Oil prices back away from recent highs, but is this enough to boost stocks?

There has been a shift in sentiment for stock markets, the selloff in  US stocks on Wednesday, has impacted Asia, where stock indices including the Nikkei fell sharply. Softbank, the Japanese tech investor, dropped 10%. However, the sell off could be short lived, as the oil price falls. Brent has dropped 0.6% this morning, after reports that Israel and Lebanon have agreed to a ceasefire, which gives hope that a resolution to the Iran conflict can be found.

Europe to take its queue from the US

This has also been boosted by developments overnight in the US, the House of Representatives is seeking to block Trump from continuing the war in Iran. This still needs Senate approval, but the President also said that a resolution could be found this weekend. We have heard this before, the question now is whether the market will take Trump’s words at face value? For now, stock indices in Europe are pointing to a weaker open, and US futures are also mildly lower. In the current environment, we expect stocks to take their queue from the US, so it could be a quiet morning in Europe.

As we move through the second half of this week, the run of record highs for the US stock market has come to an end. US indices pulled back on Wednesday. The S&P 500 was down 0.7%, and the tech was mildly lower at -0.3%. There were some chunky losses for the Magnificent 7 with declines for the likes of Nvidia, Apple, Alphabet and Microsoft, as the market absorbed the impact of a rising oil price and a 4bp increase in the 10-year Treasury yield.

The AI trade is unlikely to be derailed for long

Interestingly, the declines for the tech sector were not broad-based. Top US equity performers included SanDisk, Qualcomm and AMD, which rose by more than 4%. Marvell, which Jensen Huang predicted will reach a trillion-dollar valuation, rose by a further 3% on Wednesday, bringing its gains for the week to 47%. The tech trade may have paused, but the AI trade continues to roar, just in time for SpaceX’s IPO next week.

Oil stays below $100 per barrel

The flare up in tensions in the Middle East dominated sentiment, and the oil price rose to around $98 per barrel for Brent crude. The President is once more giving mixed messages about how the war in Iran ends. On Wednesday, he hinted in a podcast that the Strait of Hormuz could remain closed through to Labor Day, which is far longer than the market expects. However, he also said that Iran has agreed not to have nuclear weapons, but they can change their mind. Interestingly, the prospect of a delayed peace deal and a prolonged closure of the Strait of Hormuz, has not pushed oil above $100 per barrel. The fact that it did not cross above this level is a sign that the market is willing to be patient, as a deal is still expected.

US stocks have much-needed pullback, and there could be more to come

While the crisis in the Middle East was seen as the main reason why stocks sold off on Wednesday the truth is, US stock indices are overbought. The illusive deal between the US and Iran might be used as an excuse to justify selling, but it could also be a way to scrape froth off the top of the market, after a 36% rise in the tech sector so far this year.

NFP in focus

US payrolls are now in focus, and this is one of the most important readings for months, as it could shape Fed policy under new chair Kevin Warsh. Analysts are expecting a 90k increase in payrolls, however, the stronger than expected ADP report on Wednesday suggests that the market is already positioning for an upside surprise. This would explain the rise in Treasury yields, and the dip in sentiment towards stocks yesterday, since a strong jobs report could push the Fed closer to ditching its loosening bias at its meeting later this month.

Warsh’s first public speaking engagement will be the press conference after the 17^th June FOMC meeting. Warsh has said that he doesn’t believe in forward guidance, so he may choose not to contribute to the updated Dot Plot. His thinking on this is sound, he believes that the Fed does not have a good track record of forecasting and it can threaten the Fed’s credibility. However, the risk is that his speech is vague, which confuses the market, triggering more volatility. This is something to watch in the coming weeks. Otherwise, we expect Warsh to be wary of rocking the boat. He has already told Fed staff that he will stick to the ‘best of Fed traditions’, whatever that means.

Geopolitics, economics and the AI trade meet

Overall, as we move towards the end of the week, the focus is on how geopolitics, economics and the AI trade interact in the next 24 hours. Can anything disrupt the run for semiconductors? It will need to be something big.

Broadcom disappoints, as revenues miss target

We will have to see if the trigger for a pull back in US AI stocks is Broadcom’s disappointing results. Its stock price fell 5% in post-market trading after posting disappointing revenues for last quarter, however, sales still rose 48% YoY and revenue forecasts for this quarter were ahead of analyst estimates. AI revenues more than doubled on an annual basis, and further gains are expected in the current quarter. Ultimately, there isn’t much to complain about in this earnings report, but after rising 40% this year, Broadcom’s stock was priced for perfection.

Is narrow US market breadth a problem?

One of the biggest risks for the AI stock market boom is its own success. The US tech sector now makes up 39% of the entire market capitalization of the S&P 500, which is the highest on record and more than the 2000 dotcom bubble. The narrow breadth of this market rally is a concern, if one AI name rolls over, then the entire US stock market could come under pressure. However, there is growing acceptance that AI use will boom over the coming years, and this is feeding profit estimates for semiconductor and other tech companies.

These strong profits are propping up stocks, and suggest that valuations, although high, may be justified. Tech earnings account for 35% of the net income at the S&P 500, which is twice the share from 2000.

Narrow market breadth is a problem for investors, but it’s worth noting that most bull cycles narrow as they go on. Added to this, 60% of the S&P 500 are above their 200-day smas, so lots of companies are trading well, its just that a handful are trading exceptionally well, and this includes the likes of SanDisk, up 600% YTD, Micron up 260% and ARM, which is higher by more than 200%.

As we get closer to payrolls, the focus will be on whether the stock market rally can continue with the current headwinds, including a prolonged conflict in the Middle East, and a potential for tighter global monetary policy.