Gold powers to fresh record, as stocks slip, but there could still be further upside to come

The gold price is surging this morning and has cleared the $4000 per ounce hurdle for the first time. The gold price is higher by more than $50 on Wednesday morning, as risk aversion falters and There is a hint of risk aversion in the air as we move through to the middle of the week.

The S&P 500 closed lower on Tuesday for the first time in eight sessions. The declines were moderate, the S&P 500 fell by 0.3%, and the Nasdaq was down by 0.6% on Tuesday. There were some clear laggards, including Tesla, which fell 4% and Oracle, which was lower by 2.5%.

Tech sell off not yet in danger zone

Interestingly, the Magnificent 7 mega cap tech stocks plunged at the same rate as the Russell 2000, and both underperformed the S&P 500 yesterday. The question now is whether Tuesday’s sell-off is a pause in an established uptrend, or if it is the sign  of something more sinister?

Stocks sold off across Asia, led by tech, and the dollar is higher once again. Stock market futures are pointing to a slightly higher open in UK and US stocks later today. This could indicate that investors are willing to buy any dip, and that the slip in stocks will be temporary.

On balance we expect stocks to be directionless today as we wait for the FOMC meeting minutes later on Wednesday.  In the longer term, a lot is resting on earnings season, and the tech giants will mostly report their results at the end of this month. Thus, we could see more frequent periods of investor nervousness in the lead up to these corporate announcements.

Are animal spirits taking over?

After a series of record highs, a pullback is to be expected. While short-term losses are very common during uptrends, and even a sign of a healthy market, there could be more focus on the potential for a deeper slide in equities at this stage of the market rally. Barclays and Goldman Sachs have noted exceptionally high levels of investor bullishness. Goldman Sachs said that their clients are the most bullish about stocks since December, while Barclays reported that sentiment is close to exuberant levels.

Usually, these indicators are signs that we are at the peak of the market, and they can be used as contrarian signals. Fear about animal spirits could see a more cautious tone to markets this week. This is already evident in the forex market, the dollar is making a strong comeback this week, led by gains vs. the yen and the kiwi dollar, and the dollar is once again the top performing currency in the G10 FX space on Wednesday.

Oracle’s paper thin margins, spread concern about profitability and AI

The AI trade wobbled on Tuesday after Oracle reported thinner than expected profit margins from its cloud business. Oracle’s share price has had a strong run in recent weeks and has rallied by 22% in the past month after ChatGPT maker Open AI signed a deal with Oracle to purchase 4.5 gigawatts of cloud computing power. The fact that this deal may be slow to pay off could unnerve investors, especially since the biggest listed hyperscalers, including Microsoft, Alphabet, Meta and Amazon, have spent a combined $300bn this year alone on capex spending for AI.

IBM: where there is AI spending, there are stock market gains

However, we think that it is too soon to call an end to the AI trade. As Oracle’s stock price came under pressure, IBM’s stock price jumped, after it announced a deal with Anthropic, that has already shown huge productivity gains in a private preview of the service. IBM users reported average productivity gains of 45%, through the automation of tasks such as code generation, reviews, and workflows. IBM is considered a dinosaur in the tech space, and its share price has lagged well behind the Magnificent 7. The fact that its share price is higher by 18% in the past month is a sign that where there is AI spending, there are stock market gains, for now. This may be unfair on IBM, the results of its trail with Anthropic is exactly the sort of benefits we need to see from AI investments to keep the AI trade afloat.

The AI trade is not dead yet

The trouble is that the market is priced for perfection, and any blemish will be punished. This makes the upcoming Q3 earnings season interesting. Any wobble in the AI trade is likely to be amplified across global markets due to its sheer scale. 8  AI linked stocks on the S&P 500 are now worth $4.5 trillion, and the Magnificent 7 tech stocks now account for more than 30% of the S&P 500. However, a pullback from here would be welcome, and could ultimately lead to another leg higher as investors look for attractive entry points. Thus, we do not see a prolonged sell-off right now, and the AI trade is not dead yet.

EU steel tariffs on the UK suggest a new, more dangerous phase of trade wars

News that the EU would raise steel tariffs by 50% for UK imports could weigh on sentiment towards the UK and the currency bloc later on Wednesday. If a deal is not struck soon, then this could be the nail in the coffin for the UK steel industry. Around 80% of UK steel exports go to the EU, however, the EU is rushing to protect its own dwindling steel industry after a wave of cheap Chinese imports. We expect that heated negotiations are going on in the background to secure better conditions for the UK. However, this move by the EU tells us two things: 1, President Trump has unleashed a trade war with  global ramifications for years to come, and 2, the UK is still suffering because of Brexit.

The pound continues to hover near the $1.3400 lows, and GBP/USD has fallen below its 50-day and 100-day moving averages this week, which is a bearish development for the currency.

UK banks in focus after FCA ruling on payout

We will also be watching UK banking stocks closely, especially Lloyds and Close Brothers, after the FCA ruled that they could face an £11bn hit from the car loan mis-selling scandal. Although these estimates are towards the lower end of the range of forecasts, it is still a chunky cost that these lenders will need to absorb. In an environment where risk sentiment is on pause, it could be hard for the UK’s banking sector to avoid downward pressure later today.