We might expect a deceleration of the global economy, but it will be soft, because there are some seeds that could grow within a few years. Although there are cumbersome presences on the parterre that could create not a few risks, the impact on investors is limited, while the interest is still being generated by the technology and artificial intelligence. Matthew Ramenghi, Chief Investment Officer of UBS, in this interview explains what the risks and possible positive effects on economies are.
Matteo Ramenghi, how do you assess the market performance over the summer in light of the wave of quarterly data and inflation figures that were less worrying than expected?
The summer was a positive one for stock markets. They hit new records, buoyed by publicly traded profits and lower-than-expected US inflation, fueling expectations of more accommodative monetary policy from the Federal Reserve. Valuations continued to rise, and the S&P 500's price-to-earnings ratio surpassed 22x, near its highest level in twenty years.
Yet investors are also keeping an eye on the numerous underlying risks: from the independence of the Federal Reserve, to geopolitical tensions in Ukraine and the Middle East, to tensions over international tariffs. Not to mention the ongoing political crisis in France, with the prime minister awaiting a vote of confidence on Monday. How do you assess their behavior?
It's true that several risks are looming in the background, but they have had a limited impact on investors' decisions. For example, the independence of the US central bank remains a controversial issue: Fed Chairman Jerome Powell's term expires in ten months, while Trump has intensified his criticism, and two changes to the governing committee could occur. On the geopolitical front, despite the meeting between Trump and Putin in Alaska, peace in Ukraine still appears distant. Some market surveys place only a 35% chance of a ceasefire by the end of the year. When it arrives, it could have positive economic effects for Europe, with exports unblocked and a reconstruction project estimated by the International Monetary Fund at over $500 billion.
And then what?
The sharp increase in US tariffs is beginning to have some effects, both on inflation and on exports for certain sectors and countries. Trump has taken a very firm stance toward Europe, while China has obtained another postponement until early November. Political and financial tensions persist in France, with a new vote of confidence for the Bayrou government scheduled for September 8th. The country is failing to adopt measures to contain the deficit, which remains above 5%, while public spending exceeds 56% of GDP, well above the European average. French government bond yields, which have essentially reached those of Italy, could be further impacted by potential rating downgrades.
In this context, technology seems to be the preferred option for investors.
Technology continues to dominate the stock markets: never before have so many investors concentrated so much capital in so few stocks. Today, the top ten stocks in the US index represent approximately 40% of the total market capitalization. After a strong performance, expectations for this sector are extremely high, and the margin for error is limited. For example, Nvidia shares fell 3% immediately after the company posted better-than-expected results in both revenue and profit and confirmed it would be able to sell artificial intelligence chips in China.
However, doubts have emerged about the true profitability of the stellar investments made in Artificial Intelligence, as MIT recently found.
Capital investments in AI by the four largest companies (Meta, Microsoft, Alphabet, and Amazon) exceed $200 billion annually. However, revenue growth is not keeping pace with these investments, and the scale of depreciation is putting pressure on margins. A recent MIT survey reports that 95% of the companies surveyed have yet to realize quantifiable benefits from AI investments. A similar call for caution comes from OpenAI CEO Sam Altman, who noted that some investors are showing "overenthusiasm."
Some believe this data suggests the creation of a market bubble, particularly in the tech sector. What do you think?
"Currently, the signals are mixed. Valuations are certainly very high, and bubbles historically coincide with periods of enthusiasm for new technologies. The US stock market has high multiples, but it's important to note the difference between the Magnificent Seven tech giants, which are trading at nearly 30x, and the other stocks, which are trading below 20x."
Has there been an increase in the presence of retail investors lately? Do you think the debt in the markets is excessive?
Another factor to monitor is the participation of small investors, which is now much higher than pre-pandemic and tends to be procyclical. However, leverage on stock market investments stands at 1,8% of market capitalization, close to the long-term average and far from the levels of the 2000 dot-com bubble. Therefore, there is no significant overhang in the markets. Furthermore, one of the typical causes of a bubble bursting is a rapid rise in interest rates. Conversely, we expect the Fed to cut rates by one percentage point by June, while the economic benefits of recent rate cuts in Europe will gradually be felt.
Overall, how do you see the global economy going?
"Overall, we expect the global economy to slow without any major shocks, for future corporate earnings to be strong, and for a decline in interest rates to support markets next year, although some volatility is possible or even likely. In the short term, there is also a real risk of AI overspending," but in the medium to long term, exposure to technology remains important for portfolio performance.
What is your advice for those who have already invested in the stock markets?
“Investors already aligned with their strategic asset allocation in terms of equity exposure may consider remaining invested, despite some dizziness at these levels.”
And what about those who are underexposed?
These investors can leverage any corrections to increase their positions in long-term themes such as artificial intelligence, electrification, and longevity. Falling US rates tend to favor emerging markets, and we are looking with interest at the Chinese tech sector and India.
Regarding investment-grade bonds that are offering good returns, how do you foresee the trend?
"In the bond space, well-rated issues continue to offer attractive yields relative to expected inflation; yields on 5-year government bonds could decline further in the coming months, and we continue to favor intermediate maturities (7-XNUMX years). Finally, we remain cautious on the dollar given the high public deficit and more accommodative monetary policy."
