Investors look beyond the AI wobble

Media headlines need a headline number but the reality for investors is more nuanced. Last week’s AI wobble looks less worrying from the perspective of a diversified and balanced portfolio.

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Mixed bag

The US stock market fell by 1.5% last week, with cracks in the dominant AI theme grabbing attention. But look beneath the surface and it’s a more complex picture.

In sector terms, there were both winners and losers. Technology was off 3.7% and basic materials 1.9% lower. But energy stocks were 4.5% up and real estate 2.6% higher.

Similarly, while large cap stocks were 1.9% lower, small caps were only modestly in the red, down just 0.2%. In style terms, growth was 4.1% off but value stocks actually rose by 0.5%. Of 900 US companies tracked by Morningstar around 500 were up on the week and 400 down.

That mixed bag of performances makes a strong case for a diversified portfolio. Your experience of the markets in recent weeks will be very different if you were all in on semiconductor and memory stocks - the Korean market is down more than 20% from its early June peak - compared to a broad-based portfolio - the equal-weighted S&P 500 is up 2% over the past six weeks.

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What’s on investors’ minds?

Three key questions dominate as the first week of the traditionally slower summer period get under way. What’s happening in the Gulf? Where next for AI? And how do those two feed through into earnings, valuations and the overall level of the market.

On the geo-political front, the news flow is not great. Nine consecutive nights of air strikes and US deaths in the region make an early resolution unlikely. The oil price has bounced back, above $90 a barrel for the first time in a month. And that’s likely to reverse the recent favourable moves in inflation and so make cuts in interest rates less likely for the remainder of the year.

The second uncertainty - the outlook for AI - is even harder to call. The early enthusiasm for ‘picks and shovels’ investments in semiconductors, memory and other enablers like power generation and data centres looks to have run its course.

More interesting is who the long-run beneficiaries of the AI boom turn out to be. The internet bubble 25 years ago showed that the early objects of investor enthusiasm are not necessarily the long-term winners. No-one predicted in 2000 that the likes of Walmart and Domino’s Pizza would be the biggest beneficiaries of the new technology transforming the global economy. Something similar is bound to happen with AI.

And the comparison with 1999 matters because there are key differences too. The main one being that the current market boom is underpinned in a way that the earlier one wasn’t by incredibly strong earnings growth.

As we get into second quarter earnings season, forecasts point to annualised growth of more than 20%. That makes it hard for companies to beat expectations, but it underpins the current level of the market, keeping valuations in check and justifying recent gains.

In the spotlight

This week’s main focus will continue to be inflation and interest rates. After last week’s unexpectedly benign inflation print in the US, it’s our turn this week. Wednesday’s CPI data for the UK is forecast to show a modest reduction, again largely driven by lower petrol prices.

Meanwhile, the ECB makes its last interest rate decision before its summer break. No change is expected, after the region’s better than expected inflation reading, although rising oil could put a spanner in the works. The current odds on a July interest rate hike remain negligible at under 15%.

Burnham’s first 100 days begin

In more normal circumstances, a new UK Prime Minister might be expected to dominate the headlines. But in market terms its barely eliciting a shrug from investors. With seven Prime Ministers in a decade, we’ve got used to change in Downing Street. 

Attention now focuses on what the first 100 days will bring. More importantly from a market perspective, perhaps, will be what the Autumn Budget in October will throw our way. Let the speculation begin.

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• Read: What can we expect in the Autumn Budget?
• Read: Investing in the UK stock market: 5 British ISA fund ideas
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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Direct shareholdings should generally form part of a well-diversified portfolio of other investments. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.