Following the recovery rally of the previous quarter, markets rewarded investors with many new market highs through Q3 with investors entering it with optimism. The losses incurred in April from the U.S. tariff shock had recovered and investors embraced equity markets with a heightened sense of optimism. As the quarter progressed global trade uncertainty dissipated, and any lingering recession fears quickly evaporated. Better than expected corporate earnings provided substance to hopes that companies would be able to effectively navigate their way through disrupted supply chains and changing global trade policies. Afterall, it wasn’t long ago that management teams and business models were exposed to supply disruptions and evolving operating environments during the pandemic with lessons likely learned and applied again.
The extreme levels of tariffs announced by U.S. President Donald Trump in April have since come down through agreements and frameworks and while uncertainty remains investors seemed comfortable with the expected lower-level tariff rates.
Stocks related to artificial intelligence (AI) continue to benefit from an exuberant investor base that continues to drive prices of this segment higher. This isn’t reminiscent of the dotcom bubble back in the early 2000s when many companies with little to no earnings rocketed up on investor excitement. Back then, those dreams of largely speculative investments faded quickly as reality set in and prices came under pressure. Many of the AI stocks are large global businesses delivering outsized growth and investors are flocking to these investments driving up their valuations. The concern, and something that must be considered, is what happens to this excitement and prices if the growth of these companies or the prospects of growth that supports their heightened valuations slips a little. We know the answer because we’ve seen what happens; prices go down to reflect a potentially new reality. So, while it's exciting, and potentially beneficial to be invested in AI now and into the future, it’s also prudent to do so with an understanding of the potential associated risks.
While many risks have faded away another’s re-emerged and lingers in the back of many investors mind’s—large fiscal imbalances and debt loads occurring around the world. Government deficits and the mounting debt burden faced by many countries could lead to rising long-term interest rates as capital competes to attract lenders. Markets received a taste of this in early September when rising long-term rates led to a short-lived pull-back of the equity markets but they were quick to recover and move forward with optimism.
We remain positive on the long-term prospects of equities, supported by positive economic and earnings growth prospects, continued dovish central bank policies and a moderated inflationary environment. While rising long-term interest rates may pose a headwind to equities, we feel good about the prospects of quality, reasonably priced stocks growing earnings in a rising rate environment.