Heritage Capital Research By Dave Moenning on May 19, 2023 07:32 am
I was asked recently to sum up the action in the stock market as succinctly as possible. As long-time readers are likely aware, brevity is not exactly my strong suit. But after giving it some thought, I did manage to come up with a two-word summary, which also doubles as the title of this week's market missive: "AI or Bust!" In short, if you are investing in the big AI (artificial intelligence) names such as Nvidia (NVDA), Microsoft (MSFT), Alphabet (GOOGL), or even some of the next-tier AI themed companies such as Meta (META), Advanced Micro Devices (AMD), Synopsis (SNPS), Amazon.com (AMZN), Palantir (PLTR), Salesforce (CRM), or more recently ServiceNow (NOW), congrats, you are having a great year! More specifically, Deutsche Bank noted this week that their basket of ten megacap tech names (MSFT, AAPL, AMZN, GOOGL, META, V, MA, NVDA, NFLX, ADBE) sported a YTD gain of +33.3% as of Wednesday's close, while the S&P 500 index was up +8.0%. However, if you happen to believe in a little something investing professionals like to refer to as "portfolio diversification," well, my condolences, because the "rest" of the markets aren't having near as much fun. In fact, Deutsche Bank tells us that an index of the remainder of the S&P 500 (I.E. the other 490 stocks) is actually down -0.5% on the year. Value stocks (as defined by VLUE) are down -1.4% YTD as of Wednesday's close. Dividend payers (using DVY as a proxy) show a loss of -6.7%. Small Caps (IWM) are up just 1.4%. Similarly, Mid Caps (MDY) sport a gain of 1.7%. So, don't look now fans, but it looks like 2023 is shaping up as a "diworsification" year. Joy. So Many Headwinds The reason behind the situation is pretty simple. You see, there a great many macro headwinds that markets are flying into. There's the "looming" recession, which just about everybody on the planet is calling for and assures us is right around the corner. There is the Fed's antagonistic stance. There is the inflation problem. There is annoying fact that we are in the midst of what, so far at least, is the second biggest series of bank failures (as defined by assets) in history. There is the money supply issue (for those of you keeping score at home, M2 is heading the wrong direction). There is the possibility of a credit crunch (which certainly doesn't sound good). And then more recently, there is the question of whether or not the boys and girls in DC are going to squabble their way into defaulting on the country's obligations. Talk about a "wall of worry!" From my perch, it is this litany of macro concerns that has kept the vast majority of stocks bottled up and going nowhere fast. For every potential positive argument such as the consumer is doing just fine, thank you, or that jobs are plentiful, or the fact that inflation is trending in the right direction, or that the Fed is about to press the pause button, there is that long list of macro issues to worry about. But There is a Bull Market In... On the other hand, there is one area that is hot. As in red hot. And that's AI, which is being billed as the next big thing. Or as many, including yours truly, have put it; the biggest thing in tech since the advent of the internet. We're talking game-changing stuff here. Many liken the opportunity for investors to that of buying Apple, Microsoft, or Google in the early 2000's. Or Tesla (TSLA) a decade ago. Or... Well, you get the idea. No, the road will definitely NOT always be smooth and easy. Some companies will fail. Some will mess up. And we have no idea the extent and/or profitability of these AI darlings in the future. But it is safe to say that there is likely to be a lot of innovation ahead. And, in turn, investing opportunities. Big Boys Piling In Don't want to take my word for it? Big name hedge fund players, who all seem to have the phrase "billionaire investor" attached to their names when mentioned in the media, are falling all over themselves lately talking about the opportunity that is AI. David Tepper, Stanley Druckenmiller, Paul Tudor Jones, and Steve Cohen have all made headlines gushing about the importance of this theme - this week. As the proud owner of Nvidia, which is arguably the poster child for the AI movement, I am almost giddy to see the stock up over 110% this year. I am thrilled that Palantir and Salesforce have popped over 55% in 2023. And that our holdings in Microsoft, Alphabet, and Amazon all sport healthy gains over 30% YTD. Bear Warnings The bears are quick to argue that the moves in these stocks are nuts and that buyers have "lost touch with reality." "Look at the P/E's" they scream. But here's the thing. When you are talking about something that represents as Steve Cohen called it, "a wave of opportunity" that he expects will create jobs and boost profit margins, the trick is to make sure you are on the train as it steams down the tracks - not argue about what the appropriate P/E is for a dominant player in game-changing technology. Microsoft or Colgate? Speaking of P/E valuations, let me ask you a question that may provide another example of the dichotomy in this market. Looking ahead five years, would you rather own Microsoft or the purported king of the "safety trade" - Colgate-Palmolive (CL)? Before you answer, consider that "Mr. Softee" (MSFT) sports a Price-to-Earnings ratio of 34.4. "Ooh, that's high," the bears exclaim. But history (and NDR's computers) tell us that 34.4 is in the lower realm of the company's 5-year P/E range between 23.6 and 57.6. On the other hand, the P/E for CL currently stands at 41.6, which is at the very high end of its 5-year range of 22.5 and 42.7. So, which is it? The software used everywhere and a company on the forefront of AI at 34.4 or the maker of toothpaste at 41.6? Hmmm... On the AI Train In case it isn't obvious by now, I am firmly seated on the AI bull train. I'm not exactly sure what I can do with ChatGPT 4.0, or Bard on my phone or how to use these large language models in my business. But the applications I'm reading about from a host of companies during the current earnings season is mind-numbing. Cutting to the chase, AI is going to be everywhere. Heck, even Wendy's (WEN) announced last week that they are currently implementing AI to improve their drive-thru experience. Another big question is if this "next big thing" will be a long-lasting investment theme or something that flames out quickly? While Ms. Market has proven over time that she doesn't give a hoot about what I think, my take is that AI is just getting started. Will the AI "gold rush" end at some point? Sure. Will there be scary pullbacks? Yes, count on it. Could the AI space become a drag on a portfolio at some point? Absolutely. Especially if/when things get too hot. And yes, a recession or a credit crunch could certainly cause investors to curb their enthusiasm. To be sure, nothing is easy in this business. But I think most will agree that it's a lot more fun trying to determine when to bank some gains or buy a dip in a raging bull than to worry about why those value holdings are struggling mightily. So, for now, it looks like it's "AI or Bust" in this market. Thought for the Day: People too weak to follow their own dreams will always find a way to discourage yours -Unknown Wishing you green screens and all the best for a great day,
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