Do markets have an A.I. blind spot?

Market Recap

• Equity markets continued their correction this week, with some firm economic data unable to counter the reality that rate cuts are not coming as soon or aggressively as previously thought.

• The S&P 500 fell 3.2% by late Friday, with Technology, Consumer Discretionary and Communication Services posting the deepest declines alongside some steep selloffs from the likes of Netflix.

• Meantime, the TSX gave back a more modest 0.7% as the sector mix was relatively favourable.

A.I.

Recently, artificial intelligence (A.I.) chipmaker Taiwan Semiconductor Manufacturing Company (TSMC) delivered softer sales guidance for the coming quarters, prompting questions about the future of A.I.-related names and the Technology sector in general. In our view, TSMC’s earnings and guidance should trigger questions. Even though the company actually beat earnings expectations, its forecast for market growth in the semiconductor industry was down, causing its share price to slide by around 6% on Thursday. Going forward, there are two questions investors should be asking about A.I. names: 1) Are there any supply chains that they should be worried about? And 2) Will competition rise in the near term as others get into the space? While nothing runs forever, we believe there is still room for further expansion and growth from some A.I.-related companies. However, some of the biggest names in the space currently look overpriced from a pure price-to-earnings (P/E) ratio standpoint. That said, valuations should be compared to future market size. By that measure, some of the highest-priced names begin to look less exuberant.

Bottom Line: We believe that the A.I. theme is far from over, but TSMC’s guidance should be a reminder to investors to ask the important questions and understand the current run-up in prices.

China

Last week, U.S. President Joe Biden unveiled plans to triple tariffs on Chinese steel producers—the type of move that, in the past, has caused prices to rise at home. This is a potentially major step toward further escalation of the trade war between the U.S. and China. A rise in tensions is no surprise; for months, we’ve believed that the upcoming presidential election would generate a lot of political posturing. This proposal goes a bit deeper than mere sabre-rattling, however—in our view, Biden wants to impose steel tariffs so that the U.S. can carve out critical supply lines. They have done similar things in areas such as A.I. and microchips. The U.S. is currently in a better position to negotiate than China given that it has a stronger economy and China is still under pressure from a weak property market. Aside from steel, the Biden administration also appears to be focused on areas where China is very competitive and/or the main supplier, such as EVs and solar panels. While there may be political benefits of ramping up the trade rhetoric for Biden and Trump, the end result is likely to be higher inflation for domestic consumers.

Bottom Line: As we approach the U.S. presidential election, further escalation of trade tensions between the U.S. and China is likely, which could lead to higher prices at home.

Currency

For months, the U.S. dollar (USD) has been dominant. Lately, however, other countries have stepped up efforts to defend their currencies’ purchasing power. Against that backdrop, what is the outlook for the USD-to-Canadian dollar (CAD)? The CAD has done fairly well this year against more major currencies—the problem isn’t that it has been weak, but that the USD has been very strong. The U.S. Federal Reserve’s (Fed) language on higher-for-longer interest rates has only exacerbated the problem, keeping the USD even more elevated the further out rate cuts are pushed. Unfortunately, we think this trend will continue in the near-term. Our expectation is that the Bank of Canada (BoC) is likely to cut rates before the Fed, which would drive down the loonie on a relative basis until the Fed decided to catch up later in the year (assuming inflation moderates and the U.S. economy warrants a rate cut). As a result, we wouldn’t be surprised to see the CAD trading at $0.70 USD given that it’s currently around $0.72.

Bottom Line: The strength of the USD is likely to persist, potentially pushing the CAD down slightly in relative terms.

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Delayed Again: The Soft Landing that Never Comes.