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  • Writer's pictureBen TeSelle

Dorato News - July 2023

Portfolio Issues - Revolution?

Artificial Intelligence is the latest “revolutionary” technology that investors cannot miss out on. That was the general consensus if you tuned into the financial media during the 2nd quarter, and the massive popularity of ChatGPT seemed to bolster those claims.

However, we have seen this type of story before. The metaverse and blockchain are recent examples of excessive hype that haven’t translated into the monumental changes that were promised.

Right now, we see investors predicting big tech will benefit immensely from new products similar to ChatGPT. That is a possibility, but there are plenty of other sectors that will benefit as computing and programming continue to advance.

We think artificial intelligence is a powerful tool, but fundamentally changing the way companies function seems far-fetched. Those that use new technologies to increase efficiency are likely to enjoy some increased profitability. And that is the primary goal of companies: to make money.

So, will big tech have a monopoly on new technology? That seems unlikely. If that scenario played out, we imagine the government would intervene. The more relevant question is, how will companies use new technology to their advantage?

The internet transformed the way companies conduct business, but it did not change the overall function of our capitalist system. The likelihood of us having a handful of companies controlling everything is about as likely as returning to the gold standard.

“I’m programmed to promote the Next Big Thing out of Silicon Valley. How about you?”


Market View - Nuttiness, Part Two

Way back long ago, during the pandemic, investors believed that technology stocks were both a safe haven and the only chance for growth. Remember that? Work from home, the cloud, the metaverse, video games. Those were all tossed into the hopper as reasons for tech stocks’ outsized performance. In 2022, that all came crashing down. Yet here we are again, in 2023 with a variation of the pandemic theme, only this iteration strikes us as even nuttier.

The S&P 500 is up about 15% year to date, but that gain is due almost entirely to a small handful of stocks: the largest technology and tech-related companies. Apparently, the safe haven and growth beliefs are back in full force, with an added dash of artificial intelligence hype. Not all technology stocks are benefiting from this trend, only the biggest. So any sort of diversified portfolio is not keeping up with the index, which is heavily weighted to those large technology companies. In fact, an equal weighted performance measure of the companies in the S&P500 is essentially flat for the year.

We’ve seen this movie before, so why are investors doing the same thing they did in 2020-2021, only in a more concentrated and nuttier form? We don’t really know. All we know is that this fad, too, shall pass. By the end of May, the performance of the S&P500 was more concentrated in a handful of the biggest companies than its been since the 1970s. In June, that trend started to break down, so perhaps the credits to this annoying movie are starting to roll. Again, we don’t know. But whether it’s now, or a few months from now, it shouldn’t be long.

There is another place where there has been a large performance gap between assets. This is between US stocks and foreign stocks, and that gap has been growing for at least a decade. This, too, probably won’t last forever.

Compared to the stock market, the bond market has been relatively calm. The Federal Reserve has continued to push up short-term interest rates, to about 5%. But longer term interest rates are about where they were at the beginning of the year, in the 3.5% to 4% range. The US Aggregate Bond index is up about 2% so far this year, a far sight better than the 13% loss in 2022. Bond investors seem to think that the Federal Reserve is making the right decisions, and they expect the economy to slow, if not tip into recession.

We agree that the Federal Reserve is making the right moves, but we think that inflation is likely to prove a bit more durable than bond investors currently expect. The emergence of China over the last 30 years exerted a powerful downward force on US inflation. That force is unlikely to continue in the future, both because the US is re-thinking it’s relationship with China, and because cost reductions from using Chinese suppliers have probably reached their limit anyway. We also have a Congress that wants to spend much more than it’s income, which is inflationary. And if the Federal Reserve faces a choice between a serious recession and inflation, we think they will choose to allow some inflation. For those reasons, we favor inflation-protected bonds over standard US Treasury bonds.

At first glance, it looks like the stock and bond markets have widely divergent views. How can stocks be up 15% when the bond market is predicting a recession? But since the stock market is being driven by a small number of technology stocks, and many other stocks are down or flat for the year, the outlook may not be that different. The odd one out is those big technology companies. Can they grow faster than the rest of the economy, and through any possible recessions? As you might guess, we think not. Time will tell.

As always, we advise investors to keep steady and not respond to all the flashing lights and ringing bells of the markets.

Sources: Economist, Wall Street Journal, Value Line, Vanguard, Applied Finance Group, Schwab

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