we think, you know, the Fed could give the Fed some reason, you know, to pause. Market pricing right now is, you know, is for about a 45% chance of a hike in September.
As a result of the weak labor market report, it wasn't so weak that the Fed could now put equal measure, we'd say, on the labor market and the inflation or price stability aspect of its dual mandate. But it certainly, you know, makes the job, the Fed's maybe decision a little bit easier if you see some weakness in the labor market, see wage growth. And if we get an inflation print for July, that's relatively contained.
It certainly won't make September pause a done deal, but it will make it much less likely or in some really strong data in August suggesting otherwise. So overall, you know, the data from last week is consistent with our view that the U.S. economy is growing around the trend of 2%. Inflation will continue to moderate and the Fed will be on hold this year, not have to raise rates at all.
Outside of economic data, there has been a lot of focus on the Q2 corporate earnings season, which is beginning to wind down. Q2 earnings have been very strong. So what are some key highlights and takeaways that matter most for the investment outlook?
Well, the fundamental story from like a labor market perspective could look fine, not great. But the earnings story has been nothing short of kind of spectacular. We do have about 90% of the S&P 500 companies who've reported.
And the second corner, earnings per share, is on pace to grow about 30% once you exclude some of some one-time investment gains for Google and for Amazon. So very good numbers overall. A lot of this is due to semiconductor stocks, so a boost in earnings growth, energy companies that got a benefit from higher oil prices.
But the median stock is still experiencing 12% earnings growth, which is one of the best quarters in a few years. So very good numbers overall, but it's also kind of relatively broad-based. Looking forward, that's kind of you could say is already kind of priced in.
Looking forward, what matters is the guidance for these companies for Q3, but it's kind of ongoing. And oftentimes, as earnings season plays out, companies guide for the current quarter, so in this case Q3, lower, then ultimately kind of beat the numbers in the subsequent quarter when the numbers actually come out. So far, we're not seeing those downward revisions.
We're actually seeing earnings revisions for Q3 go a little bit higher. And so bottoms-up earnings expectations right now are still having 20% earnings growth in the third quarter and even in the fourth quarter. So this earnings momentum is likely to stay very strong for the rest of this year.
One of the consequences of that is the actual valuations for S&P 500 has gone lower because you're seeing equities, yes, they reached an all-time high, but earnings growth this year is far surpassing the price performance. So the forward multiple based on the next 12 months of earnings expectations has actually gone from about 22 PE to down to about 20, given these very, very strong earnings numbers. Now, one thing that is interesting about the results, it's a little bit of kind of arrive and travel and arrive, meaning the markets that were anticipating really good numbers that contributed to certainly good performance through June, less so in July, but as a result of really good numbers and sort of beating expectations, we actually didn't see stocks popping a whole lot.
For stocks that beat both on their earnings expectations and sales expectations, they did outperform the market overall on the following day after they reported, but only by about 80 basis points, which is just over half of the historical average. What this entails and what it means is that the markets were expecting good numbers, the companies delivered, and it's kind of shrugged off to some extent to that overall result. But the key story is very good numbers, forward-looking earnings stories remain very positive.
That is a key fundamental driver for why we remain constructive on equities, both in the U.S. but also abroad. Now, a topic, Jason, that you and your colleagues have written a lot about and have spoken a lot about here on Top of the Morning is the AI economy. It's a continuous, fast-evolving topic.
What are some recent developments that you find to be most noteworthy? Well, as you say, this is fast-evolving, the key in narratives and debates about how this whole AI development, the spending, the implications, the consequences, those can change almost month to month. And so a topic that I'm going to address on a regular basis on this call is how is that narrative playing out, because it is clearly driving a lot of the economy, as we laid out in the report, but also the equity market performance overall.
And so given that earnings season is largely done, I just wanted to highlight, I think, a few interesting takeaways that we can get from that earnings season and other developments over the past few weeks. And the first is that what we're actually seeing as a result of the earnings season is that companies are showing an ability to monetize this disinvestment, that we're seeing kind of clear examples of enterprise use of AI. These are sort of generating sufficient and kind of measurable returns, more than enough to cover the cost of the token, the cost of compute.
That is one of the big concerns, is there going to be a return on investment? So companies are seeing these benefits. That's a positive sign from what we think is kind of the AI flywheel of companies have to see the productivity benefits.
If they do, the demand for compute will go up, the demand for compute goes up, then that justifies the CapEx spending that we're seeing. So the ROI on that CapEx investment range is relatively attractive. A development over the past month or two that's certainly going to become a question mark in the minds of investors is these open source models, many of them are Chinese.
If you have open source models that are essentially free to use for companies to use them, does it sort of undercut to the value proposition of frontier models? That might be a little more advanced, but definitely sort of more expensive. And there's a lot of CapEx being spent to justify both the inference, the development of those models, but also the applications of those.
What it looks like though is kind of the notion of this Jevons paradox, that as you make an application or a tool less expensive, it actually increases the overall demand because now companies can get more benefit and they're more likely to want to invest. And there's evidence that we're seeing this kind of play out. All this is reflected in the performance of stocks.
We're seeing the hyperscalers, but also more clearly the semiconductor stocks benefiting here with the application layer. I think the real question mark remains with some of the model providers because of how they will ultimately monetize some of their development costs. Another key story in the whole AI economy, but also investing, is the financing.
A lot of money is being issued on the debt side to finance this CapEx build out, whether it is investment in great corporate bonds, private credit, some sort of securitized finance. There's essentially a huge demand for capital. We've seen spreads for some of these issuers kind of widen out.
And there's a question whether is there enough appetite among investors to fund all this investment without spreads going and yields going higher. So we've seen spreads wide for some of these hyperscalers, but they've also tightened a little bit. And I think companies and issuers are sort of conscious of this, conscious of concerns about cost of capital.
And there are situations where these companies are sort of providing guidance to investors that as we come to issue $10, $20, $30 billion of investment in corporate bonds, that this might be a one-off. If they want to issue again this year to sort of signal for investors who are looking to get attractive yield, that it's also not an infinite supply. I think that's also helping to tamp down some of those concerns.
But it is becoming an issue, I think, so far that it's well-contained. But when I think about the two key drivers of the whole AI economy story is you need to see the productivity gains, the return on investment, we're seeing some raw evidence of that. Financing could be a constraint.
Without the financing, this could train the ability of the investment cycle to materialize. But so far, that hasn't been the case. We're seeing companies being able to raise the capital if necessary.
That could certainly change. But at the moment, through this part of the summer, that has not been an issue overall. So certainly more to come in the coming weeks and months on these topics, but I think that's some interesting takeaways from the second quarter earnings season about the AI economy and where we're headed.
It still feels very much sort of all momentum is in a positive direction for the time being. Now taking into account, Jason, all of these factors you shared with us, let's talk a bit about investment recommendations. Now coming off of a good week for the equity markets, what are CIOs key investment messages and recommendations at this time?
Well, one of the key messages, we like equities kind of across the board in the U.S. and globally, but it's also to sort of diversify across equities and not to be so concentrated in some of these tech stocks. We've seen over the past couple of months a real broadening out of performance, whether it's looking at an equal weight S&P 100 index outperforming, small cap stocks kind of outperforming, other more cyclical sectors outperforming. There is opportunity to do well in equities that doesn't require being concentrated in a handful of AI-related stocks.
So that's, you know, we think that will continue to play out and the earning story is beneficial. You know, the Fed not hiking as those expectations come down, that's also beneficial to some of these more cyclical and non-AI parts of the market. So that's one key message.
We've said to seek opportunities in commodities. You know, gold, we downgraded the neutral a couple of months ago. We did see gold last week up about 8%.
It had sort of, you know, been sort of reaching a flow around $4,000. For year-end, we have a price target of $4,600, but by next June, we have it at $5,200. What's noteworthy is that a lot of investors were on the sidelines, whether it's institutional investors or certainly retail investors on gold after, you know, the big pullback.
Last week, there were reports of the Chinese central bank, the PBOC, actually kind of went out to buy gold. And then, you know, data points and anecdotes of investors then starting to kind of re-engage and realizing if the floor is in and there's upside here and that sort of structural trend to maybe de-dollarize questions about sort of, you know, Fed's, you know, kind of commitment to fighting inflation, that's kind of renewed a little bit as the Fed did not hike, you know, a couple of weeks ago. That sort of provides, you know, structural tailwinds for gold.
So even if it doesn't perform over the, you know, the rest of the year, like significantly, we still think on a more medium-term basis, it remains quite attractive as a diversified overall. So those are a couple of key messages that we hit the doggies of somewhere for investors to kind of keep in mind as they think about, you know, any adjustments to their portfolios for in the very near term. Well, Jason, always a very helpful touch base.
Great to be back with you here on Top of the Morning. Thank you again for keeping our listeners informed on the factors driving market movement and how to position accordingly. And as always, do look forward to picking back up with our conversation in the week ahead.
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