Markets Confounding Recession Expectations

June 2023

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Despite all the talk of slowing economies and recession, equity markets have delivered strong returns for the first five months of 2023.

Equity Markets

The following chart shows that the global equity market is up over 10% year to date (over 8% to end of May).

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As discussed last month, the strong performance of equity markets has been concentrated into a few technology stocks, which in turn are benefiting from their perceived strong positioning to benefit from the rise of Artificial Intelligence.

By way of example, the technology heavy US NASDQ is up over 30% year to date.

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Artificial Intelligence (AI)

AI is a branch of computer science that aims to create machines capable of displaying intelligent behaviour. It involves programming computers to process information, make decisions, and learn from experience similarly to how humans do.

Machine Learning (ML), a subset of AI, uses algorithms to analyse large data sets, learn from this data and make predictions or decisions without being explicitly programmed to perform the task. Deep Learning, a further subset of ML, structures algorithms in layers to create an "artificial neural network" that can learn and make decisions on its own. ChatGPT, which has quickly become one of the best know apps uses deep learning.

AI has broad applications across numerous fields including healthcare, education, transportation, and security among others. It's being used to analyse and interpret complex data, assist in disease diagnosis, automate tasks, personalise learning, and much more.

While AI holds immense promise, it also presents significant challenges. Ethical considerations such as privacy, job displacement due to automation, and decisions made by AI systems are key issues that need addressing.

Overall, in my personal view, the advent of AI will in time prove truly transformational, but what it will mean for different individuals, companies, sectors and markets will not become fully clear for some time.

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Nvidia, a Trillion-Dollar Company

The market cap of Nvidia now tops €1 trillion dollars, only the 5th company to achieve that landmark valuation and the first chip company to do so. Apple was the first company to reach a trillion-dollar valuation in 2018.

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Nvidia Corporation, founded in 1993, is a globally recognised technology company, best known for creating graphics processing units (GPUs) essential for gaming. The company is now regarded as a?key player and innovator in the AI sector, providing powerful software and hardware solutions that facilitate the development and deployment of AI models.

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Better Cash Returns Available

Over the past year, the ECB has raised rates by almost 4%, but banks are not paying up. We are busy helping our clients to achieve better returns on their cash, while also diversifying individual bank risk. After many years of negative rates on safer assets, it is good to be able to help clients to achieve positive returns on cash. While there are negative aspects to higher inflation and interest rates, the approach we are using is now delivering positive returns of 2-3%, and will continue to increase in line with European short-term rates.

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EU Core Inflation Down a Little

Core Euro inflation (yellow line) has fallen a little further in May but remains well above the long-term target of 2%. As a result, we expect the ECB to raise interest rates again next month.

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Economies Proving Resilient

There is a lot of uncertainty out there about what happens next. In the US the most anticipated recession of all time still has not arrived in the numbers. As such, investment markets can’t decide what will happen to interest rates as the following graph clearly shows.

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The graph shows that the market no longer expects the Fed to cut rates this year, but clearly that view has oscillated a lot over the past five months.

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US Gets Past Debt Ceiling Problem

The US managed to avoid a crisis by agreeing to raise the debt ceiling.

Crypto

The US Securities and Exchange Commission (SEC) has in recent days sued both Binance and Coinbase. Between them, these two companies account for half of global trading in digital assets. While crypto or digital currencies are continuing to evolve, it is clear that at least for now, this remains a risky and largely unregulated asset class.

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May and YTD Market Numbers

So, as we can see both equities and bonds are up in the first five months of the year, while energy costs continue to fall.

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Our Investment Outlook

Overall, we remain cautious about what happens next recognising that (a) it takes time for higher rates to have an impact, (b) that core inflation remains high and (c) we continue to see lots of indicators pointing in difference directions.

• The impact of the fractures in the banking sector is to ultimately put further downward pressure on economic growth.
• That downward pressure, if it translates into a reduction in company earnings, may ultimately lead to an uptick in unemployment (the jobs market has remained incredibly resilient up to now).
• Central bankers likely need to be more data dependent going forward and see core inflation begin to fall if they are to avoid raising rates further. The risks of a policy mistake (by raising rates too far) have also increased, particularly in the EU.
• Ukraine and other geopolitical risks remain significant with bad outcomes not currently priced into markets. The core assumption of markets, at the moment, is that the Ukraine war will not end, or escalate significantly any time soon.
• Overall, markets are likely to remain volatile until there is more certainty around (a) financial stability, (b) core inflation falling back to the target of 2% and (c) the depth and length of economic slowdowns / recessions.

For short-term investors, this is not a market to be in, but for our clients who are long-term investors we continue to advise them to follow their plan and use market weakness to build on positions.

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John Tuohy is Chief Executive of Acuvest, an Irish-owned, independent advisory firm specialising in wealth management, pensions, and investment advisory services for individuals, companies, pension schemes, charities, and institutions. John is a Chartered Financial Analyst (CFA) and a Fellow of the Chartered Association of Certified Accountants.