Market Essentials | June 14, 2024 edition

The AI speed train

Well, it’s still all about the AI speed train. The tech sector is undertaking a rush of capex spending on AI and its infrastructure, and it’s this that’s underwriting the U.S. economy. Consumption may be slowing, and hiring may be easing, but the levels of investment spending on data centers, and the advanced and expensive components needed to support the AI boom, show no such signs.

Our updated forecasts

Here at DWS, we have just finished our latest quarterly CIO Day on June 13th  where all the firm’s economists, portfolio managers, and strategists debate our 12-month forecasts. We don’t entirely dismiss the chance of a recession, but we think it has gone from a normal probability of perhaps 15%, to now more like 10% or less, effectively a tail risk. For the U.S. equity market, we raise our 12-month target for the S&P 500 from 5,300 to 5,600. This is our June 2025 forecast (from March 2025 before), and I would normally associate rolling a forecast out a further three months with about an additional 100 index points. But this is 300 higher – why?

• Well, first of all, I have raised my earnings forecast for next year from $265 to $270 per share, that’s earnings growth of around 11% for the next twelve months, and I am forecasting 10% growth through 2026.
• And, secondly, I am keeping my relatively high price-to-earning (PE) multiple of 21.5 on those earnings, that’s how we justify our forecast.
• Take a moment to reflect that year to date, the S&P 500 – which is now effectively a growth index – is up around 15%. Pure growth is up around 20%, and value and small cap are up 5% and flat respectively. That’s been the story of the year so far – large cap growth.

Let’s be clear…

I still think the economy should slow, and I do think the U.S. Federal Reserve (Fed) will cut, but not before the election. The truth is that the rate setters at the Fed need more clarity on a number of key issues – the path of the Trump tax cuts, tariffs and trade policy, and fiscal policy – before they can confidently make their next move. I think December is likely the timing of a first cut, and then I’d suspect a quarterly cadence from there, with perhaps 75 basis points (bps) of easing in total. The market is still bifurcated, it’s the Great Eight, and the Other 492 and, frankly if the market cracks, I think it’s this latter group that are more likely to be the catalyst, and drag tech down with them.   

Sober optimism

If I had to sum it up, I like the phrase “sober optimism.” It’s fine to be optimistic, and, yes, my earnings growth forecasts are positive – they have to be to justify the 5,600 we discussed. But, for tech and communications to grow their earnings at 15%, with U.S. GDP at more like 1.6-1.8%, well that’s not normal. Beware of paying too much too soon, and not getting enough upside potential –  many companies are already priced for this substantial growth, now they need to justify it. I am reminded not of 1995, but of 1999 – in terms of valuations, enthusiasm, concentration, and household equity allocations. I suppose I worry that we’re partying like it’s 1999! Yes, tech keeps giving us actual, and very impressive earnings growth (which at least is one difference to 1999), but we still have a fiscal problem, and we still have an inflation problem. I can assure you that inflation is like a golf handicap – going from 3% to 2% is a lot harder than going from 6% to 3%.

 

Enjoy the party, but beware the hangover…  

– David