The authors: DJE's Strategy Team monitors and assesses the markets on an ongoing basis using fundamental, monetary and technical criteria.
July was a mixed month for equity markets. European exchanges made solid gains, while the US and Japanese markets declined in euro terms. The main driver was the sharp correction in semiconductor stocks. At sector level, by contrast, energy, financials and real estate performed well, whereas many artificial intelligence (AI) names came under considerable pressure.
Looking ahead to August, our overall stance remains constructive. Following the steep price falls of recent weeks, the correction in the semiconductor space looks more like a shake-out than a structural break. Late July saw record selling volumes on several trading days, with retail investors selling on an unprecedented scale. At the same time, the major operators of cloud and AI infrastructure remain fundamentally robust. One large cloud provider has now set out in concrete terms for the first time that investments in AI infrastructure reach break-even after three years. With a useful life of five to six years, that leaves a further two to three years in which those investments can generate returns.
Europe, too, is in better shape at present. Broad European equity markets have cleared key technical resistance levels, and earnings estimates are rising. Energy, financial, insurance and industrial stocks have beaten expectations so far. Primary insurers are also benefiting from high interest rates and more favourable reinsurance terms, while reinsurers face continued pricing pressure.
Interest rates, however, remain a demanding environment. Ten-year US Treasury yields recently stood at around 4.7%, moving back towards the 5% mark. Governments' substantial borrowing requirements also argue against any pronounced fall in yields. The market is pricing in two US rate cuts by year-end, though whether they will materialise remains open. Interest rates therefore continue to weigh on the economy.
All in all, the market environment remains constructive, but it calls for a selective approach and rigorous risk management. The biggest near-term risk is renewed yen strength on the back of further rate hikes in Japan, which could trigger the unwinding of carry trades in the technology sector. Beyond that, our attention is focused chiefly on the further trajectory of AI investment and the US interest rate environment.
Opportunities we see:
Semiconductors and AI infrastructure: The correction of recent weeks was unusually severe, with record selling volumes on several trading days in late July. This points to a shake-out rather than a structural break in the long-term AI trend. At the same time, the major operators of cloud and AI infrastructure remain fundamentally robust. The first concrete figures on the profitability of high AI investment suggest that the question is no longer whether these projects pay off, but increasingly how high the achievable returns will be.
Memory chips: Korean memory chip manufacturers came under particular pressure, driven largely by growing competition from China. At the same time, companies expect the supply bottleneck to tighten further in 2027 compared with 2026, as new production capacity is coming on stream more slowly than anticipated. Memory chips now account for 40% to 50% of the cost of new data centres. Meanwhile, the acceleration in earnings growth peaks this year – a development that matters for valuations.
Bonds issued by large technology groups: Risk premiums on the bonds of major cloud and AI infrastructure operators have widened recently, lifting their current yields. At the same time, the large providers are not regarded as being at risk of default.
Europe: The technical picture has improved and earnings estimates are rising. Energy, financial, insurance and industrial stocks have beaten expectations so far.
Primary insurers and reinsurers: Primary insurers continue to benefit from high interest rates and favourable reinsurance terms. Reinsurers, by contrast, remain under pricing pressure.
Chinese technology companies: Chinese AI models are competitive both technologically and on price, with comparable applications costing considerably less in some cases than their US counterparts. At the same time, many Chinese technology companies are trading at low valuations by historical standards.
Gold: Technical sentiment has fallen to a very low level. Even so, gold has held the USD 4,000 mark despite ten-year US Treasury yields rising from 4.45% to 4.70%. The Chinese central bank continues to buy gold below USD 4,000. Structurally, rising government debt worldwide remains a supportive factor.
Seasonality and geopolitical easing: Statistically, a favourable phase of the US presidential cycle begins in the third and fourth quarters. A de-escalation in the Middle East or in the war between Russia and Ukraine could lend markets additional support.
Risks we are monitoring:
Yen and carry trades: Further rate hikes by the Bank of Japan could strengthen the yen. The current trend still appears manageable: a yen appreciation of 3% to 5% is considered absorbable, whereas risks increase markedly at around 10%. A sharper appreciation could prompt the unwinding of carry trades and set off another correction in the technology sector.
Slowing AI investment: Should the major operators of cloud and AI infrastructure cut their capital expenditure budgets, demand for memory chips could fall significantly, weighing on semiconductor stocks.
Funding of AI investment: If risk premiums on large technology groups widen further, the market may increasingly question whether their high levels of investment can be financed. Growing pressure on free cash flow could weigh on both the equities and the bonds of these companies.
US interest rates: The market is pricing in two rate cuts by year-end, but they are far from certain. Should inflation prove persistent and rate cut expectations be scaled back, US yields could rise further. A yield level above 5% would weigh on longer-dated bonds while also dampening consumption, the housing market and the wider economy.
Competition from Chinese AI models: If the US stops short of banning Chinese models, their cost leadership could increase margin pressure on US providers. That, in turn, could temper expectations for the AI investment cycle.
Geopolitics and gold: A peace agreement between Russia and Ukraine could lead to the release of Russian foreign exchange reserves. Central bank gold purchases could then ease off, putting pressure on the gold price.
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