“It’s The Climb” — Miley Cyrus
Miley Cyrus was probably not considering the stock market in her hit song, but the old adage that markets ‘climb a wall of worry’ seems to pertain to 2023, at least as we approach the mid-point of the year. The climb this year though is full of dangers and finding one’s footing seems particularly difficult. The climb, however, continues to ultimately advance. In spite of increased interest rates by the Federal Reserve, inflation declining but in a slow and sticky manner, a regional banking mess after the collapse of Silicon Valley Bank and others with regulators who can’t quite fully restore depositor confidence, a pending debt ceiling violation by the US government, evidence of weakening consumer confidence and demand, and many companies forecasting weakening sales and profit growth, the S&P 500 is up 8% for the year. When looking at the broader stock markets, there has been a broad range of returns with international developed markets up close to 11% but US small value stocks down 5.6%. Broad diversification has clearly helped this year, not just geographically but by industry sector too. Energy is down 9%, and financials are down 6%. Technology, however, is up 22%, and consumer discretionary is up 15%.[1] The overall resilience is impressive. Have we hit peak ‘worry’ or are there new worries to come that can knock the climber down or even off the wall?
Japan and Germany at New Highs, Really?
Japan’s Nikkei index hit a new 52-week high this past Friday, and Germany’s Dax index hit a new yearly high on May 2.[2] Europe and Japan are dealing with higher rates and inflation too so what’s going on? Both regions lagged the US in terms of timing and pace of recovery from the pandemic. Japan is enjoying a surge in demand especially in the services sector thanks in part to strong tourism with a weaker yen and strong exports. A weaker dollar, inflation falling from its peak, and lower valuations have helped the German market rise over 14% this year.[3] It has been a while since international markets have outperformed the US. With the US continuing to trade at historically high valuations relative to the other developed markets, this outperformance may endure. Global diversification still matters.
Is Artificial Intelligence (AI) a Massive Technological Advance or Not?
In my last letter I kidded a bit whether or not I or ChatGPT wrote the letter. The ability of chat boxes to not just gather information but to analyze and compose is sweeping across and impacting large swaths of the economy. A recent Forbes Insight study discussed how the automation of routine tasks and much more rapid data analysis can boost productivity, enhance collaboration, and the quality of work life.[4] Consumers will start to notice too. For example, Wendy’s in partnership with Google is piloting AI drive-thru technology – where customers will give their order to an AI chat box instead of a live person.[5] From helping pathologists more quickly and accurately analyze tissues to helping travelers make recommendations on what to see and do at the prices, AI technology is already pervasive. So yes, it is looking like a massive advance. There will of course be plenty of debate about what pros and cons this new AI world will bring and how best to regulate it, but there is no going back.
What does it mean for my investment portfolio?
The mega 5 players – Apple, Microsoft, Alphabet (Google), Amazon, and Meta (Facebook) are all rolling out AI-related new or enhanced products and partnerships. Their size and scale provide them inherent advantages. At Team Hewins, our allocation to large domestic equities is primarily index based. These five companies plus leading AI computer chip company Nvidia have a 22% weighting in S&P 500; therefore, our portfolios are well exposed to the leading names.[6]
With the productivity enhancements of AI so pervasive, all sectors stand to benefit. A well- diversified equity program is a simple, smart and safe way to play AI. Just as with the advent of the internet over 25 years ago, there will be winners and losers. There will be temptations to make big specific bets on individual names that are considered great AI plays – be careful! Remember names like Lycos and Pets.com from the internet boom? The internet is still here, but those companies are long gone.
While the economy faces the full impact of the Federal Reserve interest rate hikes, the debt ceiling debate, and the regional banking crisis, it also is engaged with the early stages of the AI transformation. The coming months could continue to be a slow and arduous climb, but the coming years could very well bring remarkable changes to business and life overall. Our program will remain globally diversified which is helping you withstand the immediate economic and market concerns but will also allow you to fully participate in the advances that AI can bring to business productivity and efficiency.
Best wishes for an enjoyable and restful summer!