by Kimberly Woody, Senior Portfolio Manager
Nor will it be any time soon. The future is bright for AI, but it is much like the internet in 1999. We can see the promise and we know the transformative effects, but how it all plays out will take some time, and if history repeats, many of the players we see as essential may not even be a factor in 10 years. That said, the technology landscape is far less fragmented and not as characterized by completely novel progress as in the the latter half of the 1990’s. So todays’ technology giants may succeed in securing a strategic place in a brave new world, whereas tech giants were almost universally displaced by the internet. AI could allow for the ultimate and infinite leverage of the information technology infrastructure established first by the pick and shovel players and subsequently in the cloud. AI is not feasible in a world without cloud-based computing. But the key to understanding the role of incumbent players is knowing more about how intellectual property will be treated, regulation will be allocated and the complexity of the technological environment. The solutions to these questions may not be provided by the larger players.
The recession seems to be perpetually two quarters in the future. Inflation is cooling and history tells us that inflation recedes at the same rate it increases. As a result, one would expect a rapid retrenchment. Headline CPI is up 3.0% versus last year, an extraordinary recovery from the 9.1% gain at the peak in June 2022. In the July CPI report, we saw meaningful month to month deceleration in airfares (-8.1%), used cars (-0.5%), snacks (-2.6%), furniture (-0.3%), car rentals (-1.4%) and shelter with rents (-0.4%). Jobs are plentiful, jobless claims have inflected lower and lower levels of inflation boost real income and consumer purchasing power. The lighter CPI print also increased the odds of fewer rate hikes in 2023 and rate cuts in 2024. While we’ve barely scratched the surface thus far for second quarter earnings reports, consensus predicts negative earnings growth as measured by the S&P 500 components with healthcare (-16.9%), materials (-33.1%) and energy (-49.6%) as contributors. This would be the third quarter of negative earnings growth for the S&P500 and begs two questions. First, are we currently IN a recession? And second, does it matter to the pricing of risk assets?
Probably not. There are multiple corollaries associated with a precipitous drop in measures like inflation or M2 or a Fed hiking cycle, but we continue to emphasize we have limited (arguably zero) economic experience with phenomena such as COVID and the economic shutdowns. And not just COVID, but the response to COVID from a policy level. M2 and debt to GDP reached levels we had never previously approached. We really have little idea how monetary policy interacts with a pandemic. Arguably all normal patterns of money supply, the real economy and inflation are probably heavily distorted.
And so we look for evidence of serious weakness in the economy or asset classes. While a weaker dollar is not positive for US purchasing power, it does alleviate significant pressure associated with dollar denominated debt repayment. Economies outside of the US get a bit of a breather as they remain in tightening mode but economic data points to conditions generally worse than in the US. Growth stocks should continue to outperform their value counterparts and large cap should remain dominant. The case for small cap equities has many moving parts but in the event that rates move lower, and given their below historical valuations, upside may be in order. Bonds have rallied from their lows but rates remain unchanged from one month ago, so the upside trend has yet to be confirmed. As always, gold remains uniquely positioned as a hedge against uncertainty and so remains a key component of our broader asset allocation.
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Sources: US Dept of Labor, Factset
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