Sticky inflation clouds rate outlook, but AI and earnings keep markets resilient: Santosh Rao

The artificial intelligence-led rally continues to be one of the biggest drivers of global markets, but investors are now seeing the momentum spread beyond technology stocks. According to Santosh Rao from Manhattan Venture Partners, while concerns over AI-related capital expenditure and supply chain bottlenecks remain, broader participation from sectors such as healthcare, financials and transportation points to a healthier market. At the same time, sticky inflation and resilient economic data have strengthened expectations that the US Federal Reserve could keep interest rates higher for longer, lending support to the dollar while weighing on commodities and emerging markets.

Speaking to ET Now, Rao said the long-term AI growth story remains firmly intact despite supply constraints in certain parts of the semiconductor ecosystem. “AI is still very strong. AI momentum is still strong… overall, the demand for AI will continue. We are still probably in the third or fourth inning of a long, long game here.” He added that the rally is becoming more broad-based. “The bigger takeaway from the market is that the market is broadening. AI-enabled stocks are doing well. Healthcare is participating, financials are participating, transportation is participating. Those are good signs that the economy is in good shape,” he said.

On the monetary policy outlook, Rao believes inflation remains the Federal Reserve’s primary concern and has increased the probability of another rate hike this year. “Inflation is proving to be very sticky… there are a lot of inflationary forces out there.” While he expects policymakers to remain cautious, he believes “one hike makes sense based on my reading of the market… the probability of a hike has definitely increased,” he said.

Rao also argued that strong corporate earnings continue to justify elevated equity valuations. “What is holding up the whole market is strong earnings growth. For 2Q, it is expected to be 20% plus… and we are going to end the year with more than 20% EPS growth overall.” While acknowledging that valuations remain high, he noted,

“Valuations are high, but that is okay… they are supported by good earnings growth. Right now, the path of least resistance is up because the fundamentals are good,” he said. He added that geopolitical developments, particularly in the Middle East, remain a bigger risk than domestic economic conditions.

Discussing commodities, Rao said expectations of higher US interest rates are strengthening the dollar, creating headwinds for gold, silver and other commodities. “A stronger dollar definitely works against all commodities… the dollar is going to keep going up, and that is negative for the commodities market.” He also cautioned that “a strong dollar does not work in favour of emerging markets,” suggesting that both commodities and developing economies could remain under pressure if US yields stay elevated.

Overall, Rao believes the combination of resilient AI demand, healthy earnings growth and a broadening equity rally continues to support markets. However, inflation trends, Federal Reserve policy and geopolitical risks are likely to remain the key factors influencing investor sentiment in the months ahead.