Despite the cooling of interest rate expectations in May, the U.S. stock market continued to rally and the "Magnificent Seven" is still leading US stock market breakthroughs. In this story, UBS Chief Global Equity Strategist Andrew Garthwait and UBS IB Chief Strategist Bhanu Baweja discussed what will happen to the US stock and commodity markets on the back of global PMIs rebounding.
Q1:With most of the "Magnificent Seven" experiencing significant upward adjustments to earnings estimates for Q1 and 2024 overall, except for Tesla and Apple, how concerned are you about concentration risks?
Andrew: The S&P is very close to recent highs so hard to say there is a downturn. But tactical indicators suggest consolidation phase should continue. It's worth noting that the "Magnificent Seven" delivered stellar corporate earnings, which supported their valuations and drove up US stocks at the index level.
The "Magnificent Seven" are also diverging. For example, companies with significant revenue exposure to hardware are trading at a valuation multiple equivalents of that for software stocks; while the EV industry is still facing a number of problems (EV overcapacity, strong competition from China, stretched valuations). In contrast, tech giants who can monetarise Gen AI and have strong pricing ability are more favoured.
Q2: Do you believe the "high-for-longer" narrative will dampen the outlook for mid-small caps?
Andrew: Future gains in US equities will involve a wider range of sectors than just large-cap stocks. Compared with large caps, mid-caps are pricing in a recession and have low valuations. However, lower rates are a necessary catalyst, especially so for European stocks. The risk is that late cycle bull runs often end up in a bubble, and breadth remains narrow. On balance we expect a larger breadth in the current market run.
Q3: How does UBS foresee oil prices evolving, and what implications does this have for energy stocks?
Bhanu: We see crude oil prices (Brent) averaging $83 per barrel through 2024. Through Q2 2024 we see the market in deficit, and pricing average $86 per barrel. Stronger than expected demand from China is a key variable here. Iran Israel tensions have not changed the near-term outlook, but the skew of the distribution has changed with risks to the upside having increased. However, with OPEC+ still having spare capacity, some of which should be used to increase production at their next meeting on June 1st, 2024, and Shale production quite elastic to higher prices, it will be difficult to maintain prices above $90-$100 per barrel range.
We believe that above $90 per barrel demand also begins to get destroyed implying that level should provide a cap over the medium term. We have been overweight Energy equities both in the US and Europe through most of the last 12m, but we feel they are presently pricing in oil prices close to $75 per barrel, which is bang on our forecast over a 5y horizon. We have therefore pulled our recommendation for the Energy sector down to neutral.
Q4: How would you interpret the drivers behind gold prices?
Bhanu: Gold has been closely linked to financial market variables since the early 2000s, its main drivers being US real interest rates, global uncertainty, inflation expectations and the dollar. Of these, the role of US real interest rates is key. Our model says that a 1% change in US real interest rates has, over time, led to 14% changes in the gold prices in the opposite direction. However, this relationship broke down completely in 2022, when Russia attacked Ukraine, and the Central Bank of Russia was sanctioned. Since then, global central bank and sovereign wealth funds’ demand for gold has surged and shows few signs of fading. Gold’s response to lower real rates remains the same as history, but its response to higher real rates has become much lesser. This asymmetric response to real rates has made Gold a favourite trade for us through 2024.
Our strong preference for Gold has been further cemented through periods of heightened geopolitical tensions this year, such as the Israel – Iran conflict. Through this gold proved to be a diversifier in the portfolio, performing strongly as other risk assets were selling off. By contrast, crypto currencies just mimicked high beta equity risk. Thus far into 2024, Gold’s strong performance is despite higher real interest rates. In the remaining part of this year, we think Gold will perform strongly because of lower real interest rates.
Q5: The industrial metals complex, particularly copper and aluminium, is expected to continue its strong performance due to fundamental shortfalls and key factors, such as China's green metals demand, restrained onshore supply, and a cyclical recovery in Western manufacturing. How do you assess the potential upside in copper?
Bhanu: Copper prices have surged through our medium-term target of $4.50/lb. Although this comes at the same time as improving PMIs and an outperformance of cyclical stocks, we don’t believe this rise in copper is signalling an imminent surge in global growth. Speculative longs in copper have reached 2011 highs. A cleanout of short positions in COMEX is the reason why copper prices in this exchange have risen relative to those at the LME. A backwardated copper futures curve on COMEX has usually been followed by lower spot prices. We don’t see the pick-up in global capex intentions or global industrial production to be consistent copper prices at his level.
China remains the single largest importer of copper and demand here has been very steady. While that is remarkable given how weak investment in China is, there is no upwards inflexion in demand here, and thus actual demand doesn’t explain the surge in the copper price. China’s electricity grid and housing market are key drivers of demand for copper globally, together accounting for 35-40% of global copper demand. The demand for copper for renewables both from within China and outside it accounts for only 3-5% for global copper demand, not large enough to move the needle. Limited supply/inventories and excessive speculation are key reasons behind the rise in copper. As such, we see the price consolidating lower.
