April Notes

Investmments and asset allocation concept. Where to Invest? Newspaper and direction sign with investment options. 3d illustration
william montgomery cerf
  • The Bubble that Wasn’t:   With the global tech sector up 12% this year, after rising 50% in 2023 (Meta and Nvidia up 43% and 82% respectively this year), one might reasonably ask if this is this a bubble waiting to pop.  We think not.  While the tech sector price earnings ratio (P/E) at ~26.8x is roughly a 37% premium to its long-term average, it is still dwarfed by the peak of a ~60x P/E at the height of the dotcom bubble of 2000.  And then, there was just air.  Now, market leaders are generating powerful ROE and cash flow, not just in hopes for meteoric future growth (wither American-On-Line and Netscape!!).  The substance creating the foundation is Artificial Intelligence (AI).  We project 40% growth in AI revenue this year, and a ~72% annual growth rate of demand growth over the next 5 years, representing a fifteenfold cumulative increase in 5 years.  (Smartphones took more than 10 years to grow revenues by 15 times.). What’s more, as AI tools start to permeate the entire corporate sector bringing enormous increments in efficiency and productivity, expect the value creation to spread, albeit unevenly, throughout other sectors:  industrials, healthcare, financials, etc.   As such, while there is some risk of overconcentrating in large cap technology we like the exposure and suggest that investors stay diversified within equities with a balance of strong companies across industries and geographies, many of whom will be winners in the adoption of AI tools.  We also think there is value in small cap stocks given their discounted valuations and likely catalysts such as reduced interest rates and increased M&A activity which was slow during COVID and in the high interest rate aftermath. However, we’re not projecting material increases in stock prices from today’s record levels for the remainder of the year.

Soft landing or no landing, we still expect the Fed to cut rates about 75 basis points this year.  We’re still in the soft-landing camp, notwithstanding continuing strong labor reports.  GDP growth is starting to moderate and labor markets are starting to cool, as are hourly earnings growth rates. While equities might not have much room to rise from today’s levels for the remainder of 2024, a decline in the 10-year yield to 3.5% from 4.3% implies a total return of ~9.3%.  Fixed income remains a powerful tool to hedge equity risk and generate a very positive real return.   As rates decline, the value of holding liquidity in cash will decline and the opportunity cost will rise. 

All this leads to the same conclusions:  Stay diversified and don’t time the market. Diversification is the best way to create long-term wealth creation in a risk-controlled way.  That message was clearly out of favor during the decade of near zero interest rates.  This old school of advice is truer now than it has been in a long time. Also, know that trying to time the market can create enormous costs.  Time in market is way more important than timing of the market. Get this and much supporting detail here: House View April

  • Artificial Intelligence Zoom Seminar:  April 4, 4PM EST Invitation below. Here, Montclair Investment Partners brings together our Chief Economist and our Senior Technology analyst to look beyond the hype and reflect on what’s real, what’s not, how it is reshaping industries worldwide considering patterns of adoption etc. Please join.  Invite a friend.
  • Diversification is Uncomfortable; That’s a Feature Not a Bug:  Nobel Laureate Harry Markowitz famously called diversification “the only true free lunch in investing.”  That’s not quite true.  For many, the cost is discomfort.  If you look at your portfolio and you are happy with every component, then it’s likely that you are not well diversified.  Some assets will always underperform. Having non-correlated returns within a portfolio is precisely what reduces risk and improves risk adjusted returns.  Sticking to systematic diversification also helps us defend against many behavioral biases that we are all vulnerable to, for example, buying high and selling low or “Recency Bias”.  (See attached “Risk in Private Credit.”)
  • Is Concentration a Threat to the US Equity Market?  No.Many note the dramatic concentration of returns, much AI-fueled, of the “Magnificent 7”.  One rightly wonders whether such a concentrated source of returns is sustainable or if it indicates a future of structural vulnerability.  Since early November through the beginning of March those 7 stocks rose 34% while the S&P rose 21%.  The top 10 stocks in the index now comprise about 32% of the entire market capitalization.  However, 1. Academic research shows that the US market is in fact, one of the most diverse in the world.  Only Japan has less concentration.  2. Large tech companies will likely continue to grow disproportionately, fueled by generative AI developments.  However, AI among the leaders means nothing if AI tools fail to become integrated into other large and small cap technology and non-technology company business models in coming years.  Large tech may be the big winners, but they will win because other companies worldwide embrace the technologies and the tools to incorporate more capital and labor efficiencies to their businesses.  Thus, we see continued value in the many parts of the market currently lagging, including small cap stocks and non-US developed market stocks as they integrate these new and still rapidly evolving tools. (See attached: “Is Concentration a Threat to the US Equity Market.”)
  • Private Credit:  Too Good to be True?   Some fear private credit will see a rise in defaults and losses in 2024, as prior rate hikes weigh on company cash flows. But we think the asset class can weather the uncertainty, thanks to private managers’ ability to choose the most resilient creditors. Near-term challenges warrant careful investing. Yet the long-term case for private credit as a diversifier and potential improver of a portfolio’s risk-return characteristics remains intact, subject to awareness of the risks.  (The highlights of this argument are in the attached “Risk in Private Credit”.)
  • Top Ten Planning Topics for 2024:  Many changes may have an impact for you and your family.  Topics include increases in annual and life-time gift exclusions, a scheduled sunsetting of lifetime gift exclusions in 2025, and the related value of careful insurance planning and asset titling, and more. (See the attached “Top 10 Planning Topics”).  Talk to us if there are issues relevant to you.  We are here to help.  We have internal senior partner specialists in estate planning strategies, income and transfer tax planning, family office structuring, business succession planning, charitable planning and family governance, among others.
  • Book Corner:  Our Biggest Fight: Reclaiming Liberty, Humanity and Dignity in the Digital Age, by Frank McCourt, Jr.   With the passion of Thomas Paine’s plea for freedom from the yoke of British rule, McCourt argues that as the evils of today’s social media and smart phone depencency and are now well known, we need a revolution to liberate ourselves from the technology monopolists before it’s too late.  McCourt adds to the now familiar cannon documenting the insidious consequences of “Surveillance Capitalism”. For example: the narrowcasting of information to our social media feeds so we only receive information consonant with our prior and existing views, improving our eyeball stickiness, and therefore maximizing the dollar value of our eyeballs to advertisers. This narrowness erodes debate, fosters myopia, invites manipulation from malevolent actors, both domestic and foreign, and corrodes trust in the public institutions that otherwise supported a healthy democracy for over 200 years.  Still more insidious is the manipulation of images and expectations sent to our children by social influencers large and small, creating and reinforcing hopelessly idealistic and narrow views of beauty and desired behavior feeding a wave of self-image and body image-fueled depression among teens.  Patterns of learning loss and shortening of attention spans associated with excessive use of narrow burst attention-grabbing social media is also now well established.  McCourt’s is a call to action.  His solution is a new internet protocol, the Decentralized Social Networking Protocol (“DSNP”), in which we each take back ownership of our personal information giving us control to sell, share, leverage and communicate with our personal information as we see fit, removing the near monopolistic control of our information by a few tech giants such as Google, Facebook, Byte Dance and Amazon.  His rendition of the scope of the problem is compelling; his solution set less so, in my view.  But the effort to foster public debate on these topics is important, timely and admirable.
  • Borrowed Wisdom:

“Privacy is dead, and social media hold the smoking gun.”  Peter Cashmore

“Without privacy, there was no point in being an individual.” Jonathan Franzen

“Being famous on Instagram is basically the same thing as being rich on Monopoly.” Anonymous

“Social media have created jealous behavior over illusions. Sadly, some are envious of things, relationships and lifestyles that don’t even exist.”   Anonymous

“The dark side of social media is that, within seconds, anything can be blown out of proportion and taken out of context.  And it’s very difficult not to get swept up in it all.”  Nicola Formichetti

“The bad news is that the obsession with social media is almost certainly producing unhealthy side effects. Scientists have discovered that constant exposure to websites like Facebook and Twitter can alter the brain, affecting the ability to process emotions. It can also lead to restlessness, negative self-image, a decline in happiness, and in extreme cases, depression.” – Damon Zahariades.

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By Monty Cerf

Official blog of Monty Cerf, also known as William Montgomery Cerf