S&P 500: Market expectations becoming 'much more sensible' as AI hype continues

Analysts are raising their targets for the S&P 500 as the artificial intelligence hype pushes tech stocks further. Threadneedle Strategies Founder Ann Berry joins Yahoo Finance Live to evaluate AI growth drivers, the World Bank's forecast for emerging markets, and the state of commercial real estate as mortgage rates remain elevated.

Video Transcript

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AKIKO FUJITA: Well, the S&P 500 has been doing much better than expected so far this year. Mostly led by a few big names. The rally causing analysts to raise their end-of-year targets for the index. BMO capital's Brian Belski raising his target to 4550. And Truist Keith Lerner going up to 4,500. Joining us now with her outlook on the market is Ann Berry, Threadneedle founder.

And I'm looking at where S&P 500 levels are right now, hovering near that nine-month high.

ANN BERRY: Yeah.

AKIKO FUJITA: Does it all make sense to you?

ANN BERRY: It makes no sense to me. And actually, I was a complete naysayer on the S&P. We'd had this conversation often. I would have thought flat from the summer to the end of 2022. And I would have thought flat to down from the end of last year to where we are today. So this outperformance has been something I certainly didn't expect.

- What do you think this means just in terms of where things stand today? The odds of a recession. Because, yes, we do have a number on the street raising their year-end price targets for the S&P. But Deutsche Bank is sticking with its call, saying that it still sees a recession here. So where do we go, do you think?

ANN BERRY: Well, Goldman also came out and said the probability of recession coming down from 35 to 25%. And this is one where the recession keeps eluding us. And it feels as though all the criticism that's been leveled at Jay Powell that he got how to bring inflation down wrong, I think he actually may prove out, at the end of the day, to show that he can get it down without getting us into recession territory. Also didn't see that coming.

AKIKO FUJITA: So, does that put us in a better position going into year-end? I mean, all this talk about a soft landing, a hard landing, it certainly feels like things are starting to ease a bit.

ANN BERRY: It certainly feels as though things are easing in terms of cost input inflation. It feels as though we've got more realistic outlooks for earnings based on consumer demand. We saw a bunch of big companies flush their bad news for their earnings outlook for the rest of the year, and the market seems to have recovered.

So it feels as though, with a couple of exceptions, AI being a little bubble territory ish at the moment being one of them, expectations seems to be a lot more sensible across the rest of the ecosystem, which in turn, I think is leading to a little bit of leveling out.

- And do you think we'll see broader participation in terms of the winners here? Because a lot of the leadership gains, a lot of the gains that we have seen since the start of the year have been names tied to AI.

ANN BERRY: Yeah.

- Most of them, at least. Do you think we'll start to see that maybe broaden out?

ANN BERRY: Well, we're seeing it today. If we look at the market today and to go back to your question Akiko, do you understand what's going on in the market right now. Consumer discretionary is on a tear today. Everything from travel, to apparel, to traditional retail seems to be getting back up in the green today.

And it feels as, though, perhaps there's anticipation that there will be a pause when it comes to the rate decision that's due out next week, which in turn may help ease the burden on consumers. Perhaps that's driving some of it. But I do-- I am concerned about the concentration of uplift we've seen in a couple of tech names.

AKIKO FUJITA: Yeah. I mean-- let me pick up on that point. Because you talked about a potential bubble. Is it not? I mean, it feels like investors are kind of hungry to latch on to anything--

ANN BERRY: Anything.

AKIKO FUJITA: --that points to the optimism. And AI is just kind of the buzz at the moment.

ANN BERRY: Yeah. Well, look, I think in terms of AI, here's why I think it's different from some of the other bubble terminology that we've seen over the last couple of years. NFTs being one of them. Meta's-- the metaverse being another.

AI has been around for longer, and it's real. And there are real applications not only in the consumer-facing pieces that have captured our imagination, there are real B2B applications which I think is what's different about AI. I think what investors are trying to do is find the picks and shovels around AI. And that's why we're seeing Nvidia do what it's doing.

But when I think about where the winners will be, I think it's going to be the companies sitting on the massive data sets that drive the quality of AI innovation and applications. So I think these big tech winners like Google--

AKIKO FUJITA: Talking about Microsoft, Alphabet.

ANN BERRY: --Microsoft, they've got the data, and I think the bigger going get bigger and scale is going to win here.

- And let's talk about what we're seeing play out internationally overseas. Because the World Bank projecting that global growth is going to slow to its slowest level that we've seen lowest level since 2008.

ANN BERRY: Yeah.

- Now, the organization does expect growth to slow to 2.1% in 2023, yet we're still seeing a lot of investor excitement overseas. A lot of outperformance here from a number of the international markets. Where are you seeing the most opportunity at this point?

ANN BERRY: Well, I'm still a bull on the domestic economy. And I think the US is uniquely positioned relative to Europe, relative to Asia, to continue to have what I would call some intelligent growth. It feels as though it's not going to be too strong relative to the macro conditions. We don't have a reopening anymore. Some nations are still having a reopening.

But just to talk about those World Bank outlooks. A heavy concentration, 70% of that downward revision, is in emerging economies. And that's where I come back to strength, and that's where I come back to the stability of the US.

AKIKO FUJITA: But from an investment standpoint, what about a place like Europe, for example? We keep hearing that it's cheap. So sort of, the valuation right, and things haven't gone as bad as expected.

And then you hear about a name like Japan, and it's a bit different in terms of the storyline that investors are chasing. It is about corporate reform. It is about changing that are happening. How do you look at those two markets?

ANN BERRY: Well, I think Japan's very interesting. There's excitement around Japan I don't think I've seen over the last decade. To your point, it is about corporate reform, it's about population changes as well.

Europe, I think, is still in a very tricky position. I don't think we can forget the fact that the borders of Europe are still at war. Ukraine is still a massive issue.

There are still supply chain issues, there still food security concerns, there's still energy security concerns, which no one is talking about now because it's a fabulous spring and a fabulous summer. When we go into the winter period again, and if that is not resolved, if there is no peace in Ukraine and some resolution around Europe's energy sources are going to be, I think this is a very temporary piece of relief. I don't think we're out of the woods on that one.

- And one of the big risks potentially here looming in the US is what's going on in the commercial real estate market.

ANN BERRY: Yeah,

- We've been talking a lot just about the 1 and 1/2 trillion in commercial mortgages that are going to be coming due very soon. How big of-- I guess let's start broad here. Just in terms of the threat that you think this poses to the US market.

ANN BERRY: Well, in terms of the absolute scale, it's sort of crazy to say this. $1.5 trillion is a lot of money. But in the grand scheme of credit in the US, that number is not an Earth-shattering number. But it does point to something which I think isn't necessarily being talked about enough, which is yes, you've got this issue in commercial real estate, you've got it in corporate credit too, which is a number of loans that were issued in the case of commercial over the last five years, in the case of big corporations prior.

These loans were issued in a totally different rate environment. And it was assumed that rates would continue to be low for a long time. And these credits were issued assuming that the cash flow of these businesses would grow.

No one saw coming that so much cash would be consumed to service such a high cost of debt. So I think whether it's commercial, whether it's the consumer, whether it's corporate, there's a maturity war that's going to hit over the next 36 months that's going to see people having to take on very expensive debt relative to their ability to service.

AKIKO FUJITA: What does that mean on the corporate side, specifically, when that debt payment comes due with those higher rates? What do we see?

ANN BERRY: Well I think we're seeing on the private side a lot more than we are in the public side. And so we're having to see businesses take out a little bit lower amounts of leverage, which means that their backers are having to infuse more equity.

Or we're seeing that the terms of this debt. So whether it's the next generation of commercial loans or it's the next generation of corporate loans, are going to have tighter covenants. It's going to be a lot easier for the lenders to foreclose on those underlying assets. And so I think the terms are going to be a bit of a shake-up for any borrower over the next couple of years.

- And is there anything that can be done at this point to fend off some of the risks that this does pose at this point?

ANN BERRY: I don't think there is at the moment. And here's what I think is so interesting about the market, and it's been consistent on this. The market hasn't listened. There's that expression when someone shows you who they are, believe them. The Fed's been super clear, our inflation target is 2%, and we're going to keep putting up rates until we hit 2%, and yet we keep seeing this optimism.

And so one thing I think does need to happen is realism-- and realism needs to be said-- to set in, right. The Fed is going to keep going until inflation is at its target. The target, by the way, is not going to change. Europe's being consistent and on point in tackling it. The US is going to continue to do what it's doing.

And so, as a result, the underwriting has got to reflect the fact that rates are going to remain higher for a bit longer.

AKIKO FUJITA: Ann Berry, as always, good to get your insights.

ANN BERRY: Thanks for having me.

AKIKO FUJITA: Ann Berry, Threadneedle founder.