Monday, October 14, 2024
Ever since the end of 2022, there have been a handful of artificial intelligence (AI) stocks that have been driving the S&P 500 gains. You know these names very well: Nvidia, Microsoft, Meta, Apple, Tesla, Amazon and Alphabet. All of these corporations continue to contribute to the S&P 500 due to their near constant revenue and earnings growth. However, with the recent run-ups they have all been priced to perfection. Should a hiccup occur with any of these names, investors will not be kind to their share price (for example, see Tesla’s 2024 year-to-date stock performance). The good news in all of this is that in the third quarter, we started to see a divergence of returns with small caps and even some foreign stocks receiving some traction. This bodes well for us as our diversified portfolios contain large chunks of these sectors.
As many of you know, the Federal Reserve recently lowered their overnight lending rate by 0.50% (50 basis points). You can read a lot into this move, but by and large the Fed is signaling that they believe they have inflation under control at approximately 2.4%, which is fairly close to their long-term target of 2% and their focus now is to keep employment as solid as possible. If they leave their rates higher for longer, the fear is that the Fed will tip the economy into a recession, which would obviously be bad news for labor. Remember that there is an extremely long lag when it comes to interest rate increases and decreases – I would argue a one-to-two-year lag. Thus, the last interest rate increases are still working their way through the economy and the Fed, it seems to me, just wanted to be ahead of the curve regarding recession possibilities. What I like about this Federal Reserve vs. the Federal Reserves of the past is that this group is fine with telegraphing what their plans are instead of keeping their moves close to the vest. This helps CEOs of large and small companies plan accordingly and it may be one reason the Fed has avoided a recession to this point. Historically, when the Fed raises rates as quickly as they have over the past couple of years, the economy ends up in a recession. The Fed has signaled another quarter-point decrease at the end of this year and several for next year. This is good news for the housing industry and also small companies that have a lot of debt on the books as they will be able to refinance for cheaper.
Now let’s circle back to our diversification theme. Investors largely anticipated this 50-basis point decrease by the Fed. That sent bond yields lower and, thus, our intermediate bond prices higher. With debt servicing becoming a smaller concern for small companies, small-cap stocks rallied in the third quarter. I believe foreign stocks rallied simply because investors wanted to be ahead of the curve and buy them while they were cheap. The average P/E ratio for our Dodge &Cox International fund is about 11 right now while First Eagle is about 13. Those funds seem cheap when you compare them to the average forward P/E of the S&P 500, which is about 21.4 at present. Without the Magnificent 7 stock names listed above, the S&P 500 has a lower P/E ratio of 19. Sometimes diversification is only for defense. Our defense in the third quarter scored some points for once.
P.S. CJ and I are excited to announce that our revamped aiai.biz website is now up and running. We would love to have you peruse the site and would welcome any feedback you might have. My goal has always been to have a website that is an educational resource for both existing and potential clients. While our website will always be a work in progress, we feel confident that we have a solid foundation on which to continue to build our site. If you know of anyone looking for an investment advisor, we would be grateful if you would forward our website to them.