Become a Creator today!Start creating today - Share your story with the world!
Start for free
00:00:00
00:00:01
The Macro Brief - Competing US narratives
1 Plays3 seconds ago
Alastair Pinder, Dhiraj Narula and Saul Martinez assess the tug-of-war behind US equity market performance - from AI capex spend, to higher rates, to the extraordinary earnings cycle for US financials.
Click here for appropriate Disclosures, including analyst certifications, and Disclaimers that must be viewed with this podcast: https://www.research.hsbc.com/R/101/XJNthg6
Stay connected and access free to view reports and videos from HSBC Global Investment Research follow us on LinkedIn https://www.linkedin.com/feed/hashtag/hsbcresearch/ or click here: https://www.gbm.hsbc.com/insights/global-research.
Recommended
Transcript
Podcast Introduction
00:00:07
Speaker
Hello and welcome to the Macro Brief from HSBC Global Investment Research, a weekly look at the issues driving financial markets across the world. I'm your host today, Aline van Duyn in New York, and today we're looking at what's driving US equity
US Market Fluctuations
00:00:24
Speaker
markets. Now, the market reached a record high in early June and since then has been fluctuating up and down, reflecting a tug of war between various competing narratives.
00:00:36
Speaker
On the one hand, we've got quite strong economic growth versus high inflation, high energy prices and risks of higher interest rates from the Federal Reserve.
00:00:47
Speaker
There's also questions about ai capex spend and monetization, as well as the earnings cycle. What does that tell us about all of this?
Introducing the Team
00:00:56
Speaker
I'm joined by three of my colleagues from the New York office, Alastair Pinder, our global equity strategist, Saul Martinez, our head of US financials research, and Deeraj Narula, our US rate strategist.
00:01:10
Speaker
Welcome to the Macro Brief. morning Good morning. Alastair, let's kick off with high-level overview of what's driving US markets at the moment.
AI's Impact on Tech Earnings
00:01:19
Speaker
I mean, there's many competing forces, as as you mentioned. I think the one topic that everyone is focused on and has been for the majority of this year is is AI.
00:01:28
Speaker
And you know this earnings season has been just so important for the market in terms of you know a number of factors. One, are tech companies um able to monetize all of this huge capex that they're spending um to basically deliver this AI? And you know beyond that, even beyond the tech sector, The other big question I think, ah which is coming to a lot of investors, is that are other sectors using
S&P and Geopolitical Risks
00:01:55
Speaker
AI? How is that actually impacting their earnings? And you know what are we seeing from the bottom up? And I think you know against this backdrop of heightened geopolitical risks, higher oil concerns around the Fed, ah the S&P is incredibly dependent on a strong earnings profile to go through this. And and so far, the data has been incredibly strong. 85% companies have beaten ah earnings expectations so far.
00:02:20
Speaker
The growth rate is running at around 25% year on year. these are These are really, really punchy numbers. And so I think that's a really
Banking Sector Performance
00:02:27
Speaker
good start. So let's stick with earnings for a bit and move to Saul because financials, companies, banks, brokers, you've been looking at their earnings. And as Alistair has indicated, they've also exceeded expectations. What's the story? What are the takeaways?
00:02:43
Speaker
This ah may be the strongest ah earning season I've seen from the banks and brokers, the large banks at least. The median EPS growth was 34% for the largest banks and brokers, those that we cover.
00:02:58
Speaker
um And it was pretty broad based. What really stood out most were the capital markets businesses. Investment banking is booming right now. For the large investment banks and universal banks that we cover, investment banking fees were up third anywhere from 30 to 60 percent year on year. And it's broad based advisory, debt issuance, equity issuance. The trading side is doing extremely well as well. Prime brokerage balances are growing. Equity prices are up. Client engagement is strong. Asia especially was a bright spot. But equities was up 45% to 90% year-on-year. Those are pretty astounding numbers. But even if you look at traditional banking, um it's doing well. Loan growth has accelerated from the banking system. at the but At the banking system level, it's now running high single digits. Purchase volumes are are doing well. Credit quality is doing well. So, you know there aren't very many red flags right now. Everything is kind of hitting on, I don't know if I'd call it all cylinders, but everything is moving in a positive direction.
00:03:58
Speaker
It's kind of extraordinary, Saul, that you say this is one of the best earning cycles
Broader Market Strength Beyond Tech
00:04:02
Speaker
you've seen. You're talking across a couple of decades of tracking the sector. From what I see, since the global financial crisis, this is close to the best earning cycle that I've seen. I'll just i'll just add on that. I think it's an important point, which is that, you know, I think so far, you know, discussions of investors have been so focused on ai What has been missed?
00:04:24
Speaker
is how strong the rest of the market is. Banks doing incredibly well. Even you know the consumer discretionary sector doing you know very good. Industrials, which are benefiting from the CapEx as well, building out some of these data centers, seeing huge earnings growth. And so actually beneath the surface, what we have started to see over the last few months is that it's not just tech, it's the rest of the S&P that is really starting to see quite strong performance.
00:04:46
Speaker
So given that there is this strong performance moving to Deirage, does that mean that the interest rate pressures, ah potential for higher policy rates is driven by economic strength rather than just inflation concerns? Or like where does this sit in the context of higher rates?
Federal Reserve Interest Rate Outlook
00:05:06
Speaker
Absolutely. So with regards to the outlook for rates, ultimately the Fed's thinking will be boiling down to the two sides of its dual mandate. And what we've seen in the resilience, both in the consumer as well as in the overall growth backdrop, fueled in no small part by all of this AI CapEx, is that the full employment side of the Fed's dual mandate is a relatively benign outlook. It's not a particular source of concern. We've seen the labor market hold fairly steady throughout 2026. But the other side of the Fed's mandate, bringing about price stability and returning to their 2% inflation target, has really very much been the source of focus.
00:05:42
Speaker
And of course, in no small part, it's been driven heavily by the surge in oil prices with these geopolitical tensions. And that has once again escalated over the past couple of weeks. But we have heard from policymakers that it's not just the energy prices that is putting pressure on inflation. If you look beneath the surface, we are also seeing some inflationary pressures from this AI spending. So all else equal, that has put the Fed's bias towards potentially needing to raise the level of interest rates.
00:06:09
Speaker
Now, of course, we've got the next FOMC meeting at the 28th and 29th of July. and i think Kevin Walsh, the new Fed chair, has also emphasised that inflation has been running above the 2% target for over five years now. So this is ah this is obviously an ongoing situation. Saul, how important is the Fed outlook for for the bank's outlook?
Impact of Higher Rates on Lending
00:06:33
Speaker
I mean, to some extent, you know, loans are are booming. relatively higher policy rates is actually kind of a good thing because you can charge more for loans.
00:06:42
Speaker
Yeah. All else equal higher rates are good for banks. All else equal flattening yield curve is bad for banks. I think if you have one, even two hikes, you're probably okay. But on the margin, it it does increase their funding costs. It increases deposit costs, which could put some downwards pressure on lending activity.
00:07:04
Speaker
um borrowing activity. And obviously, if you have tight monetary policy for an extended period of time, you do run the risk of an economic slowdown. The other part of that, though, is its impact on the capital markets. I mentioned what stood out most this quarter was the strength in capital markets. Companies are making acquisitions. Companies are raising equity and debt.
00:07:25
Speaker
institutional investors are engaged ah repositioning portfolios. If higher rates does create more volatility in the markets, then that could put some pressure on, you know, these these really benign, really positive dynamics. And I think one of the debates in the market is how durable are these? Is this just too good to be true? Is it sustainable? If you have tight monetary policy and higher rates, those questions do get raised even more.
00:07:55
Speaker
Now that's a good time to take a short break. We'll be back with more from the New York team in a moment.
00:08:03
Speaker
A quick message here from the Macro Brief team. If you're one of our listeners on YouTube, then we'll soon be moving. To ensure you never miss another episode of the Macro Brief, then please head to HSBC CIB on YouTube and hit subscribe.
00:08:21
Speaker
Now back to today's episode.
AI Adoption in Earnings
00:08:25
Speaker
Let's just get into the AI story a bit more. Alistair, you mentioned the earnings on the on the tech companies. Are there some other takeaways in terms of answering some of these key AI questions that you're already seeing in this earnings cycle? Or is there something that you're particularly looking out for?
00:08:43
Speaker
I mean, I think the the key thing that we're looking out for is, you know, the extent to which um know companies are adopting ah AI. And I think, you know, the key thing that we keep on trying to identify is, are there tangible examples of the monetary benefit that you can get from that? because I think that is the big question. It's okay, great. We can all use these AI models, but does it impact your bottom line? And some companies have been relatively forthcoming in their disclosure. The majority haven't. And so, again, it's this kind of discovery and that we're going through. But I mean, it's an incredibly important question because, you know, the hyperscalers are spending almost a trillion dollars of CapEx, you know, starting from 2027 onwards. And to justify that, at some point, you really have to probably produce...
00:09:30
Speaker
close to a trillion dollars of revenue or more by 2030. And the question is like, how do you just magically produce a trillion dollars of revenue? It's a huge amount of money. And so that I think is the key challenge that, um you know, investors are facing. And, you know, then you get these shocks all of a sudden from China, which has produced, you know, um you state of the art models, something like Kimi three, very cheap competing ah with the US.
00:09:55
Speaker
And it does force this this narrative, as we're saying that in in one minute, we're like, okay, AI is fantastic, it's going to be, you know, the the best thing for equity markets in the next, you know, moment, it is huge huge source of concern that we're overspending that earnings are going to slow etc. And so that I think is driving a lot of volatility within ah tech. And so, you know, from from our view, I think it's it's creating this volatility. And actually, maybe the best expression of the AI trades right now is actually, you know, not tech, but the companies are adopting it, they don't have this risk around the capex, but they do get some of the benefits ah from using it and seeing higher productivity.
Global AI CapEx Cycle Effects
00:10:34
Speaker
And I know you've written about how this is not just relevant, of course, to US companies, but is kind of a global phenomenon.
00:10:41
Speaker
I mean, 100%. And I mean, you've seen this, I mean, and and it it both works on the way up on the and the way down. You know, Korea and Taiwan had seen some of the best equity market performance, you know, between and January ah to May.
00:10:55
Speaker
And now it has seen, you know, extreme volatility. Prices are down, you know, 30, 40%. So again, it is having repercussions across the world at this point. We talk about the scale of ai and this capex cycle that we're going through. I think one testament to just how significant it is, is that we are seeing some of those ramifications even in the treasury market, which is famously the biggest, deepest, most liquid market in the world. But if you look at kind of where long-end interest rates have been in the past couple of months or but over the past year, it is kind of notable that we have seen some signs that all of this debt issuance coming through for AI-related CapEx is actually weighing on long-end interest rates. And one of the reasons for that is because if you think about the type the nature of this asset class coming into the market, we have a lot of high-quality issuers issuing long-dated debt.
AI: Inflationary or Deflationary?
00:11:42
Speaker
The buyer base tends to be a little bit crowded out when you have AI CapEx potentially competing with treasuries. And one kind of reality that we're facing now with...
00:11:52
Speaker
potentially higher rates at the front end with the Fed potentially needing to hike is that the long end of the curve, your 30-year rates, your 10-year rates, which matter for things like mortgages, etc., are very, very elevated even with respect to the front end of the curve. So you have seen kind of a steep curve backdrop despite all of that pressure from the front end.
00:12:09
Speaker
Well, I guess the other big question as well for the fixed income market is around this question of whether AI is inflationary or deflationary, in the sense that, you know, memory chips are going through the roof right now as a result of prices because of all of this capex spend demand for them. But then there is the view, which Walsh I think is one of them, which thinks that AI could ultimately be deflationary in the long run.
00:12:27
Speaker
Yeah, so that is a great point because Fed Chair Kevin Walsh has talked about how near term you get those inflationary pressures, but the structural productivity gains can reduce inflation in the long run. And we can observe kind of the market's expectation of interest in traded securities. And if you look at long-end inflation expectations, they have been very, very well contained. I would posit that that's both because of kind of potentially these disinflationary forces coming structurally from AI and also kind of the broader commitment to 2% that we've really seen the Fed reinforce over the past few weeks.
00:12:58
Speaker
Really
Banks and AI Use Cases
00:12:59
Speaker
interesting. Getting back to what companies are saying, Saul, are banks talking about the benefits of AI or are they benefiting from the boom in capital markets activity related to AI?
00:13:13
Speaker
Well, they are certainly talking about the use cases internally, and they've they've given you know a number of them largely focused on efficiency and risk management. I think what was the more interesting discussion this quarter was just how much ai is touching a lot of the parts of the businesses. The banks that I cover aren't big data center lenders, but you're seeing so much capital markets issuance that it is helping their investment banking business. I mean, I think, you know, that the the impact of this issuance is a really important question as well for equity markets because you know, just the mega cap IPOs this year could reach, I mean, close to, you know, three, $400 billion dollars of of issuance. On top of that, you've got the secondary issuance from these hyperscalers, either issuing equity or debt. Now, that's a lot of liquidity impact in the market. And, the you know, the big question is, can equities absorb that?
00:14:06
Speaker
Or is that going to be another, know, because if you take back to the, you know, the IPO and, and the and you know, the, um the dot-com bubble, that was a flag that this was the peak in the market. And so I do think that is one of the biggest concerns that people have going into the second half of the year.
Podcast Conclusion
00:14:21
Speaker
Thank you so much, everyone. This is a fascinating conversation, a lot of things that we can keep talking about. So hopefully we'll come back for an update when we have a few more answers. Thank you. Thanks very much.
00:14:37
Speaker
So that was Deeraj Narula, Alastair Pinder and Saul Martinez on what's driving US markets. If you'd like more on what's happening in Asia, then please check out our sister podcast, Under the Banyan Tree.
00:14:51
Speaker
That's all from us here on The Macrobrief. This episode was hosted by me, Aline Van Dyne, in our New York studio and produced by Tom Barton. Don't forget to like and follow wherever you get your podcasts. Thanks for listening and we'll be back again week.