Smooth Sailing through a Semiconductor Storm

Despite volatility beneath the surface, broad markets have remained resilient 

July provided another reminder that headline market performance does not always tell the full story. 

At first glance, it looked like another relatively steady month for investors, as the global stock market remained resilient. Yet beneath the surface, it was a very different story; individual companies, sectors, and regional markets experienced much larger swings. Despite the internal volatility, strong company earnings and continued optimism around artificial intelligence (AI) helped support overall market performance, even as some of the market's biggest winners experienced sharp pullbacks. 

At the same time, renewed tensions between the US and Iran led to heightened volatility in oil prices, while central banks continued to signal that interest rates may remain higher for longer. 

Together, these factors created a more volatile environment, but one in which diversification again helped to cushion the effect on portfolios.

US-Iran tensions return, but oil markets remain adaptable

Hopes that June's temporary easing in tensions between the US and Iran could lead to a more lasting agreement faded during July (though appear to be back on the table at time of writing). Shipping through the Strait of Hormuz (SoH), one of the world’s most important energy routes, had started to recover. However, renewed hostilities and restrictions on Iranian oil exports caused shipping activity through the SoH to fall sharply, pushing oil prices higher and increasing volatility. Towards the end of the month, a pause in military strikes offered some relief, although no formal settlement had been agreed and shipping remained well below normal levels.

Importantly, we note that oil flows through the SoH may not need to return fully to pre-conflict levels for prices to move back towards $70 a barrel. Several supply-and-demand factors can help absorb part of the disruption:

• Some large importers, most notably China, have been importing less oil
• Releases from strategic reserves have added to global supply
• Producers outside the Gulf, particularly in the Atlantic Basin, have increased exports
• The oil market entered the conflict with supply already exceeding demand

Over time, the disruption is also likely to encourage investment in pipelines and alternative export routes that reduce reliance on the SoH.

While a prolonged conflict remains a risk, particularly if higher oil prices feed through into inflation, our central expectation is that the disruption is unlikely to have a lasting impact on global growth or financial markets.

Strong earnings offset AI-related volatility

Against this backdrop, company earnings remained an important source of support for equity markets. The second-quarter US earnings season was particularly strong. By the end of July, just over 60% of the largest US companies had reported, with 86% delivering profits above expectations. Overall earnings growth remained exceptionally strong.

Technology companies also continued investing heavily in AI infrastructure, including data centres, chips and computing capacity. While businesses remain confident in AI's long-term potential, investors are increasingly asking a different question: will all this investment translate into meaningful profits in the long term?

Last month, we discussed how fast-growing companies, particularly those linked to AI, can experience larger swings in their share prices than the broader market. That was evident in July, as some of the companies and markets that had previously benefited most from excitement around AI gave back some of their earlier gains. Semiconductor shares fell, pulling several Asian markets lower. South Korea was particularly affected because a small number of large chipmakers make up a significant share of its stock market. The chart below visualises this, comparing the year-to-date performance of South Korean and global equities.