Blog: You, us, everyone

In little less than a ½ year, global stocks are up about 25 percent while at the same time, some companies related to AI were up 50 percent and more. 

Multiple driving forces are moving the market. Firstly, we note that easier financial conditions were positively impacting the market rather than better sales and earnings ratios. Long-duration stocks related to AI had an excellent comeback and higher asset prices often beget even higher prices – as investors feel compelled to participate and as they don’t want to miss out on the upward-moving market – so it is a kind of euphoria.  From a purely fundamental point of view, it’s hard to justify the higher index-level valuations, given that 2024 and 2025 earnings forecasts have barely moved over this period.  

So, markets are back to the “Boom-Bust” mode, which we have seen before. The last time this occurred was in 2020 when governments shifted to a fiscally dominant policy in response to the pandemic. In contrast to today, top-line growth was supported by a massive operating leverage as companies benefited from new technologies, shorter working procedures, and the reduction of headcount while workers and entire families were locked down at home. 

This resulted in the fastest earnings growth in 30 years, record high margins and profitability were the new standard.  The boom in equity prices was preceded by earnings growth. Additionally, valuations were also supported by cheap money and arguably the most generous monetary policy in history. The Fed continued Quantitative Easing throughout 2021, a year when S&P earnings grew 48 percent to an all-time high.

Today, stock valuations have reached similarly high levels achieved back in 2020 and 2021, yet the fundamentals are different. Most companies have experienced earnings deterioration, financial conditions have changed, in particular borrowing costs, and consumers and SMEs are somehow reluctant to engage with big-ticket purchases.

For now, average bottom-up earnings expectations for 2024 and 2025 remain flat, post the Fed’s fourth quarter dovish shift. In the case of small-caps, earnings estimates are down 10 percent for 2024 and 7 percent for 2025, foreshadowing a turnaround. The question for investors at this stage is whether the market can finally increase more sustainably. The ultimate answer to this is whether companies can deliver the expected earnings growth. 

The classic late-cycle winners can be found in AI-driven infrastructure developments, aka data center build out and energy. The sector is lagging big-times the market rally since October 2023 and loosening financial conditions could positively impact capital-intensive companies. While there are some ESG concerns around some fossil energy companies, we note that the sector’s valuation is compelling and remains one of the cheapest and most under-owned asset classes in the market.