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Iron Capital Insights

  • Iron Capital Insights
  • June 15, 2023
  • Chuck Osborne

A Strange Year Thus Far

It has been a strange year in the market. The headlines all seem good with the most-followed broad stock market indices all headed up, but as I always say, it is what is happening underneath the surface that tells the real story.

Those headline numbers have been skewed by a very small handful of stocks. It started in the beginning of this year with the stock of large technology companies rebounding from what was a bad year last year. Then the market became fixated with artificial intelligence (AI), and stocks like Nvidia and a handful of companies who are perceived as being on the cutting edge of AI have skyrocketed – especially in the month of May.

© Dima Berlin

In the meantime, the majority of the stocks in the market are languishing, and several of the most solid and conservative stocks are actually getting beaten up. The excitement over AI is understandable, since this is cutting-edge technology that many believe will be bigger than the internet in terms of the change it brings to our society. A word of caution: Technological change never happens as quickly as the zealots believe, and it seldom happens in the ways predicted. This is likely a bubble, but bubbles are normal when new things come around.

What doesn’t make sense is the fact that the gains in AI stocks have seemingly come at the expense of everything else. Much of that still comes from the idea that the Fed will cause a recession, or at least that is the story. To a certain degree this makes sense, because one of the lessons of the last 15 years has been that technology companies can grow even when the economy isn’t, so they have counter-intuitively become defensive in nature. However, that doesn’t mean that actual defensive stocks – the stocks of companies that just chug along and deliver solid dividends come thick or thin – should have lost their recession-proof status. Yet, these have been beaten up this year, after holding up extremely well last year.

It is frustrating, especially when it is now becoming obvious even to Wall Street that the most-anticipated recession of all time isn’t coming. Inflation is dropping. The consumer price index came out this week, and inflation has grown at 4 percent over the past year – the lowest reading in a long time and less than half of the peak. The producer price index, which follows wholesale prices and usually is a leading indicator of where inflation is going, also came out this week:  negative month-over-month, and just 1.1 percent over the last year.

What does the Fed do? They finally stopped raising rates. Then, as we have complained in the past, they just had to talk. They are now saying they will raise rates two more times. That is a load of garbage and anyone paying attention knows it.

Can the market continue to go up with the Fed talking tough? That depends. It depends on the market rotating away from the AI bubble and toward the other 495-ish stocks in the S&P 500, just as an example. Regional banks are selling at valuations not seen since the financial crisis, and while the environment has gotten tougher, we are a long way from a crisis. Energy stocks have taken it on the chin and the most boring stocks of them all, utilities, have been mysteriously beaten down. If all of these various categories bounce back, then the second half of this year will be very strong.

On the other hand, if the market keeps fixating on a non-existent recession and AI, then we have probably gone as far as we can. We don’t think that is going to happen, but in the short term, anything can happen. That is why prudent investing requires patience. Strange times eventually work themselves out and patience is rewarded.

Warm regards,

Chuck Osborne, CFA
Managing Director