Last week, the stock market crashed as fears of a recession soared, but Capital Economics predicted that the artificial intelligence boom will continue to drive stock prices higher.
Stocks fell after Friday’s unexpectedly weak July employment report and a sharp deterioration in the Institute for Supply Management’s manufacturing index on Thursday. The S&P 500 fell 2.5%, the Nasdaq fell 3.6% and the Russell 2000, which had been surging on a rotation into small-cap stocks, fell nearly 7% this week.
Meanwhile, concerns about economic growth have raised expectations of a more aggressive monetary easing cycle from the Federal Reserve, with Wall Street expecting interest rates to eventually fall by more than 200 basis points.
Diana Iovanel, senior market economist at Capital Economics, said in a Friday note that stock rallies should resume.
“Fears of a U.S. recession have resurfaced, raising the possibility of further interest rate cuts by the Fed,” she wrote. “But the U.S. economy is unlikely to be an obstacle to stock market gains for much longer.”
Equity valuations are far from indicating an “economic upheaval,” and credit spreads are still near record lows, she added.Capital Economics expects the Fed to cut rates at every meeting from September through July next year.
Iovanel said a recession was unlikely and that growth would pick up again after a slow period in the second half of the year.
“So I don’t expect risk sentiment to worsen any further,” she said. “Ultimately, I don’t think there’s much in the economy to prevent an AI bubble from gaining steam again anytime soon.”
In fact, Microsoft, Meta, and Google recently reported earnings that they spent a combined $40.5 billion on the infrastructure, land, and chips that power their AI services in the second quarter, and each company has signaled that figure will be even bigger next year.
That spending is likely to end up at AI chip suppliers like Nvidia, whose revenue and stock price have seen incredible growth in recent years.
Others on Wall Street are urging investors not to overreact to the sudden weakness in hiring. Claudia Sam, the former Fed economist who created the “Sam Rule” recession indicator, told Fortune magazine on Friday that she’s not worried right now about the U.S. sliding into recession, noting that household incomes are still growing and consumer spending and business investment remain strong.
Still, recent labor market trends have been weak at best, said Mr. Sahm, now chief economist at investment firm New Century Advisors.
“This has been very accurate for a long time and should not be ignored,” she added, noting that “recessions can develop slowly and then come suddenly.”