A One-Two Punch

Two influential organizations, the OECD and World Bank, both warned last week that the global economy is in a precarious state and heading for a substantial growth slowdown later this year. To add to the bearish mood, strategists at Morgan Stanley said they expect a sudden pullback in corporate earnings to slam the brakes on the recent US stock market rally. To be sure, not everyone agrees, with bulls pointing to the fact that the handful of tech stocks pushing the market higher today all belong to good companies with what they like to call “assured growth” due to AI. In fact, in a research report out last week, Bloomberg Intelligence estimated that the generative AI market will expand at a compound annual growth rate of 42%, reaching $1.3 trillion by 2032.

Elsewhere, oil prices jumped at the start of last week after Saudi Arabia pledged to cut output by 1 million barrels a day from July. Global bond yields also spiked after two shock interest-rate hikes last week served traders a reality check that central banks are far from done fighting inflation. Finally, the US securities market watchdog delivered a one-two punch to the digital assets industry last week, suing both Binance and Coinbase for a wide range of violations. Find out more in this week’s review.

Macro

In its updated outlook published last week, the OECD said that the global economy is poised for a sluggish recovery following the impacts of Covid and the outbreak of war in Ukraine, dogged by persistent inflation and the restrictive measures implemented by major central banks to mitigate rising price pressures. The organization forecasts global economic growth will slow from 3.3% in 2022 to 2.7% this year, before picking up to 2.9% in 2024. Both those levels are below the 3.4% average in the seven years before the pandemic. The US, the euro area, and China are all expected to see the same relative sluggishness in their recoveries, according to the OECD.

The OECD’s cautious outlook comes a day after the World Bank issued a similar warning about the delicate state of the global economy, saying a significant growth deceleration is imminent later this year as tighter monetary policy exacerbates the lingering shocks from the pandemic and the ongoing conflict in Ukraine. Greater-than-expected resilience in the early months of 2023 led the institution to raise its global growth forecast for the year to 2.1% from the 1.7% predicted in January. But it cut its outlook for 2024 to 2.4% from 2.7%, and warned that risks to the outlook remain tilted to the downside.

Elsewhere, global bonds slumped last week after two shock interest-rate hikes served traders a reality check that central banks are far from done fighting inflation. Both the Bank of Canada and the Reserve Bank of Australia surprised markets with more rate hikes to combat stubbornly high price gains. The moves led to a big selloff in global bonds and pushed traders to rethink their bets of US rate cuts later this year, with interest rate futures at one point fully pricing in a 25-basis-point hike by July. All eyes will be on US inflation data this week, which will provide further clues on the Fed’s future path.

Stocks

The S&P 500 entered a bull market last Thursday after surging more than 20% from its October low, but not everyone is convinced the good times will keep rolling. In a research note published at the start of last week, strategists at Morgan Stanley said they expect a sudden pullback in corporate earnings to slam the brakes on the US stock market rally. More specifically, they expect earnings per share for the S&P 500 to drop 16% this year, driven by slowing revenue growth and shrinking profit margins. On the back of that, the investment bank expects the S&P 500 to end 2023 at 3,900 – roughly 9% below today’s level.

Instead, the strategists are optimistic about stocks in Japan, Taiwan, and South Korea. The tech-heavy markets of Taiwan and South Korea, after all, are seeing their world-leading semiconductor companies benefit from the booming demand for all things AI. Corporate reforms, the return of inflation, and a recent endorsement by Warren Buffett, meanwhile, have stirred excitement for Japan’s undervalued stocks, sending them to a three-decade high last month. Morgan Stanley also recommends holding shares of companies in defensive sectors, investment-grade corporate bonds, the US dollar, and developed-market government bonds, particularly long-term Treasuries.

To be sure, not everyone is as pessimistic as Morgan Stanley when it comes to the US stock market. Goldman Sachs, for example, anticipates mild growth in S&P 500 earnings per share in 2023. Evercore ISI, meanwhile, recently raised its S&P 500 target for the year-end by 7% to 4,450. The firm believes that easing inflation will push the Federal Reserve to pause its aggressive rate-hiking campaign, and that the stimulus provided during the pandemic will continue to support the stock market. Time will tell which investment bank ends up being correct.

One of the bears’ key arguments is that the breadth of the current market rally is just too narrow. If you recall from last week’s review, we explained how US stock indices have never relied on such a small number of stocks to stay afloat, with the market being largely bolstered by the growing frenzy for AI. And you don’t need to look too far back in history to remember that the tech sector’s extreme dominance set the stage for the dotcom crash in 2000.

But the bulls argue that things are different this time because the handful of tech stocks pushing the market higher today all belong to good companies with what they like to call “assured growth”. To put that “assured growth” argument into perspective, consider a recent report by Bloomberg Intelligence that estimates that the generative AI market will expand at a compound annual growth rate of 42%, reaching $1.3 trillion by 2032, from $40 billion last year. With such impressive growth ahead, don’t count on the AI hype calming down anytime soon…

Commodities

Oil prices jumped at the start of last week after Saudi Arabia pledged to cut output by 1 million barrels a day from July, taking its production to the lowest level in several years. The move comes as oil prices have slid over the past 10 months despite multiple efforts by producers to limit supply. In April, Saudi Arabia and other OPEC+ members announced a surprise cut, causing the price of WTI crude to briefly rally above $80 per barrel. However, it has since reversed, dropping below $70 per barrel at one point last month as demand concerns weighed on the outlook, especially in China. Analysts reckon that Saudi Arabia’s latest move will provide downside protection rather than fuel a sustained rally, and while it may offer short-term price support, the overall market dynamics for the coming years remain largely unchanged.

In announcing the surprise cut, the Saudi Arabian energy minister said he “will do whatever is necessary to bring stability to this market”. That’s left Saudi Arabia potentially sacrificing further market share in an effort to prop up prices. Other OPEC+ members pledged to maintain their existing cuts until the end of 2024, while Russia made no commitment to curb output further and the United Arab Emirates secured a higher production quota for next year.

Crypto

The US securities market watchdog delivered a one-two punch to crypto exchanges last week. On Monday, the Securities and Exchange Commission (SEC) sued Binance – the world’s biggest crypto exchange – for a wide range of violations, including mishandling customer funds, misleading investors and regulators, and breaking securities rules. A day later, the SEC sued Coinbase – the largest US crypto platform – for allegedly evading regulations by letting users trade numerous crypto tokens that were unregistered securities (according to the SEC).

The lawsuits are the clearest signs yet that US regulators are serious in their crackdown on the crypto market, which could push digital currencies back to the fringes of the American financial system. Coinbase, which generated over 80% of its revenue in the US last year, is now facing a near-existential threat to its business model. As you can probably imagine, investors didn’t take the news too well: they sent Coinbase’s shares 12% lower on Tuesday.

This week

• Monday: Earnings: Oracle.
• Tuesday: UK labor market report (May), US inflation (May).
• Wednesday: UK monthly GDP (April), Fed interest rate decision, eurozone industrial production (April).
• Thursday: Chinese industrial output and retail sales (May), ECB interest rate decision, US retail sales (May). Earnings: Adobe.
• Friday: Bank of Japan interest rate decision.