Artificial Intelligence (AI) Fueled Market Rally… Don’t Be Fooled

It’s no secret, as of the end of July the stock market (S&P 500) is up ~20% year-to-date.  What you might not know is that 66% of that growth came from just 7 stocks; they are known as the Super 7.  All Super 7 stocks (Microsoft, Apple, Nvidia, Tesla, Alphabet, Amazon) have something in common, they are the major players in Artificial Intelligence (AI).

We’ve been talking about a people (workforce) shortage for almost two years now, and we still feel it when we go out to eat, go to the store, when we hire contractors, and even at work.  However, our population has grown by about $250,000 people per month over the past year and believe it or not many of those people are entering the workforce right away; this is why the unemployment rate has remained unchanged.  The shortage is obviously improving but not at a (nearly) fast enough pace.

Nearly two years ago we predicted a push for businesses to automate due to the shortage of people in the workforce.  The struggle still exists, and the market believes there is more room for growth, pushing AI companies to higher valuations.  The problem here is determining if this is the new norm, meaning, are all AI stocks going to be expensive for the foreseeable future?  By expensive I mean the price an investor is willing to pay for a stock for every $1 of earnings (PE Ratio).  For example, as of the day & time of writing this one of those Super 7 companies has a PE ratio of 107.62 while the entire market is at ~20, and the twenty-five-year average of the entire stock market is ~16.5.  As you can tell, not only is the entire market currently overvalued (as compared to the 25-year average), but that one Super 7 company is drastically overvalued.  However, the market predicts that those earnings will grow significantly over time, so investors are (more than) willing to pay for the stock at current prices.

The take-away here is that the market rally (so far) this year is (mostly) fueled by AI.  What we need to keep in mind is that inflation is still high, and that the Federal Reserve is still battling to keep it under control.  Markets presume that we will avoid a recession and implies reductions in policy rates by early next year, which is contradictory of recent public comments by Fed officials that another rate hike is coming later this year.

We still feel that economic growth is going to slow, and our portfolios are positioned to withstand a mild recession if it comes.  On the other hand, we have benefited from the AI rally by owning most of the Super 7 but not over-allocating them within each account, this is on purpose.  We have even been taking (some) profits off the table while continuing to own these stocks while diversifying into other stocks at lower valuations (per $1 of earnings) within sectors we feel will benefit under current economic conditions.

If you have any questions regarding your investment strategy, please don’t hesitate to contact us.

Andy Roberts

Past performance is not indicative of future results

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These are the opinions of RDG Wealth Management and not necessarily those of Cambridge Investment Research, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. 

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