Market Comment - October

Forecasting where the stock market will be heading is becoming increasingly tricky. There are convincing arguments in either direction. While the “healthy correction consensus” among investors has been proven wrong for a while, volatility has increased considerably during the past weeks, courtesy of the earnings season. On the geopolitical front, Donald Trump visited China to hopefully finalize a trade deal with President Xi Jinping. The most meaningful terms were the suspension of rare-earth export controls by China, while the U.S. promised to reduce tariffs on Chinese imports. President Trump’s previous threats were more a part of a dramatic episode within a reality TV show, and the U.S. President has finally realized that both countries need each other — maybe the U.S. even more than China.

After all, the meeting was a positive event, but the market did not reward it much. The technology sector dominated the market once again, helped by large caps, which lifted the sector ETF XLK 6.64% to a new all-time high. Healthcare did well and slightly outperformed (XLV +3.64%), followed by utilities (XLU +2.16%). The remaining sectors traded flat or down, with the materials sector performing the worst (XLB –4.42%), dragged down by the mining industry. The sum of the sector overview in the U.S. is leading to a very unhealthy picture.

The technology large caps accounted for the gains in the S&P 500 during the past month. The S&P 500 traded up 2.27%, while the S&P 500 Equal Weight Index lost 1.06%. Looking at the S&P 500 Buy Signal Indicator, only 50.20% of stocks are on a buy signal. That’s not a good number for a market trading at all-time highs. So, we come back to the overarching question: how long can the AI trade go on? Our answer is, in terms of time, we don’t know. In terms of price, we have a setup for the U.S. technology sector ETF XLK that suggests we are not done. In the short run, we need more evidence that this will work.

On the other hand, if the technology sector profits from the installation phase of the technical revolution of AI, we could ask the question: are there sectors that could be at the beginning of a deployment phase, meaning that through AI, their business improves and the top and bottom line profit from the deployment of AI?

In a recent article, the Financial Times highlighted how a team led by Nobel Prize–winning scientist David Baker has used an artificial intelligence tool to create new functional antibodies — a breakthrough that could speed up drug development using the cutting-edge technology. The pharmaceutical industry widely uses antibodies to create drugs, such as for cancer and coronaviruses. But creating the proteins using computers has been a long-standing challenge in drug design. While AI for drug discovery may be obvious and make sense, there is evidence that the road to success will be bumpy and not an easy one. There are few AI-discovered candidates in late-stage clinical trials, and not one has been approved.

Another industry group that has been quickly implementing AI is cybersecurity. Unfortunately, it has been a strong underperformer during the past few weeks. The Stoxx 600 did slightly better than the S&P 500 in local currency, as luxury goods and healthcare performed well, while industrials underperformed. But the U.S. dollar continued to rebound, gaining 1.71% against the euro and 1.18% against the Swiss currency.

The lesson from the past four weeks is that the menu for bulls is getting smaller once again. The number of stocks behaving well is decreasing. This situation can improve again, but for now, this is what investors have to deal with.