The trends, risks and opportunities investors should watch

What’s driving global markets in the second half of the year?

In the latest Mid-Year Outlook, Chief Market Strategist & Economist @Guy Miller breaks down why markets continue to surprise on the upside.

• Global growth remains steady
• Central banks may pause prolonged tightening
• Tech investment (especially AI and semiconductors) is driving momentum
• Equities still have room to run 

Despite geopolitical noise and oil shocks, markets are proving resilient, supported by liquidity, earnings and capital spending.

Transcript

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Guy Miller, Chief Market Strategist & Economist, Zurich Insurance Group: 0:00

Welcome to our mid-year outlook, which we have titled Making Hay While the Sun Shines. Now, we remain of an optimistic attitude, as we were at the start of the year. And looking forward, we see trend-like global growth.[Music ends] We think the central banks will be refrained in tightening, so we're not expecting a prolonged tightening cycle. We are expecting capital spending to be the key driver of growth and financial markets through the remainder of this year. And when we look at the markets themselves, we think liquidity and further M&A, strong earnings will keep these markets moving higher, with equities our favorite asset class. Now, since the start of the year we've been asked a lot about what's been happening in the Straits of Hormuz, why it's not had such a big impact in terms of global growth in markets. And I wanted just to share with you some slides which gives you some feeling of why that's been the case. Now, if we look at the first slide here, this is looking at the price of Brent oil and we've adjusted this for inflation. Remember, $80 a barrel of oil today is not the same as it was 20 years ago. And you can see that even the spike that we had up to about $120 a barrel, by historic standards, was only around the average level. And of course, since then, we've seen price of oil come back down again. Now, the second thing that I wanted to talk to you about is that economies have become much more efficient with their use of oil. So the amount of oil per unit of output has improved dramatically over a number of years. And in the chart I'm showing you here, you can see for all the key economies of the world, the big economies, in fact for most economies, that oil intensity has declined. In other words, more productive use of the oil that is indeed used. So that's another reason why this has had less of an impact in terms of the issues with the Strait of Hormuz. Now the third and final point I just wanted to say was, when we look at where we and today you can see the blue line is the price of oil, it got up to that kind of 120 level I mentioned. And since then it's come back down to where we stand today, which is around about the same level that we were at before the Iran War broke out. The red line is the Strait of Hormuz tanker crossings. In other words, the number of tankers going through the strait. And as you all know, this was pretty much zero for a good two or three months. Now we've begun to see that pick up. Now the financial markets are thinking we're going to see further improvement in that. We think that's broadly the case. But remember, there's going to still be unrest, there is still going to be backing and forwarding here. The memorandum of understanding or memorandum of misunderstanding as it's become known is going to see changes and tweaks made to it. There's going be still further skirmishes. But broadly speaking, we think it's on everybody's side or everybody's interest to see some improvement and to find some at least short to medium term resolution. And that's a positive. Now, while the price of oil has come down, it has had an impact in terms of inflation. And this higher inflation readings that we're seeing have resulted in the central banks becoming more hawkish, more a tightening policy rather than easing policy. And we even had the ECB only a week or so ago move interest rates as well. We think that's going to be one and done. But nonetheless, we don't have the same tailwind of policy that has been helping financial markets. Now, as I said, we don't think this is something to be overly concerned about. Because with the price of oil coming down, we think some of these inflation pressures will ease as well. But what about the other drivers of growth that we have been speaking about? Well, there is still some fiscal policy coming through, but the main driver, we suspect, the one that's going to grab most of the headlines for the remainder of the year, is technology. The tech spending boom continues. And if you look at the chart I'm showing you here, this is the big US hyperscalers and this is a debt issuance. Now usually these big tech hyperscalers have got incredibly robust balance sheets, very strong free cash flow and they use that to fund their capex. But recently as the chart shows they have been using the financial markets to do some borrowing. Now it's not enough to be worried about they're still very robust balance sheets, but that borrowing plus their free cashflow is being used to spend and that spending is finding its way as revenue into many other tech sectors and this is why the tech sector right now is so hot and likely to remain so. That spending is particularly focused and acute in things like semiconductors and memory prices. And if you look at this chart here, this is looking at DRAM memory, you can see the prices of both high and low end have skyrocketed. They're not up one or two percent. These are up multiple times in a very short period of time. There's a big supply-demand imbalance. Supply is relatively constrained. It takes time to build these fabs to produce semiconductors, But demand is almost insatiable. Because of the spending that we're seeing on things like defense, on renewable energy, and of course, AI. So spending still outstripping supply and that's leading to super normal profits for many of these companies. Now that is highlighted in the chart I'm showing you here. The red line is the MSCI APAC equity index, which has been doing incredibly well. And actually sub-components of that things like Taiwan and Korea have done incredibly well. They're almost like vertical lines because these companies are in such demand for their goods and they can charge effectively what they would like for these goods, leading to supernormal profits. And that's seen in the blue line here. The blue line actually, which is earnings estimates for next year, it was kind of flat lining until relatively recently. And you can see now that's exploded. In other words, earnings growth expectations are actually outstripping the move higher in the equity markets. And that means that the PE multiple has actually declined, the green line that you can see here. Earnings are growing faster than the stock price is appreciating, and that's leading to a positive valuation metric coming through. So again, another reason why investors believe there's some visibility, this could last longer and they're not overpaying for some of these companies. I note, however, they're very cyclical and once earnings begin to turn, once new equilibrium between supply and demand is reached. There clearly will be downside, but we just don't think it's yet. Now the last thing I wanted to point out about, I mentioned these spending by these hyperscalers. And this chart shows you the capex that's coming through. Very large numbers coming through, 800 billion or the like, I expected this year and next year and growing. But that means that they're spending more money on their future, which is a good thing, investing in terms of capital spending. But it also means actually they're spend a little bit less, certainly relatively less in terms of stock repurchases and dividends. The blue line you can see here is actually slipping somewhat. Now that means that one of the drivers of equity markets, this buyback from big players, is no longer quite as obvious as it's been. But remember all these supernormal profits I mentioned that other tech companies are making? Well, guess what they're doing? They are actually buying stock back and increasing dividends in some cases. So when we put all of this together, we think the cap spending boom is still, frankly, relatively early stages. The combination of defense spending, renewable spending and AI spending suggests to us at least that this has got further to run for some time. Expectations are high, but look what's happening to earnings. They're also incredibly high. So as we look out for the remainder of this year, remember trend like global growth, we don't think this is the start of a protracted tightening cycle by[Music starts] the central banks. Liquidity remains high, M&T is good and capital spending continues to boom. Netnet, we think this is a time to make hay while the sun shines. And as always, read the full report on Zurich.com.[Music starts]