Artificial Intelligence

At the beginning of June, Goldman Sachs research indicated that all of the return for the S&P 500 year to date through May was attributed to just seven stocks; the other 493 stocks in the S&P 500 have an average return of zero, nada, zilch. How did that happen?

It started as reversion to the mean, but as we moved into the month of May, something else started to take over…something that is certainly artificial, but is it intelligent?

AI has become a mania. I am no technology expert, but I do know a little about how the market reacts to technological breakthroughs. The market response is a phenomenon called the Gartner Hype Cycle. It begins with a technological trigger, and we move to the peak of inflated expectations as early publicity leads to grossly exaggerated claims of potential. Then we enter the trough of disillusionment: Technology is never adopted as quickly as the zealots believe it will be, and when the fantastic predictions fail to materialize immediately, bubbles burst. That leads to the slope of enlightenment – Technology is never adopted as quickly as zealots believe, but it is adopted faster than naysayers would suggest. People start to see realistic applications, and these realistic applications eventually lead to the plateau of productivity, where the new technology is being used to make our lives easier – not as first imagined, but in real ways nonetheless.

To read the full report, please download the PDF.

~Second Quarter 2023

How is your business?

I recently asked that question at three different locations for one of our clients and got three slightly different answers.

The first answer came from the CFO, who told me they would probably do fewer acquisitions this year because of higher interest rates. The second came from a field office who said that business was good; last year had been a record for them, and this year looks slightly better.

The third location rep said they were doing fine, but one of their clients was seeing a slowdown because part of their business had come from Russia.

These three stories are a great indicator of the actual impact the Fed has on the economy by raising interest rates: Actual daily life, including most business, does not rely upon borrowing, therefore is not impacted by interest rates rising.

Financing activities are directly impacted. They will not be shut down, but the higher cost of borrowing will mean that some deals are no longer profitable. This impacts Wall Street’s view.

Structural barriers, such as sanctions against Russia or other regulations, have a large impact. Supply, demand, interest rates – none of that matters if regulators shut the activity down.

To read the full report, please download the PDF.

~First Quarter 2023

Does the Fed have any real power?

Wall Street strategists are far more bearish than Wall Street analysts. The strategist community sees the current situation as driven by the actions of the Federal Reserve; the theory goes that the Fed raising rates will cause economic activity to slow down, the economy to go into a recession, and the market to crash. This argument seems logical, but it ignores a significant factor and makes some assumptions that might not hold true.

First, it ignores the fact that the market has already dropped well into bear market territory. Secondly, it assumes that Fed actions have a significant impact in the real economy.

How does the increase in interest rates impact companies? There are two possible ways. First: If they sell a product that requires most customers to use financing, but most businesses do not sell products that are so expensive that their customers must finance them. Second: If a company must borrow a great deal of money to run its operation, the interest expense on that debt would cause earnings to go down. In the manufacturing days of the 1970s and 80s this was true, but is it today?

Analysts, on the other hand, see the world from the bottom-up, and it simply does not look so bad from that view.

To read the full report, please download the PDF.

~Fourth Quarter 2022

Does The Fed Have to Pivot?

For those who pay attention to financial pundits, the word “pivot” is becoming very familiar. These sources of pseudo-wisdom keep saying that the stock market cannot maintain a rally until the Federal Reserve pivots from a policy of raising interest rates to a policy of lowering interest rates. They are, as usual, wrong, but there is something bigger afoot here:  This modern idea that we must be on one extreme or the other. In this case the Fed must be either raising interest rates to fight inflation or lowering interest rates to fight a recession. This is absurd; The Fed can just hold steady, maybe provide some stability.

The Fed is overrated. They have undue influence on financial markets, but how much control do they really have over the real economy?

We are battling inflation today which, to a large extent, has been driven by rising gasoline prices. One of the main drivers of high gas prices is the lack of refining capacity. Under today’s regulatory environment, opening a new refinery would be next to impossible. The Fed can raise rates forever, but that will not refine a single gallon of gas. Increasing refining capacity will require some regulatory reform.

To read the full report, please download the PDF.

~Third Quarter 2022

As our economy slows and inflation remains stubbornly high, one must wonder if we will ever learn our lessons. We have been here before and we know what causes this, yet here we are once more. We did not learn the lesson of the 1970s; but why?

Macroeconomists are too fixated on aggregate demand. They believe that if aggregate demand is stimulated – through low interest rates or government spending – then supply will simply react. Supply didn’t react in the 1970s, and it is not reacting now; hence, inflation.

In the 1970s the Fed raised interest rates to lower aggregate demand, but then policymakers countered that action. For example, Nixon implemented price controls, which actually stimulated demand while curtailing supply. The result was shortages; growth slowed further, and inflation persisted.

The Fed did eventually raise rates again and kill inflation, but they had the help of the Carter and Reagan administrations, which both freed up supply through regulatory and tax reform. That is what it took then, and that is what is needed now.

“Those that fail to learn from history are doomed to repeat it.” ~ Winston Churchill

To read the full report, please download the PDF.

~Second Quarter 2022