Markets and Political Sentiment

Last week, markets saw little movement overall, remaining mostly flat to slightly down. While a surprise election call captured headlines, global markets were more focused on Nvidia’s corporate earnings and the minutes from the US Federal Reserve meeting.

Interestingly, the FTSE 100 showed minimal reaction to the election news, with global trends having a greater impact on UK stocks than domestic politics. This is partly because little change is expected. A Labour victory appears almost certain, but the party’s self-imposed spending rules will limit the economic effects. There may be a slight boost to growth from public investment, but a significant policy change—such as improving trade and customs relations with the EU—remains unlikely. More important for the medium-term outlook are the Bank of England’s interest rate cuts, which will proceed unaffected by the election.

In the US, Nvidia’s remarkable six-fold profit increase underscored the ongoing AI boom. While the chipmaker’s earnings were highly anticipated, they were somewhat overshadowed by the Federal Reserve’s meeting minutes. The minutes noted a willingness among Fed members to tighten policy further if inflation risks materialise, which momentarily spooked investors. However, this should not be surprising, as inflation is a natural consequence of US economic strength. Recent price data has been more encouraging, and it’s unlikely the Fed will tighten again soon.

Currently, growth and inflation are acting as checks and balances on the markets. Investors are excited about strong business sentiment and profits, but these come with inflation pressures and the prospect of prolonged higher interest rates. The Fed doesn’t need to intervene much to prevent market overreach; the interplay of growth and inflation expectations does that naturally. In this environment, decent stock returns supported by earnings growth are likely, but dramatic increases are not. This seems like a reasonable trade-off.

AI Trade Broadening?

“Nvidia day” has become a globally watched event, and the AI chipmaker did not disappoint. First-quarter revenues were up 262% year-on-year, boosting its stock further and elevating the company to a $2.5 trillion market cap. Nvidia is the undisputed leader of the AI craze, having doubled its market cap from $1 trillion to $2 trillion in just nine months.

This impressive price action has some investors concerned about Nvidia—and AI stocks in general—being overvalued. Despite a landmark year for earnings growth, Nvidia’s 2023 profits were still below Home Depot’s and only slightly above Russia’s sanction-hit Sberbank.

It’s important to consider a few points. First, stocks can be overvalued even if they have great underlying potential and transformative products, as seen during the dotcom bubble. Second, overvalued doesn’t always mean a bubble. Stock market bubbles typically require exuberance fuelled by loose financial conditions, which we currently do not have.

AI stocks have high valuations, but so do many fast-growing US companies, where popular AI investments are concentrated. These valuations seem reasonable compared to the lofty predictions for generative AI, such as Goldman Sachs’ estimate that it will add 7% to global GDP over the next decade. Nvidia’s profit growth already supports such predictions.

Investors are focused on the profitability of these technologies, not just the hype. We are already seeing the AI investment theme broaden to include second-round beneficiaries, such as materials and energy providers needed for large data centres. Goldman Sachs estimates that power demand from data centres will more than double by 2030, benefiting utilities and those financing power purchase agreements. Investors are prioritising long-term opportunities over mere buzzwords, and identifying these profit opportunities is crucial.

US Election: It’s Politics

Despite strong US growth, many Americans are unhappy with President Biden’s economic handling. According to a Financial Times poll, 58% disapprove of his policies, and only 28% think he has benefited the economy. Inflation is the biggest concern, especially as the less well-off struggle with rising prices and interest rates. This inequality contributes to the widespread dissatisfaction despite strong aggregate data.

Political affiliation significantly influences US consumer sentiment. There is a strong correlation between economic outlook and party allegiance. This is not just about votes swaying to whoever promises better economic prospects; it also reflects deeper, more stable party loyalties. The divide in economic sentiment between Democrats and Republicans has more than doubled since the Obama and Trump presidencies. While it has shrunk slightly under Biden, it remains much wider than before.

Important

This article is for information purposes only – should not be perceived as financial advice. We recommend you should always speak to a financial adviser before making any investment decisions.

Please note, past performance is not a reliable indicator to future returns. Your investment may fall as well as rise, and you may not get back what you put in.