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Economic conditions may be challenging, with stocks experiencing significant volatility and persistent inflation, but some economists believe that these turbulent times can present new opportunities (as well as risks) for investors.

What’s happening: The global economy is constantly changing. The labor market remains remarkably resilient, but other economic indicators, such as spending and manufacturing, are weakening. Additionally, turmoil in Russia can cause another inflation spike if its extensive commodity exports are disrupted.

In the earlier part of the year, central banks seemed to be pausing or winding down their year-long regimen of painful, inflation-fighting rate hikes. However, policymakers have recently changed their stance and are warning investors that more pain is on the horizon.

US stocks have managed to recover from their recent bear market and enter bull territory. However, analysts are still uncertain whether this is a bear market in disguise, and markets ended last week significantly lower, breaking a multi-week winning streak.

Indrani De, head of global investment research at FTSE Russell, believes that investors have good reason to be optimistic, as macroeconomic signs point to a renewed appetite for risk.

Before the Bell: Inflation and Bond Yields

Indrani De: Inflation remains high, but the crucial factor is its trajectory, which is heading toward disinflation. Different countries are at various stages in their inflation journeys, leading to significant dispersion between asset classes and countries. This requires investors to be more selective.

Resilient economic growth in the US has resulted in higher earnings forecasts. Stocks have performed particularly well since the US dollar weakened from its recent highs in the last quarter of 2022. A weak dollar is beneficial for risky assets and large-cap stocks.

The market tends to focus on short-term policy rates, but the 10-year Treasury yield is more important for equities and other risk assets. This rate peaked in early 2022 and has since decreased and stabilized, which has helped tech stock growth.

Artificial Intelligence and Market Froth

It’s not only cyclical factors like better-than-expected GDP and upward corporate earnings revisions that are driving optimism. There is genuine hope that artificial intelligence (AI) could lead to a structural upgrade in economic growth prospects, similar to the 1990s when internet stocks sparked growth in the tech sector and eventually impacted the entire economy.

AI can potentially boost productivity and economic growth significantly, but if the rally remains concentrated solely in technology, it could be riskier as no single industry can grow indefinitely in the stock market.

Potential Worries for Markets

While there are reasons for optimism, it’s essential not to underestimate the risks that remain for stocks. Valuations may have outpaced growth improvement prospects, and there are other economic risks, such as a slowing manufacturing purchasing managers’ index and tightening bank lending standards. The macroeconomic picture is mixed, but optimism drives US equity markets higher.

Looking Ahead: The Third Quarter

Predicting market performance is challenging, but analysts and companies continue to make forecasts. For the third quarter, analysts are most optimistic about the Energy, Communications Services, and Information Technology sectors, while they are most pessimistic about the Consumer Staples sector.

In conclusion, while the current economic landscape presents challenges, there are also opportunities for investors who can navigate the risks and find growth potential in various sectors.

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