The bulls are back. After a few weeks of wobbles brought on by trade tensions and concerns that mega cap tech valuations are at odds with reality, markets this week regained their swagger. A trio of developments – cooler inflation, renewed trade optimism and the onset of Big Tech earnings – has restored animal spirits. Whether this latest bout of exuberance endures through Christmas will depend on whether reality bites.
Cooling, with caveats
The first reason for cheer was inflation. Last week’s inflation data out of the US was unequivocally good news. Consumer prices are still above the Federal Reserve’s 2% but trending down. September data showed durable goods and core services easing, even in areas affected by Donald Trump’s tariffs. Investors duly seized on the belief that the disinflationary dynamic remains intact.
Yet, as ever, there are caveats. Goods inflation looks benign largely because car prices, both new and used, have plunged. Strip out autos and core inflation runs above 4% on an annualised basis. Services tell a similar story. Remove the depressed shelter component (which typically lags other sectors) then “supercore” inflation similarly hovers near 4%, fuelled by steep airfares and other volatile categories.
Regardless, the broad direction is enough to give the market hope. Inflation may not be tamed but it certainly appears more docile. The market, as ever, is pricing in progress rather than needing perfection. Traders now expect rate cuts through 2025 and into 2026 and believe this will be enough to get consumer sentiment booming again and hopefully breathe life back into a stalling house market.
Trade winds blowing again
A second source of investor optimism lies in geopolitics, or the (temporary) pause thereof. After weeks of bickering and tension, the world’s two largest economies are talking again. Treasury secretary Scott Bessent and China’s vice-premier, He Lifeng, met in Malaysia over the weekend ahead of the first Trump-Xi summit since 2019, which is scheduled for later this week. The talks, according to both aides, were “constructive” and produced a “basic consensus” on a framework that will hopefully cover export restrictions on rare earths, shipping levies, fentanyl and Chinese purchases of US soybeans.
Trade truces, and even more so the mere noise around them, have a habit of being less durable than hoped. Still, even a temporary pause in tariff escalations gives investors reasons for hope that following the dialogue will come tangible and more lasting progress. US equities duly rallied.
The five that shape the world
The third and final act of this week’s market theatrics belongs to Big Tech. On Wednesday and Thursday, five firms – Microsoft, Alphabet, Meta, Amazon and Apple – unveil their latest results. Together they account for roughly a quarter of the S&P 500 market capitalisation. What they say about cloud computing, digital advertising and, of course, artificial intelligence will shape sentiment and the direction of the stock market for the final quarter of the year.
AI hype has fuelled a three-year bull market. Yet, as questions mount over when the vast investments into AI will pay off, investor patience is showing signs of strain. For the rally to continue, these giants must convince investors that betting hundreds of billions on AI capex – an estimated $360-billion this year, rising to $420-billion next year, according to Bloomberg estimates – will translate into actual profits and not mere hype.
None of this is to say the AI bet isn’t a good bet, it is merely to point out that it is a bet. The chips have been pushed to the middle of the table and if the cards fall badly, the losses will be painful.
Thus far the earning season has impressed – 85% of companies reporting have beaten expectations, which according to Bloomberg is the best showing in four years. But the fate of the stock market over the remainder of the year rests on this handful of tech behemoths and their wager on AI. Its success, or failure, will dictate whether the current bull market stretches into next year or comes crashing back down to reality.
Echoes of 1999
Amid the hype and bullishness lie several unsettling echoes of the late 1990s. Back then it was the dotcom start-ups with no earnings. Today it is the loss-making firms in AI-related sectors such as software, biotech and beyond. Torsten Slok, chief economist of Apollo, notes that since Trump’s “liberation day” tariff announcement unprofitable companies in the Russell 2000 benchmark have astonishingly outperformed profitable ones.
It’s an uncomfortable rhyming of history with the dotcom boom, when negative-earnings companies also overtook those with positive earnings for a prolonged period. Then, as now, investors justified exuberance by pointing to a technological revolution which would transform productivity and profits. This time the hype is draped in the dreary language of machine learning rather than the upbeat froth of pet-food delivery start-ups. But the dynamics are eerily familiar.
Bubble talk is everywhere. David Solomon, boss of Goldman Sachs, recently likened the current mood to dotcom mania. A Bank of America survey shows that a record share of fund managers is calling AI stocks a bubble. Even Sam Altman of OpenAI, whose firm sits at the centre of this feeding frenzy, said “yes” when asked if there was an AI bubble.
The International Monetary Fund, rarely excitable, joined the chorus last week. Asset valuations, it warned, stand “well above fundamentals”, raising the risk of a “sharp correction”. Markets, they add, appear “complacent as the ground shifts”. The message, from an institution not prone to alarmism, was clear: buckle up.
And yet markets continue humming along as if nothing is wrong. This is not mere complacency; that would imply a lack of awareness of the dangers lurking in the shadows. It is something darker; an explicit decision to blithely ignore the obvious downsides and carry on regardless.
Investors are left with a tough choice. Err on the side of caution but risk missing out on another leg-up of what could be another couple of months or even years of upside? Or just close your eyes and dive in, regardless of mounting risks?
When sentiment is this strong, it is clear what investors are doing. Far too many money managers are quoting former Citigroup CEO Chuck Prince, who said, “as long as the music is playing you have to stand up and dance”. They all know he said that just before the financial crisis, but they aren’t being ironic.
The music is playing and investors are dancing, but for how much longer no one knows. For the time being, party on. DM