Jean Boivin – Head of BlackRock Investment Institute together with Wei Li – Global Chief Investment Strategist, Beata Harasim – Senior Investment Strategist and Carolina Martinez Arevalo – Portfolio Strategist all forming part of the BlackRock Investment Institute share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
Key Points
Tech rally rolls on: We see a small group of tech winners leading stock gains as a feature of the artificial intelligence (AI) theme – not a flaw. We stay overweight U.S. stocks.
Market backdrop: The S&P 500 notched a fresh all-time high last week, led by tech stocks. U.S. 10-year Treasury yields held steady near 4.25% during the holiday-shortened week.
Week ahead: We’re eyeing to what extent U.S. PCE inflation for May shows a slowing of services inflation after upside surprises earlier in the year.
U.S. stocks have climbed to all-time highs thanks to the technology sector. We’re less concerned than some in the market about the small group of tech stocks driving gains. Why? First, excitement over AI is being met by tech firms delivering on and beating high earnings expectations. Second, profit margins for tech are leading the market, but they’re also recovering in other sectors as cooling inflation eases costs pressures on margins. We stay overweight U.S. stocks on the AI theme.
We think strong gains for tech stocks have been fueled by market focus on AI and investors preferring quality given high macro and market uncertainty. The sector is up 30% this year, nearly four times higher than the rest of the S&P 500, according to LSEG Datastream data. See the green and orange lines in the chart. Looking back to 2023, tech’s dominance is even clearer: The sector has soared 100% since then, while the rest of the index rose 24%. AI has helped drive that outperformance by brightening corporate earnings for tech firms. Analysts expect they’ll rise 20% in the next 12 months – well above forecasts for the rest of the market. Tech firms have so far delivered on lofty expectations: Their earnings grew 23% year over year in Q1. In a world where mega forces – big structural shifts – drive returns now and in the future, we eye the short- and long-term impacts of AI on earnings.
Strong balance sheets are also a reason we like tech, and we are less concerned about valuation metrics. Free cash flows – excluding operational costs – as a share of sales are nearly double for tech than for the broader market, and tech has the largest profit margins across sectors, LSEG Datastream data show. Plus, many top tech names are highly profitable and cash-flush, allowing them to fund the buildout of AI infrastructure such as data centers. A search for such quality may have spurred investors to flock to U.S. stocks even more in recent weeks as their European counterparts have retreated. Much of the slide in European stocks came after the results of the European Union elections and news of a snap election in France.
Broadening earnings
U.S. tech strength is overshadowing gains that are broadening out to other sectors – up about 8% so far this year. Eight of 11 of the S&P 500 sectors saw higher margins in Q1 versus the same period last year. The reason: support from nominal GDP growth that looks set to remain above the pre-pandemic average due to higher inflation. That outlook seems likely even as the pace of real, or inflation-adjusted, growth slows. Inflation falling from its pandemic peaks – though remaining high – has eased pressure on margins by lowering costs. Guided by mega forces, we see sectoral opportunities as risk appetite broadens out. We still favor healthcare given support from recovering earnings, drug innovation and aging populations. We also like the industrial sector because it will help build out the infrastructure needed for AI and the low-carbon transition. Supply chains rewiring along geopolitical lines will also affect the sector as companies and countries bring production closer to home.
What could halt the climb in tech stocks? Markets could lose favor for the sector if hopes for AI are dampened, such as if they feel corporate spending on AI hasn’t paid off in a boost to earnings or margins. Any regulatory changes limiting adoption could also affect AI’s potential to keep supporting tech. In a less likely scenario, other sectors could jump ahead of tech if growth accelerates, and inflation falls enough to allow the Federal Reserve to cut interest rates more than expected.
Our bottom line
The concentration in U.S. tech stocks is a feature, not a flaw, of the AI theme. We stay overweight U.S. stocks on a six- to 12-month, tactical horizon and still prefer the AI theme. We like industrials and healthcare as stock gains broaden.
Market backdrop
The S&P 500 notched a fresh all-time high last week, led by tech stocks. U.S. 10-year Treasury yields held steady near 4.25% during the holiday-shortened week. Since France’s snap parliamentary election was announced, spreads of 10-year French government bond yields over German bunds have hovered near their widest levels since the euro area crisis. The Bank of England left rates unchanged – but we think it will likely start rate cuts in August after the early July election.
We’re eyeing May U.S. PCE data – the Fed’s preferred inflation measure – for signs that services inflation is easing. Cooler-than-expected U.S. CPI data for May showed falling core goods prices. But sticky services prices mean inflation will continue to outpace the Fed’s 2% goal in the medium term.
Week Ahead
June 25: U.S. consumer confidence
June 27: U.S. durable goods
June 28: U.S. PCE; Japan unemployment data
June 30: China NBS manufacturing PMI
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