Will AI take over the world? The market ping-pongs from AI being “the greatest boom ever” to “it is already overdone and these enormous investments will never pay off.” So, which is it?
Most likely none of the above, but let’s take a deeper look at what happened last quarter. The S&P 500 went up 15.20 percent. Small company stocks, represented by the Russell 2000 index, were up 21.49. International companies in the MSCI EAFE index were up 11.08 percent, and Emerging Market companies in the MSCI EM index were up 24.15 percent. On the surface: all is well, and this is a record-setting, broad-based rally.
Below the surface: things were a little more turbulent. The S&P 500 was led by a 258 percent return for SanDisk, driven by huge demand for memory caused by AI. Of course, we all know that technology leadership means that large-growth companies do best, and the rest of the market lags. This is what happened in the dot-com boom and with the FANG stocks, the Magnificent 7 stocks, etc. Small caps did best last quarter. Of course, they have been led by companies like Bloom Energy, up 767.99 percent over the last year. Bloom Energy is an energy company that builds on-site, modular power generation systems. That isn’t AI… but of course it is, because the AI companies need a lot of power to run those data centers.
Emerging markets also did well, and we all know that means third-world countries mining raw materials, right? Not so fast; those results were driven by South Korea and Taiwan, whose markets soared due to AI-fueled demand for semiconductors and other electronic equipment.
On the surface it was a broad-based rally, but underneath, it was all AI. Unfortunately, not all AI-related stocks are created equal. NVIDIA – the poster child for the AI boom, the large company investors flock to for AI exposure – was down 2.8 percent for the quarter. On the surface everything is a smooth ride up to record results, but underneath, the volatility is dramatic.
We discussed this is our recent Insight, “Is the Market Broken?,” and it is becoming a common topic among other market pundits. The market research company Fundstrat has described it as a spread between market volatility and individual stock volatility. According to them, this spread is the widest it has ever been. I must admit that is consistent with my 34 years of experience.
So, what can we do? The more things change, the more they stay the same…the answer is diversification, and AI is putting a strange twist on that concept. When we diversify a portfolio, we don’t simply want more holdings; we want holdings that have a low or even negative correlation with one another. In the past, that often simply meant exposure to different market segments – for example, we wanted technology, energy, and financials. AI is driving diversification within technology as different AI-related stocks do well, or poorly, during different stages in the AI development.
If one had told me a year ago that we would have an AI-driven market rally and NVIDIA’s stock would be down during a record-breaking bull run, I wouldn’t have believed him. Yet here we are. So, back to the question: Is AI the future of everything, or is it overhyped and mostly done? Yes. It is the future, and it is overhyped. AI will be like everything else – there will be winners, but also losers. Diversification is still an investor’s best friend, no matter what your AI agent tells you.
Warm regards,
Chuck Osborne, CFA
