Trick or Treat
On the evening of October 31, children in costumes go from door to door asking, “Trick or treat?” Whoever opens the door decides what follows: a small, sweet treat or a trick. In financial markets, too, treats and tricks are currently close together. What looks sweet today may well taste sour tomorrow.
The economy provides the first treat. Corporate earnings growth is particularly encouraging, and an important driver is the investment cycle around artificial intelligence. Strong demand for AI infrastructure is creating new revenue and earnings potential and is thus supporting equity markets.
Yet AI itself is increasingly becoming a source of tricks. The market has high hopes that heavy investment will generate not only revenues but also sustainably rising margins and earnings. This has contributed to valuations falling for months despite rising share prices: earnings expectations have risen even faster than prices. The seemingly low forward P/E ratios are therefore tied to a demanding condition. In semiconductors in particular, current valuations assume exceptionally strong earnings growth. If these expectations are not met, valuation ratios can change quickly.
The macro side has a few tricks itself. High energy prices are adding to inflationary pressure, making it harder for central banks to steer monetary policy. At the same time, large government deficits and rising term premiums are pushing up long-term bond yields. Higher yields are attractive for bond investors, but they also raise the cost of capital and put pressure on risk assets.
October showed that markets are sensitive to these tensions. However, this does not signal a lasting trend reversal. As long as the economy and earnings remain intact, the treats outweigh the tricks from today’s perspective. Expectations are high, however, and so is the potential fall.
Enjoy the read.
Best regards,
Gzim Hasani, CEO
Bekim Laski, CFA, Chief Investment Officer
