The economic conditions for stock market growth at the beginning of the year were simply ideal – government spending was increasing, markets expected falling interest rates, energy was very cheap, and the development of artificial intelligence sparked a long-awaited investment boom. Indeed, growth was recorded across various sectors and continents. The US stock market grew by about 12%, European stocks rose by about 10.5%.
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This year highlighted the leadership of distant Asian markets – South Korean indices rose over 64%, Taiwan’s nearly 59%, Japan’s about 31%. All these markets stand out with their technology companies, which have become cornerstones in the AI supply chain ecosystem. The overall trend shows that markets dominated by the technology sector are growing faster. Europe, due to relatively higher sensitivity to energy prices and a smaller technology weight, is lagging slightly behind.
Rising energy prices suppress demand
At the beginning of the year, oil cost just $60 per barrel, an energy market surplus promised milder inflation and higher industrial activity. However, the war in Iran quickly disrupted the situation, and after an acute conflict phase, oil prices stabilized between $80-95. The situation in the refined oil products market is more complicated – refining margins remain at record highs.
The energy sector situation is not sharp enough to provoke a serious economic slowdown but certainly no longer stimulates growth. This time demand is weaker than during the 2022 energy shock, making it harder for companies to pass rising costs onto consumers. This suppresses overall price growth but negatively affects profit margins of energy-sensitive companies. Compared to the beginning of the year, the outlook for cyclical, industrial, and consumption-dependent sectors has worsened.
The cost of money at record highs
The conflict in the Middle East affected not only energy prices but also interest rates. Rising inflation forced the European Central Bank to raise base interest rates by a quarter of a percent. A similar decision is expected in September. The Federal Reserve abandoned plans to cut rates, and the market now expects a slight rate increase as price growth in the US remains rapid.
Moreover, a steady rise in yields continues in the bond market. Due to recurring energy shocks, large fiscal deficits, and relatively high inflation, investors demand higher returns when lending to governments. The cost of 30-year borrowing in Germany, Japan, and the US has risen to heights not seen in 10-15 years. This affects not only governments’ borrowing capabilities but also borrowing costs for businesses. Compared to the beginning of the year, capital has become harder to access, and the stock market typically reacts negatively to worsening financing conditions.
Government spending pace slows down
Large government investment plans continue to stimulate the global economy. Investments in Germany are expected to gain momentum in the second half of the year. The US deficit is growing due to military spending, and economic stimulus continues in China and Japan. Higher government spending will stimulate the economy and stock markets throughout the rest of the year, but this impulse will fade in 2027. The situation is complicated by the rising cost of debt and growing concerns about debt sustainability. In the short term, fiscal policy will still provide a positive boost to stocks, but in the medium term, as deficits normalize, the effect will reverse.
The AI boom matures but does not slow down yet
The technology sector remains the hottest topic for several years in a row. Massive investments in artificial intelligence development and data centers increase economic activity and bring dizzying profits to microprocessor and memory chip manufacturers. Not only technology giants benefit but also construction companies, energy firms, and various network component manufacturers.
This year, so-called hyperscalers increased investments by almost 80% to $725 billion, and next year they are expected to reach as much as $1 trillion. Investments continue to grow, but the growth rate is slowing. The question arises whether such ambitious plans can be realized – there is a shortage of memory chips, insufficient electricity supply, and increasing planning challenges. Moreover, from this year, such large-scale investments can no longer be funded solely by internal cash flow, leading to record issuance of debt securities, with financing schemes becoming more complex and less transparent.
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Rapid debt growth signals both a late stage of the investment cycle and increasing risks – high financial leverage makes the system fragile, and any shock becomes much more painful. The behavior of AI players also signals market expensiveness and investment cycle maturity. This year we saw SpaceX’s initial public offering, and similar moves are expected from OpenAI and Anthropic – AI model developers are rushing to take advantage of favorable market conditions to raise as much capital as possible.
AI investments have undoubtedly been the main driver pushing markets to new heights. Current company plans indicate that their pace will increase further in the near future, but investors are becoming increasingly critical of such spending, so soon the major players will need to demonstrate investment payback.
The investment cycle has confidently moved into a mature, late stage. Today, there is still healthy skepticism in the market, but often at the end of the cycle, unmeasured euphoria reigns. This is usually a time of dizzying stock price increases, which is very dangerous because it is always followed by a decline.
Risks grow, but so do opportunities
Currently, the overall economic environment remains favorable for further stock growth – interest rates are higher but not enough to stop AI investments. Energy is more expensive but not overly so. Government deficits maintain economic temperature. Global economic growth remains stable, and this time the energy shock should not trigger a long-term inflationary spiral. Under such conditions, the bull market can continue, but risks are increasing, and it is especially important for investors not to lose discipline.
We observe a steady rise in the cost of money worldwide. If this trend continues, a more pronounced stock market decline is likely to follow. Overall, the stock market has been driven up by incredibly fast-growing profits, but questions arise about their sustainability – relative valuation metrics such as R. Shiller CAPE or W. Buffett’s indicator show a record overvaluation of the stock market, largely related to AI investments. Although the AI “arms race” seems unstoppable, deteriorating capital availability may force a slowdown in investments, which would trigger a stock correction.
However, the situation could turn for the better. The conflict in Iran, although increasingly frozen, can still be resolved. Then cheaper energy would provide a double positive impulse – through lower prices and eased financing conditions; as energy prices fall, markets would again start talking about interest rate cuts. On the other hand, even with the conflict simmering, energy-producing countries are rapidly investing in alternative supply routes. It is possible that in 2027-2028 we will again talk about an energy market surplus. In such a scenario, European markets would be the biggest winners.
No one can say how much longer this AI-promise-filled stock market rise will last. Although the overall economic background has worsened compared to the beginning of the year and risks are accumulating, this does not mean that investing is unnecessary. Still, the situation requires caution. It is extremely important at such a late cycle stage not to succumb to greed and not to take excessive risks.
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