AI glass turns half empty

Markets remain close to all-time highs, but sentiment has softened as investors shift their focus from the AI productivity story to the new technology’s perceived threat to existing business models.

Shifting sands

One moment AI is the great saviour, cutting costs and boosting profits. The next it’s a huge threat to the corporate status quo, creating uncertainty for increasingly precarious workers.

The reality is that the new artificial intelligence is both of these at the same time. All that’s happened recently in the markets is a change of emphasis. The glass was half full. Now it seems to be half empty.

So, while the Dow Jones index briefly sat above 50,000 at the start of last week, and the S&P 500 hovers close to an all-time high around 7,000, sentiment has soured.

Last Thursday, the US benchmark fell 1.6%, and the Nasdaq was 2% lower, as investors sought out the next AI victims. Wealth managers and business to business data providers have been in the spotlight. Last week, it was the turn of software as a service providers, providing a range of HR and customer handling services.

Markets have moved into a sell-first and analyse-later mindset. Some of the market moves may be an over-reaction. But in the short-term it has created a febrile mood.

It’s focused attention back on the Magnificent Seven. For so long the leaders of the pack, they have become the also-rans in the past six months. The market’s biggest tech stocks have gone sideways, a shift that’s been disguised by the rest of the market playing catch up. History suggests, however, that when the biggest companies in the index fall, it is hard for the headline index to hold up.

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Inflation in focus

It’s a quiet start to the week with much of the world on holiday. It’s President’s Day in the US today. The start of Lent and the Carnival celebrations are keeping markets shut for a couple of days in much of South America. And China is gearing up for tomorrow’s New Year celebration, which will keep traders on the sidelines all week.

So, markets may not reflect the new subdued mood very clearly this week. But there’s no shortage of data for investors to focus on.

Here in the UK, the main number in the spotlight will be Wednesday’s inflation print. The persistent rate of price increases may finally be coming to an end, with a fall in the consumer price index (CPI) from 3.4% in December to 3% expected. That should be the start of a series of declines to close to the Bank’s 2% target by April and, hopefully, a consistently close to target rate for the foreseeable future.

The Bank of England will be watching the inflation number closely. It will also be watching this week’s employment and wage data and retail sales on Friday. All in all there will be enough data to clarify its view of where next for interest rates. They were held at 3.75% in February and financial markets are pricing in a 60% chance of a cut in March and a slightly higher probability of a cut in April.

Bullish bonds

Sentiment may be softening in the equity markets but fixed income investors remain resolutely bullish. Corporate bond prices continue to rally, pushing down the reward required by investors for taking the extra credit risk of lending to companies rather than governments.

Typically, investors demand a higher yield for lending to companies because they are more at risk of default than governments. But recently, they have settled for less of a premium because they prefer to lend to relatively conservative companies than more free-spending governments. The spread between the yields on corporate and government debt is narrower than at any point since the 2008 financial crisis.

This is understandably making investors wary. Although the US economy is expected to be run hot in the lead up to the November mid-terms, boosting growth, analysts warn that tighter yields make corporate bonds increasingly vulnerable to an economic slowdown.

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