Frothy Valuations Reflect Economic and Tech ResilienceFrothyValuationsReflectEconomicandTechResilience

A resilient global economy and optimism that AI will pay dividends for the technology sector have catapulted equity markets. The S&P 500 in the US, FTSE 100 in the UK, DAX in Germany, and Nikkei 225 in Japan have all set fresh record highs at some point this year, as investors set aside interest-rate jitters and geopolitical tumult. Facing a tough slog in the last mile of their inflation fight, central banks have kept rates high to throttle consumer and business demand. But the economy has largely withstood the impact, even as recent data suggest US resilience may be fading. US growth for the first quarter was revised down to 1.3% from an initial estimate of 1.6% on an annualized basis. The manufacturing sector has been in contraction for 18 of the last 19 months, according to the Institute for Supply Management. Meanwhile, with the next jobs report due on Friday, forecasts suggest that employers added 190,000 jobs in May, up from 175,000 a month earlier. Outside the US, both the Bank of Canada and European Central Bank cut rates this week but cautioned that inflation remains a challenge.

Much of the rally in global equities can be attributed to enthusiasm around AI, as well as healthy cash reserves that are cushioning large tech companies from the negative consequences of higher rates. The Magnificent Seven have led the charge higher in US equity indexes, widening the gap in performance between the tech sector and its peers. Overall, US equity valuations could be viewed as frothy on a historical basis, potentially driving stronger expected returns for other developed market equities. PGIM Quantitative Solutions examined the outlook for equities, fixed income and alternative asset classes in its Q2 Capital Market Assumptions.