Sometimes less is more. This week's developments may offer several reasons for optimism. Easing energy prices and greater capital discipline in AI infrastructure spending should help reduce inflationary pressures, while strong employment and improving productivity continue to support economic growth. Combined with a historically favorable post-midterm backdrop, these trends could provide the foundation for a broader and more sustainable bull market.
Sometimes less is more. This week highlighted a few reasons that may be the case for investors. Tuesday's election results introduced the prospect of greater capital discipline in AI spending and renewed hopes for a resolution in Iran offered relief in energy prices, while economic data continued to point toward a resilient economy. After a structural bounce in the market on Wednesday, uncertainty around slower investment spending grabbed hold of the market. Slower spending with political gridlock, and geopolitical uncertainty hardly sound like a quality recipe for furthering the bull market; however, what is potentially a headwind for a small segment of the market could be a tailwind for the rest.
Several markets experienced relief from months of increasing price pressures, specifically oil, gas, and even crude oil tanker shipping rates. Optimism for a resolution in Iran has introduced the possibility of declining inflationary pressures. As we opined several weeks ago, the Fed is fighting inflation caused in part by an energy supply shock, but also by strong demand for AI infrastructure. A meaningful reduction in geopolitical tensions could reverse some of those energy price pressures quite rapidly. Last week alone, gasoline futures fell toward levels last seen in early March, right in time for holiday travel season:
Oil prices declined roughly 12%, while tanker shipping rates fell more than 30%:
The result was lower market rates on US Treasuries and lower fed funds rate expectations:
Outside of energy and commodity prices, a moderation in infrastructure spending could reduce incremental demand for electricity, construction materials, and borrowed capital. Fewer debt offerings to finance these projects could further alleviate pressure on longer-term interest rates. Combine lower energy prices with moderated capital expenditures, and you might see a Fed that may not need to do as much of the heavy lifting if underlying supply and demand pressures begin resolving themselves.
The week's economic data painted an encouraging backdrop as we move ahead from here. Sure, there are concerns of a slowdown in AI investment, but productivity growth continues to improve and accelerated to an annualized 3.6% during the third quarter while unit labor costs declined 0.7%.
Friday’s employment numbers were also positive, with the economy adding 165,000 jobs in October, while positive revisions came in for August and September totaling 84,000 jobs. This collective recipe is encouraging. Improving productivity allows companies to produce more goods and services without a proportionate increase in labor expenses. Stronger employment reinforces the growth outlook, even if it complicates the Fed's near-term rate decisions. This is the kind of economic environment investors should welcome: continued growth, increasing productivity, and moderating inflation from easing supply and demand pressures.
This brings us to the AI buildout. We remain very constructive long-term on the forward economy that results from AI, specifically its potential to sustain higher productivity per worker levels highlighted earlier. As constraints around data center construction ebb and flow, greater capital discipline could be a headwind for infrastructure providers relying on continued spending growth for future earnings. On the other hand, for the technology companies financing these projects, moderating expenditures could be a tailwind by reducing borrowing needs, improving free cash flow, and increasing returns on invested capital. As evidenced earlier, companies incorporating AI into their existing businesses may see productivity improvements, lower expenses, and higher profit margins. The AI economy can continue to thrive even if some of today's AI infrastructure stocks do not, and greater capital discipline should ultimately make the economic expansion more sustainable over the long term.
All the while, history does not repeat itself but often rhymes. Corporate earnings and economic growth drive long-term market performance. With the election in the rearview, improving productivity and lower inflation expectations lay a better foundation for markets moving ahead. Consider the forward returns for the S&P 500 following the midterm elections that left a Republican Commander in Chief with a Democratic Congress. On average across the seven instances, the S&P 500 was up over 1-, 3-, 6-, and 12-month timeframes with an average 12-month return of 15.5%.
Past performance is no guarantee of future results, but historically, midterm elections have often removed uncertainty around the direction of future policy, allowing investors to return their focus to what matters most: economic growth and corporate earnings. The coming months will undoubtedly bring new challenges, but a combination of easing inflationary pressures, stronger productivity, and greater capital discipline should help support a broader and more sustainable bull market.
Enjoy your Sunday!
- Matt
Matt Gentzkow CIMA®
Managing Director, Wealth Advisor
Matt Gentzkow is Managing Director and Wealth Advisor at Coastal Bridge Advisors, where he shares his insights with the investment committee and guides clients toward their financial goals. Before joining the firm, he held advisory and wealth strategy roles at UBS and Morgan Stanley. Matt earned bachelor's degrees in finance and economics from Xavier University and is a Certified Investment Management Analyst® (CIMA®). His market insights have been featured in publications including The Wall Street Journal and Kiplinger.
Sources: Yardeni Research, YCharts, CME Group, Carson Investment Research, FactSet, Bureau of Labor Statistics, Reuters, LGT Wealth Management, Breakwave Advisors.
The views and opinions expressed are those of Matt Gentzkow, CIMA® as of the date of publication and are subject to change without notice. This material is provided for informational and educational purposes only and is not intended to constitute investment advice or a recommendation to buy or sell any security. The information and opinions expressed are based on sources believed to be reliable, including third-party sources, but are not guaranteed as to accuracy or completeness. Third-party information has not been independently verified by CBA. Any forward-looking statements or hypothetical examples are for illustrative purposes only and are subject to change based on market and economic conditions. Past performance is not indicative of future results.