Mike Tyson said it best here. It seems like the entire world is caught up in media and internet entertainment and trying to apply it to their personal situations. This weekend it was Iran. Trump appears to want regime change and is encouraging the Iranian people to take back their country. Over the weekend, he added avenging the deaths of Americans at the hands of Iran or via Iranian proxies going back to the Iranian Hostage Crisis in 1979. That was a dark day in American history, and Trump hasn’t forgotten it. It is part of his “Make America Great Again” message. President Trump made his case for targeting Iran during his State of the Union speech, arguing along the lines of national security. He vowed that Iran must never have a nuclear weapon. That has been his major objective, which included last year’s bombing of Iran’s nuclear sites. Last year he began his efforts to remove the nuclear capabilities in the region, and the current action seems to be a continuation of same along with a stated humanitarian aspect for the people of the region as well.
Before I go into the message that I wanted to share in this week’s note, I thought it would important once again to go into how our markets performed in previous international military skirmishes.
As can be seen above, even though it is very discomforting during the conflict, afterwords, a majority of time, the markets seem to encounter a blip and within a year are at much higher prices. The one constant is market volatility. Using the Dow Jones Industrial Average (DJIA) as a proxy for all US stocks, stocks were mostly higher over the intermediate term. Below is a chart from Ned Davis Research from Monday. In the chart, it can be seen that the markets have been quite a lot stronger 126 days and 252 days after conflicts. The two exceptions happened to be in middle of a bear market that sprouted out of the Dot Com Bubble.
Since the military conflicts clearly manifests itself in the face of the progression on global economic prosperity and growth, I felt it important to quantify what could possibly be expected coming out the backside of the conflict. How long and how global in scope the conflict becomes is clearly an unknown to all, but quantifying all past conflicts has tended to be a fairly good way to manage expectation going forward in the current situation.
The next point that I wanted to cover is the changing of the guard or leadership in the markets and what this could mean for the overall market going forward. Despite concerns related to weakening employment, tariffs, geopolitics, and AI glut uncertainties, the S&P 500 has remained surprisingly resilient to begin the year. This seems to be the result of a broadening trend in the companies that are now leading the charge. Can this continue? This becomes another vexing question. If the rest of the economy is finally getting policy support, new-era stocks won’t be worth as much. They can lose some of their appeal, even if their fundamentals haven’t changed much. According to Jim Paulsen in last week’s Barron’s, “We don’t need to have a tech crash that spells the end of the bull market. The market can keep rising as we find new winners.”
Under the surface, leadership has churned. Relatedly, the percentage of cyclical sectors in relative strength uptrends has turned lower since mid-January. If we look at how growth has been performing vs. value in the short-term, it is really quite startling.
As can be seen above, the fear is that AI will eat software and spit out their employees. Just last week Jack Dorsey of Square announced laying off 50% of their workforce. Clearly the price movement of value relative to growth shows what can happen in the short run to the growth contingent should this kind of fear present itself across the board.
What I feel is going on, and is really quite impossible to quantify, is that the Mag 7 concentration is so huge in financial size and breadth that when it sells off just a bit, the amount of capital available to finance the purchase of other companies and entire country markets is so immense that it simply takes the money from the left hand in the market and places it in the right hand. What is even more important is to pay attention to whether the money is staying in equities or moving to another asset class- like bonds. This could signify an end to an overall market advance and not only a changing of which industries are leaders.
Energy, Utilities, and Materials all have more than 90% of stocks trading above their 200-day moving averages, leading all sectors. Technology, Communication Services, and Real Estate have the fewest stocks above their 200-day averages, less than 50% each. This is almost exactly the opposite from what has been the case since late 2022, yet the market overall continues to advance.
A question that continues to be bantered about is the comparison of the current AI boom to the Dot Com boom / eventual bust. How different is the AI revolution from the revolution at the dawn of the internet in the late 1990s? Will there be an AI bust? Has it already begun? This is a great and very “meaty” question yet there is only one way to end a stock market, and that is with a bubble. It has to burst, and the market needs to crash. I’m not sure AI is in a bubble. It doesn’t seem nearly as big as the dot-com bubble, and the dichotomies don’t seem extreme, as in the 1990s. When tech stocks peaked in March 2000, the broad market rolled over. The performance of the S&P 500 was tied directly to the internet sector. That hasn’t happened this time around. Tech stocks have been relatively weak since the end of October of last year, but the S&P 500 has held its highs and has even gone up since then. That can happen only because the baton is passing to a broader array of stocks. Their strength is compensating for the weakness in tech. The really big difference with today’s tech vs. the tech of the late 90’s is that back then tech was a concept with many companies that had ideas that the world was not prepared to benefit from or even understand in scale. Today, tech and AI is growing at a voracious rate and is being consumed at a voracious rate that is actually accelerating!
The question then becomes, if AI consumption and internal capital expenditures are rising at huge and accelerating rates, why are the prices of the companies flat lining and not expanding as the consumption of their products are? I believe this is because many of them are over owned, and there are now a variety of very sleepy, slower growing companies showing extreme benefits from the implementation of AI in their processes.
On top of the broadening of the winners in the US markets, we are noticing very positive numbers in international markets. This really began last year. It was masked by another terrific year in the US markets, yet the international, primarily the emerging markets did almost twice as well. People have an odd emotional reaction to the dollar—to the idea that a strong dollar is good and a weak dollar is anti-American. I never understood that. The dollar is just like interest rates. When it goes up, it can be a restrictive force. If the dollar gets weaker, our products are then cheaper to foreign buyers, and this is good for American industry. A weaker dollar means international stocks should keep winning. The pandemic was a disaster for China. It highlighted to every company in the world the need to diversify supply chains. It makes it clearer to have exposure to places like Vietnam, and Central and South America, as well.
This week started with a boom after the booms in Iran. The markets seemed to stabilize later in the day on Monday, and the familiar suspects continued their advance. Going forward we will keep a close watch on currencies, interest rates, oil and gold, and the broad equity markets. This should give us a clearer understanding of where precious capital is being deployed. We will continue to let you know what we are seeing and what to be most conscious of.
- Ken South, Tower 68 Financial Advisors, Newport Beach
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