With quarterly earnings season underway and stocks trading at all-time highs, investors could be facing a correction.
Morgan Stanley’s chief U.S. equity strategist warned that the third quarter could be “volatile” for investors due to uncertainty over a range of issues, including corporate earnings, the outcome of the November election, future tariffs and central bank policy.
“The valuation right now looks very, very lackluster to me,” Mike Wilson told Bloomberg TV on Monday. “I think it’s very likely we’ll see a 10% correction between now and the election.”
Morgan Stanley strategists were quick to point out that, apart from a few dozen U.S. companies, average corporate profits aren’t growing and likely won’t until the Federal Reserve starts easing monetary policy.
Investors are hoping Chairman Jay Powell will provide some helpful hints about the direction of monetary policy when he testifies before Congress today and tomorrow. Currently, markets are pricing in an 80% chance of a rate cut in September, given the softening labor market data.
“We need interest rates to come down, that’s number one,” Wilson told Bloomberg Television. “Or we need an exogenous positive shock on growth that doesn’t lead to an inflation problem. Tell me where that comes from.”
AI chip supplier Taiwan’s exports to the US surge
This is where artificial intelligence comes into play, specifically generative AI.
Many companies, including Apple, Meta and Amazon, are hitting new highs amid hopes that AI will transform corporate profits and increase productivity without driving up prices.
The question is whether the set of profit numbers will bear that out, starting with the big Wall Street banks reporting earnings on Friday and when the first banks start reporting their results later this week.
“We expect to see many companies provide concrete examples during the second quarter of how AI is beginning to transform productivity and cost savings,” Ed Yardeni, president of Yardeni Research, told CNBC on Monday.
The latest export data from Taiwan, a major supplier of cutting-edge electronic equipment needed for AI-powered data centers, showed that shipments of goods to the United States rose 74% in June from a year earlier, helped by companies such as Taiwan Semiconductor Manufacturing Company.
On Monday, a domestic industry giant foundry that makes AI chips for Nvidia joined, if only briefly, the elite club of megacap stocks with market capitalizations of more than $1 trillion.
Given this momentum, Yardeni believes there is little reason for investors not to chase the market rally.
“Over the past few weeks, the market has been rallying to new records because of disappointing economic data,” he said.
“I think investors have concluded that they don’t need to worry too much about an economic slowdown or recession because the Fed would move quickly to cut rates even if that became a big risk.”
AI hallucinations could erode some of the predicted productivity gains
But AI may not be the silver bullet everyone thinks it will be.
James Ferguson, founding partner at UK-based economic research firm MacroStrategy Partnership, argues that investors are not taking into account the trend towards generative AI. HallucinatingIn other words, they churn out false data and information that dilutes productivity gains.
Companies that don’t take the time to double-check their work could find themselves in a similar predicament to law firm Levidow, Levidow & Oberman.
After ChatGPT filed legal arguments citing fancifully fabricated legal precedents, the company became the subject of unfair headlines across the country.
“Fake it ’til you make it” may work in Silicon Valley, but for the rest of us, “once you’ve been burned, never do it again” may be more appropriate,” he said on a recent Bloomberg podcast, warning that the hype around AI is creating concentrated market bubbles reminiscent of the dot-com era. “If you can’t trust AI, then… […] That would effectively make AI useless in my opinion.”
