Timing the cycle: why it remains important

AI – All that glitters? 

The world’s tech giants are boosting their AI-related capital expenditure (capex) with no signs of slowing down. According to the Wall Street Journal, Meta*, Microsoft*, Amazon* and Alphabet* are set to spend $400 billion this year in capex, with a large chunk of this used to build AI infrastructure such as data centres. 

In its most recent quarterly financial report, Meta made its commitment to AI spend clear: “We currently expect another year of similarly significant capital expenditures dollar growth in 2026 as we continue aggressively pursuing opportunities to bring additional capacity online to meet the needs of our artificial intelligence efforts and business operations”.

This is hugely significant both from a macroeconomic and market valuation perspective. Initial indications suggest that this opportunity will be truly meaningful in terms of broadness and depth in its ability to both disrupt and create new industries. On that basis, while we believe that we are still early in investors’ estimations of the potential impact, the possibility remains that at some stage in the future, as the market becomes more aware of the scope of disruption, we may enter bubble territory. Now is the time to take stock and carefully consider where we are in the cycle and crucially, what may come next. 

The probability of an investment outcome changes as our position in an economic or business cycle changes. Therefore, we can look to increase our odds by attempting to ascertain what stage of the cycle we currently stand in. Good cycle timing remains one of the hardest and most satisfying aspects of being an investor. Done well, it will likely account for a lot of the success an investment team and its process enjoy.

Recession red flags

A pressing question for investors watching the latest global trade developments is: could US tariffs spur a recession? When it comes to making a call on recession, we believe the key is corporate redundancies. However, there are no strong indicators that could give us much advance warning on companies’ firing decisions – with monthly business surveys providing an average of 1-2 months’ notice. Therefore, a sharp deterioration in those hiring intentions for two months in a row could lead us to upgrade our views on recession from a risk to our base case. 

Inflation has been the buzzword for investors for some time – and while always a key consideration – is currently subordinated to the cycle call. In a recession, no one is likely to worry about inflation because it is expected to fall (with a lag). 

The tricky inflation call is determining if the cycle delivers a soft landing or muddle-through scenario. We have a few crosscurrents: housing costs are going down, while goods prices are going up. The latter is not just a result of trade tariff developments, but also thanks to 10% depreciation in the US dollar in the first half of the year. So, we believe the key is core-core service inflation (core services excluding housing). 

This is driven by wage growth. Both the Employment Cost Index and Average Hourly Earnings have been sticky in recent months at a near-4% annual rate. If the labour market stays the same, with the decline in labour demand broadly matched by a fall in labour supply – then wage growth may not slow or may not slow down at a fast enough pace to justify multiple interest rate cuts by the US Federal Reserve.

Given everything that has happened this year: tariffs at post-1945 highs, a US Federal Reserve under political pressure, sticky inflation at above target, the relative market resilience (barring the US dollar) may be a surprise to many. Post-Liberation Day markets are a different world to pre-Liberation Day. In a recessionary scenario, equities are unlikely to be unscathed. However, in a muddle-through scenario, we believe that AI will determine how much further upside for risk assets there is for the rest of the year. 

*For illustrative purposes only. Reference to a particular security is on a historic basis and does not mean that the security is currently held or will be held within an L&G portfolio. The above information does not constitute a recommendation to buy or sell any security.