Back
The US S&P 500 Index was up 10.2% for the first half of the year. If it keeps this up, this will be the fourth consecutive year of double-digit returns. This is a feat it has achieved only once in its 68-year history (1995-99 when it actually managed it for 5 years in a row). People are therefore (understandably) looking for reasons this run of strength might end soon.
My list is pretty simple:
- The US economy starts to slow down.
- The AI investment boom starts to rollover.
- A surprise.
There isn’t much to say about the last one here of course. We have had a pandemic, two wars, an inflation shock, an interest rate shock, and a tariff reset in the last seven years. I‘d be surprised if the next seven are any quieter and you should set your personal risk budgets accordingly. But the resilience of the global economy to all this has, to my eyes, been remarkable. To be an equity investor you need to be, at some level, optimistic. To be sure, none of these events felt great at the market lows. But I do take some optimism from our collective ability to roll with the punch, survive, and move on to the next challenge.
I wrote last week about the strength of the US economy. This week we had another solid US payrolls report. And with US WTI oil back below $70 a barrel (having peaked at $100 in May) I’d be more optimistic that inflation and interest rates will start to be more of a tailwind than headwind from here. This still feels like a good cyclical backdrop to be an equity investor. Which means that if I am worrying about something, it is a break in the AI investment story.
And I don’t think I am the only one. You can divide the world into the companies spending the investment and the companies receiving it. The main spenders are the big five “Hyperscalers”: Microsoft, Amazon, Google, Oracle and Meta (the old Facebook). (And as I am mentioning some company names here: please note that none of this note is ever meant as financial advice). Interestingly, these five Hyperscalers are actually down as a group year to date:
Meanwhile, the people receiving the (literally) trillions of dollars of investment are doing quite well. As I wrote here, plenty of these businesses (semiconductor and memory manufacturers) are located in Asia which is the main reason that emerging markets have out-performed over the last 18 months.
And, surprisingly to me at least, you can add US small and mid-cap equities to the list of beneficiaries. In contrast to the tech giants, the US Russell 2000 Index is up over 20% year-to-date. Part of this is because the US economy remains in a good place. But nearly 40% of that year-to-date return has come from AI infrastructure stocks. If you worry that that might be overdone, looking at the longer-term chart there is still plenty of potential catch up for the small and mid-caps to do:
But, if the market is punishing the spenders, you have to think about how long this pace of investment will last. This will of course, ultimately depend on the level of demand for AI and on how much businesses use the burgeoning number of AI tools out there. My sense is that, after a gangbuster start to the year, the rate of growth might slow as businesses start to evaluate what is and isn’t adding value in their AI spend.
As ever, we shall see. As an investor it is always easier to diversify than to predict. And it is not obvious to me US small and mid-caps or emerging markets will offer much of a safe-haven if the AI investment boom does indeed start to slow. That leaves boring old Europe and, of course, the UK as places to invest and diversify. For many of our sterling portfolios we invest in UK care homes and infrastructure more generally. Boring, old-world companies may not be benefitting from all things AI today, but equally they do not depend on the next cheque arriving from Amazon or OpenAI to keep growing. Being boring might prove to be a strength in the next few quarters.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
