Tech stock earnings, central bank independence and wars around the world are the main risks facing investors, but some are more pressing than others, according to Guy Stear, head of developed markets strategy at the Amundi Investment Institute.
While he has previously told Trustnet why he believes a market downturn would be capped in the current era of AI capex spending, that does not mean there is nothing to worry about.
In the fixed income market, he said the most pressing issue is the outbreak of war in Iran and the continued conflict in Ukraine.
While there has been some movement on the former, with a tentative peace deal in place, there is always the risk that one or both sides walk away from the negotiating table.
Meanwhile, although the Russia-Ukraine war has been ongoing for far longer, Stear noted that things could get much worse here too if Russia decides to “expand into other theatres”.
“Geopolitical risk for the fixed income market is really the big risk because that means energy prices get even more expensive and inflation gets even higher, which could arguably mean that central banks tighten policy even more,” he said. Stear currently expects two further rate hikes from the European Central Bank before the end of the year.
For equities, the biggest risk is potential disappointment in the technology sector. The second-quarter earnings season is expected to kick off from the middle of July and there are “real doubts” over whether return on capital from some of the industry’s biggest names is going to be high enough to justify the level of capital expenditure.
Equity markets have largely been driven by the AI rally for much of the past 18 months, with the most recent wave of enthusiasm heading towards semiconductor stocks and those involved in the rollout of data centres around the world.
This euphoria has caused the equity market to “ignore what's going on in terms of the Iran conflict” and continue its climb higher unabated.
“The biggest risk is a real sea change in terms of the profitability and cashflow of these companies. That's the real threat to equity markets,” he said.
Looking slightly further out, the biggest long-term risks to both markets surround central banks and governments: the rising mound of government debt and the deficits facing many developed nations around the world.
Governments have become used to being able to run large budget deficits during an era when interest rates were kept low, as they needed to try to stimulate the economy.
Now that rates are higher, this poses new problems for governments. Not only does it make taking out new debt to fund new projects much more expensive, it also means refinancing costs are higher for any shorter-dated government bonds that are rolling over.
The typical solution to this is austerity is reining in spending and increasing the tax intake in an effort to pay down the debt. However, this is often politically unpalatable to voters, which means most governments that have achieved austerity successfully can only do so from a position of strength – something that is lacking in many parts of the developed world.
“The long-term risk is [therefore] either overly easy monetary policy – to allow governments to finance themselves more easily – or simply the perception that that's the case,” said Stear.
This could manifest through political intervention (or the threat thereof), as has been seen in the US, where president Donald Trump has attempted to strong-arm the Federal Reserve into lowering interest rates despite higher inflation.
Any signs of monetary mismanagement would lead to structurally higher interest rates and a re-steepening of the yield curve, he said.
“I think that's a problem for both markets. It's clearly a problem for fixed income, because higher yields mean lower prices,” said Stear.
“It's probably a problem for equity markets as well, because it means the denominator you're using to discount cashflows is getting bigger, so the net present value of those cashflows is going down.”