I hope everyone had a fun Halloween. My kids are 10 and 3, and they had a blast dressing up and playing pretend with their friends while they scarfed down empty sugar calories.
For some investors and commentators, there is concern that the markets are also playing a bit of dress up and living off empty calories. Some professionals are warning of a major pending “sugar crash” where valuations drop to the normal range and investors are left feeling like the rug got pulled out from under them.
I start with our regular market update and then dive a bit into the concerns around whether the Artificial Intelligence Rally is a bubble waiting to burst or just a normal rise in investor optimism over a new technology.
What happened in the month:
- Indexes were up almost across the board with technology leading the way (source: ycharts.com):
- S&P 500 was up 2.3% in October, 17.5% Year to Date
- Nasdaq Composite was up 4.7% in October, 23.5% Year to Date
- MSCI ACWI Ex USA was up 2.0% in October, 29.2% Year to Date
- Bloomberg US Aggregate Bond was up 0.6% in October, 6.8% Year to Date
- The Federal Reserve Open Market Committee (FOMC) cut their benchmark interest rate by 0.25% at the October meeting, the second consecutive cut this year.
- While the government shutdown has delayed some key economic data from the Bureau of Economic Analysis (BEA), the latest estimate from the Federal Reserve of Atlanta is that the economy grew at 3.9% in the third quarter (source). That estimate is the highest we see, with the median between 2 and 2.4%, but it no matter which estimate you use, we are far from being in recession territory. For reference, GDP growth in the second quarter was 3.8% (source).
- The Consumer Price Index (CPI), the traditional measure of inflation, came in at 3.0% annual change in September. This is a full percentage point above the Federal Reserve’s 2.0% target rate. This hot reading, combined with stronger than expected GDP growth, raise questions about whether the Federal Reserve will cut rates again in their December meeting (9th – 10th) (source).
- Trade Policy: This has been dizzying to say the least. HERE is the best resource I have found for following the Tariff Policy.
- Tension on trade policy with China heated up at the beginning of the month and then cooled with Trump and Xi meeting at the end of the month, ultimately agreeing on a short-term solution. The main gain for the U.S. was access to rare Earth minerals which are essential to many modern technologies.
- The Supreme Court had been given a deadline of October 14th to review the legality of the Trump Tariffs. They pushed the review back to hear arguments on November 5th. This is getting dragged out.
Earnings: This is where the real market action is and what we think will make or break the performance through year end.
- Six out of Seven of the “Magnificent 7” stocks (the biggest companies) have reported earnings so far. The only one that hasn’t reported is Nvidia (expected Nov 19th).
- Big picture, all the Magnificent 7 beat estimates except for Tesla who had a slight miss. Big picture cloud growth (specifically Amazon, Microsoft, and Google) and continued AI -user growth helped fuel a rally in technology overall. Apple had positive words regarding expectations around China sales looking forward.
- One notable take away from the earnings reports was big plans for capital expenditures related to AI looking forward. This hurt a few companies’ performance like Microsoft and Meta, but reports were generally strong.
- The Magnificent 7 are expected to grow earnings 11.5% year over year and revenues by 15.4% year over year. The rest of the S&P 500 is only expected to grow earnings by 6.1% year over year. This tells the clear story of why we continue to see significant outperformance in those concentrated names versus the rest of the market (source 1, source 2).
I know that was a lot to digest, so here is the quick rundown: Markets are doing well based on earnings, strong economic numbers, and a rate cutting cycle. Trade is a headwind but really is just too confusing for people to follow, so they are deferring to the earnings to tell them whether they should worry. So far, the earnings are good enough to leave people less concerned over trade and instead focused on the optimism of AI.
Which brings us to the main point we want to address: ARE WE IN AN AI BUBBLE?!?!?! This seems to be the greatest concern for investors these days, and with fair reason. Many of us remember the Dot Com Bubble, where money was pouring into companies with little revenue and no profits in hopes that investors were getting “in” before everything skyrocketed.
But today is a little different. As we pointed out above, the Magnificent 7 are really where most of the investment is flowing to, and these companies are incredibly profitable and are growing revenue at tremendous pace! Sure, there are some private investments in start-up AI companies that are hard to justify, but we always see elements of that in every new technology with large market gains around them. We saw this in Crypto when Bitcoin was breaking out in 2020 and 2021, and while that “Bubble” crashed in 2022, the primary victims were those who got caught up in the “irrational exuberance” (hat tip Greenspan).
There was a great article on Reuters that details the differences. You can find it HERE. One important chart is the trailing 30 years of the Price to Earnings Ratio (a traditional measure of market value) of the Technology Sector they had in the article. The point of the chart is while we are certainly not “undervalued”, we still have a way to go before we are at the extremes we saw in the late 90’s and early 2000’s.
But the fact of the matter is, if you are concerned that we are in an AI Bubble, then there is no combination of charts or facts that will help you sleep at night. The only solution is to adjust your allocation so that you are comfortable with the risk in your portfolio. I just ask that people consult professionals on a constructive way to do this instead of taking a “GO TO ALL CASH” approach which has rarely been successful in the past. Here are a couple of alternative ideas to chew on:
- If you have a well thought out financial plan, then it is likely recent market strength has helped you get ahead of your planned long-term returns for your overall plan. It might make sense to see what changes could be made for the next five years that would bring down the overall return but keep you in line or ahead of your planned long-term returns. This way, you don’t let your short-term emotions impact your long-term financial plan.
- Consider some alternatives that don’t involve or depend on AI. A lot of companies and sectors have been “left behind” this AI rally, and many of them offer attractive long-term returns when using classical valuation and return potential models. You can still have the potential to generate the return while potentially avoiding the major concerns!
- Consider a more active strategy that will adjust with the market and risks. You can also consider hedged strategies which have a known cost of upside potential but provide significant protection to downside risk.
If you have questions about anything we discuss above or would like to discuss some of the strategies we highlighted to avoid possible AI Bubble risk, we welcome the conversation! As we have said in past commentaries, WE LOVE THIS STUFF!
Happy Holidays to all!
Chief Investment Officer
Green Ridge Wealth Planning
Disclosure:
Green Ridge Wealth Planning, LLC is a registered investment adviser. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment/tax advice. The investment/tax strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment/tax strategy for his or her own particular situation before making any investment decision(s). You are responsible for consulting your own investment and/or tax advisor as to the consequences associated with any investment.
The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Any opinions, projections, or forward-looking statements expressed herein are solely those of the AUTHOR, may differ from the views or opinions expressed by other areas of Green Ridge Wealth Planning, LLC, and are only for general informational purposes as of the date indicated.