China-US decoupling and AI define next cycle

Oksana Patron

17 July 2023

The China-US decoupling and being on the right side of the artificial intelligence (AI) investments cycle have been identified as ones of the key forces that will impact the next equity cycle, according to T.Rowe Price portfolio manager Scott Berg.

The growing trend of deglobalisation and the China-US decoupling, on both political and economic levels, is expected to see more domestic investment as both sides would be looking to reinforce their supply chain independently, he said.

Additionally, the US government will want to build the required infrastructure to help create this independence which will mean the opportunities for investors as long as they end up on the ‘right side of this change’ and a stock-specific level will become very important.

A similar logic will apply to AI investments even though its investment cycle was still in its early stages.

“Recent quarterly results from companies like NVIDIA indicate that AI is attracting large-scale investment as well as competition for investment,” Berg said.

The investments in this sector might be tremendous opportunity but, he warned, it would also require careful consideration of durability and valuation.

“Positioning for the right side of the AI cycle is important given the magnitude of spending occurring at a time when many corporate margins are compressing,” he added.

The other key themes that were expected to have an impact on the next cycle included the end of US stimulus, economic deceleration and a changed landscape for corporate profits.

Berg noted that with developed market central banks tightening monetary supply, it would be ‘highly unlikely’ to see a return to a stimulus-driven world.

He said that although the market was anticipating material interest rate cuts in 2024, it was also unlikely to happen given the clear risks posed by rising prices.

“Despite the Fed aggressively trying to suppress inflationary pressures through the removal of stimulus and one of the fastest rate hike cycles in history, there remains ample liquidity to create asset price inflation,” he said.

“While the Fed appears committed to deflating the economy, its ability to manage inflation down in a smooth fashion may be tested in the next stage of the cycle.”

Also, despite the decelerating economy, wages have continued to rise, and consumption trends have remained solid. At the same time, labour market remained tight, despite the Fed trying to induce higher unemployment and this may lead to more sticky inflation in the coming quarters.

“While the consequences of driving down inflation will potentially lead to lower economic growth, this has clearly become the Fed’s most favoured option when choosing between the rock and the hard place. However, the softer landing seen so far is acting as a soother for equity markets,” Berg stressed.

As far as the corporate profits were concerned, T.Rowe Price manager stressed that the era of low interest rates, low taxes, low wage growth, cheap commodity prices, easy technological gains, and deflationary globalisation had passed and this would have implications for profit margins for all companies.

“Markets will increasingly reward those companies that can withstand an economic decline and maintain or expand profit margins.”