Brooks Macdonald’s Cady: Inflation slowdown and AI boosts case for US equities

The Fed’s data-dependent approach to central bank policy, and AI, has led Brooks Macdonald to up its exposure to US growth stocks

Matthew Cady, Brooks Macdonald
Matthew Cady


By Matthew Cady, investment strategist at Brooks Macdonald                      

Is the end in sight for interest rate hikes? Perhaps. In recent months, the US Federal Reserve (Fed) has clearly shifted to a more data-dependent meeting-by-meeting approach to setting interest rates. Coupled with a moderation in inflation pressures, this has sparked optimism among market participants that we might be nearing the current cycle peak in interest rates. Additionally, the growing interest in generative artificial intelligence (AI) has helped to fuel positive market sentiment, with the technology sector leading the wider market this year. Here we delve into the interplay between these two trends and their impact on investor sentiment looking ahead.

Inflation slowdown eases economic concerns

One of the key factors driving investor sentiment is, of course, inflation. Bearing in mind that inflation pressures globally are far from uniform, the US’s Consumer Price Index (CPI) has been falling this year both at a headline ‘all-items’ as well as at a ‘core’ level (the latter excluding energy and food prices). Crucially, the moderating inflation data has not been at the expense of economic resilience. The recent preliminary reading of US real gross domestic product (GDP) reported quarter-on-quarter annualised growth of 2.4% in Q2, which was up from Q1’s 2% and above the Fed’s ‘longer-run’ median economic growth assumption of 1.8%.

Annual rates of inflation only tell part of the story

The latest year-over-year all-items CPI change to July was 3.2%, but annual measures can be misleading. Annual inflation rates tell us just as much about what was happening to prices last year (the base effect) as they do about prices now. Arguably the month-on-month data can often be more important as it can give a more up-to-date picture of how price changes are evolving. For July’s data, the annualised month-on-month inflation rates for headline and core are both close to the Fed’s 2% inflation target. One-month annualised inflation rates can be volatile of course, and we still have more economic data to navigate. But for now, the disinflationary consumer price picture building in the US is providing relief to investors concerned about the lagged impact of higher rates on economic growth.

Generative artificial Intelligence fuels market enthusiasm

The growing interest in generative AI is also driving the market so far this year. This technology, which is capable of generating text, images, or other media in response to input data and user-driven prompts, has gained significant traction in various sectors, particularly in the technology industry.

See also: Central banks catch their breath: Will biotech shine again as rates stop rising?

One notable example is US semiconductor company Nvidia, which delivered strong results and guidance earlier in the year. The soaring demand for Nvidia’s designed semiconductors used in generative AI applications not only propelled the company’s success, but it has catalysed widespread market enthusiasm for technology shares in general. Encouragingly, while the mega-sized technology giants initially led the market earlier this year, this narrow market leadership has since broadened. It suggests that investors are weighing up the potential for a wide range of companies in different industries to be able to use this new technology to improve productivity, margins, and profits.

What is the outlook?

Corporate results so far this year have reflected the resilience of the US consumer and mentions of ‘recession’ in company management post-result transcripts have notably decreased over the past few quarters. Although earnings growth expectations for 2023 remain modest, there is a meaningful anticipated upswing in 2024, with over 10% calendar year-on-year percentage earnings growth projected. As a result of the improved market outlook, valuation multiples have been lifted, seeing some recovery from last year’s valuation multiple compression.

All in all, the convergence of a slowdown in inflation, resilient company results in aggregate, and the growing interest in generative AI, exemplified by companies like Nvidia, have driven a positive shift in investor sentiment. That and the Fed’s seemingly more-nuanced approach around the path for interest rates later in the year have also helped to provide some stability to markets.

Against our backdrop of a global equity barbell balance between growth and value investment styles, within our US equity allocation, we seek out a growth skew. We look to our US equity weights to help support our thematic investments centred around technology, healthcare, and to a lesser extent sustainability, which are prominent within the US market. These themes are expected to continue to grow in importance in the years to come and, in our view, they offer investors the potential for longer-term growth.

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