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The Strait of Hormuz remains closed, long-term interest rates in the UK are back at levels last seen in the 1990s and inflation is on the rise again. And yet equities are up for the month, the quarter, and the year. How? My simple answer is: it’s the earnings, stupid. Companies are making money, and profits and equity prices are rising together. To illustrate this, here are equity market returns since the end of 2024 broken down into dividends, earnings increases and multiple changes:
And, as I wrote a couple of weeks ago, much of this earnings growth is coming from AI investment. Oracle, Microsoft, Google, Meta and Amazon (the Hyperscalers in market jargon) are expected to invest $1.5 trillion into the data centres that power AI in 2026 and 2027. This is benefitting both US companies (US earnings were up 25% year on year in Q1) and semiconductor manufacturers located in Taiwan and Korea. My favourite example of this is SK Hynix of Korea which went into the year on a (relatively low) 7.2x earnings multiple and trades on 6.9x today. In the meantime, the stock is up 200% year to date. (For the record: nothing in this note is meant as investment advice.)
So, stocks are rising because earnings are rising, and the AI investment story looks to be pretty resilient to oil prices. Still, I would not want to understate the impact that Iran has had on bond markets. For the UK, this means interest rates are around 0.75% higher than they would have been if war had not broken out. This is a lot! And, of course, it makes any spending plans Labour might have all the more expensive.
It is worth pointing out that the last time interest rates rose sharply (in 2022) it was the technology sector that underperformed. This has emphatically not been the case this time round. I think this is because AI investment is a jam today story. You do not have to wait a long time to get those semiconductor profits and returns are high. Both these mean your cashflows are less sensitive to interest rates. You can see from the chart below that the technology sector only really started to outperform at the end of March after the oil and interest rate shock had hit:
Instead, where the pain has been felt this time round has been in the defensive and higher quality parts of the market. Defensive equities tend to be more bond-like so it is not surprising that if bond prices fall they would struggle. For quality I think the story is more mixed. High quality businesses are supposed to deliver steady earnings growth come what may. I won’t name names here, but some quality franchise style businesses have simply failed to deliver. And others have business models where the moat looks more vulnerable as we shift to an AI-first world. And finally, higher interest rates have not helped:
Of course, nothing is forever. When AI investment starts to slow (as it must) these trends may start to reverse. But I have written a few times here that US technology profit growth is a long-term trend that we do not want to be on the wrong side of. I can’t see any reason to change this view today.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
