Market Snapshot is a weekly view from our portfolio managers, offering sharp, thematic insights into the trends shaping markets right now.
Fast reading
- The Nasdaq Composite tumbled 7% from 2 June to close on Wednesday, following a spectacular rise of more than 30% over April and May.
- The ECB raised rates on Thursday for the first time in nearly three years as it seeks to contain price rises unleashed by the Iran conflict.
Global stocks endured a bumpy week as investors fretted about the escalation in hostilities in the Middle East and the potential sustainability of tech valuations.
Sentiment will not have been helped by a spike in US inflation in May to 4.2%, up from 3.8% the previous month, as the energy shock drives up prices for US consumers.
The tech-heavy Nasdaq Composite tumbled 7% from 2 June to close on Wednesday, following a spectacular rise of more than 30% over April and May1. The S&P 500 has slumped 4.5% after rising 20% over the equivalent periods2.
“Corporate fundamentals haven’t changed, and yet equity markets feel different this week,” says Lewis Grant, Senior Portfolio Manager, Federated Hermes. “Are investors simply pausing to catch their breath, or is the party over? For the most part, it’s the sentiment that’s shifted rather than the facts.”
On top of this, Grant adds, there is a general acceptance that the US-Iran ceasefire is in name only and little progress is likely to be made in the short term. “The much-promised US-Iran peace deal remains elusive, and the resulting rise in inflation will lead interest rates higher rather than lower, and higher rates are a headwind to valuations,” he says.
Figure 1: Where next for the Nasdaq?
ECB hikes rates
On Thursday, the European Central Bank (ECB) raised rates for the first time in nearly three years as it seeks to contain price rises unleashed by the conflict. The 25bps hike lifted the ECB’s deposit facility rate to 2.25%. The move follows a rebound in eurozone inflation, which rose to 3.2% in May.
Mitch Reznick, Head of Fixed Income – London at Federated Hermes, says that while the ECB rate hike was widely expected, it does not necessarily indicate the re-launch of a tightening cycle.
“The spectre of stagflation is increasing as pressure on consumers and businesses builds due to the continued closure of the Strait of Hormuz. From here, the ECB may not want to compound such pressure by putting the brakes on the economy to mitigate the supply-shock-driven spike in inflation expectations,” he says.
The pan-European Euro Stoxx 600 has seen noticeably volatile trading over the last two months, rising less than 1% in the period between 10 April to 10 June3.
Reznick adds that should credit markets interpret commentary from the ECB as hawkish, with a tilt toward a tightening bias, it could lead to pressure on over-levered pockets of credit markets. “A stagflationary environment would make it more challenging for these companies to grow into their capital structures,” he adds.
Earnings still strong
Grant remains optimistic that equity investors will soon find reasons to return to the table because of the strong earnings revision cycle.
“It was always expected that the artificial intelligence (AI) data centre build-out would require fresh capital, but now the term sheets have been presented investors are again questioning the scale of the expenditure,” he says.
“The size of the AI capital expenditure (CAPEX) may be immense, but the downstream effects are benefitting a broad range of businesses and making meaningful GDP contributions.”
Grant continues: “The related productivity gains and margin improvements are keeping earnings per share (EPS) growth buoyant, although we acknowledge the eventual return on capital [at some of the tech companies] is an ongoing question.
“Clearly risks remain, and investors should be careful not to let their exuberance cloud their better judgement. While index level volatility has only shown signs of spiking this week, individual stock volatility has been trending up for much of the year. A cooling off period after the last couple of weeks is no bad thing: some of the individual stock price moves were eerily reminiscent of earlier boom-and-bust cycles.”
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