Key Points

• Artificial Intelligence Drives Market Growth:  As meme stock interest wanes, artificial intelligence (AI) continues to gain momentum, reshaping industries and attracting significant investments from major tech companies.

• Narrow Market Breadth:  The intense focus on AI is leading to a top-heavy S&P 500, as AI-related sectors outperform and draw investor capital away from other areas of the market. 

• Market Resilience Despite Rate Cut Expectations:  The market has largely shrugged off the scaling back of expected interest rate cuts, demonstrating continued optimism in equities despite ongoing concerns about inflation.   

• Strategic Investment Approach:  Amidst the AI boom, we are maintaining a disciplined investment approach, balancing direct and indirect AI exposure to capitalize on emerging opportunities while mitigating risk.   

From Memes to Machines:

A notable Wall Street trend from a few years back has made its way back into the headlines: meme stocks.  These stocks, driven by viral online trends and social media sentiment rather than sound business fundamentals, are notorious for their meteoric rises and dramatic falls.  GameStop Corp., the quintessential meme stock, ignited such a captivating frenzy that it even inspired Sony Pictures film “Dumb Money,” chronicling the extraordinary saga. 

Keith Gill, the financial analyst turned social media influencer better known as “Roaring Kitty,” recently resurfaced on the social platform X (formerly known as Twitter) after a three-year absence.  His cryptic post, an image of a man leaning forward in a chair – a gesture among gamers indicating that serious action is forthcoming – was enough to briefly rekindle the meme stock frenzy that he had previously helped fuel during the pandemic.  The resurgence was short-lived, with meme stock prices quickly retreating after an initial surge.  While trends may generate excitement and headlines, the episode serves as a stark reminder of the risks inherent in chasing investment fads.  A focus on long-term fundamentals remains the most reliable path to sustainable investment success. 

The meme stock resurgence underscores the market’s vulnerability to hype and speculation.  As the meme stock craze fades, a more substantive technological wave – artificial intelligence (AI) – continues to gain momentum.  This raises a critical question: is AI merely another passing trend, or a transformative force poised to reshape the very fabric of our daily lives?

The launch of ChatGPT in late 2022 sparked a global surge of interest in AI, with millions of users now utilizing generative AI systems daily.  For businesses, the potential impact may be even more significant.  AI systems, capable of processing massive datasets, hold the promise of revolutionizing research, boosting productivity, and unlocking substantial cost savings. 

The rapid proliferation of AI is reminiscent of the early days of the internet, marked by palpable buzz and a significant surge in investment.  Major corporations are now locked in an intense an arms race, pouring billions into AI research and development to gain a competitive edge.  Apple, for example, is reportedly investing $1 billion annually to integrate AI across its product line, enhancing features from auto-generated playlists in Apple Music to AI-powered coding assistance for developers. 

This widespread influence of AI is clearly reflected in the equity markets.  The large-cap market, as measured by the S&P 500, continued its upward trajectory in the second quarter, largely driven by AI-related companies in the technology and communications sectors.  This heightened enthusiasm for AI has started to siphon investor capital and interest from other sectors, narrowing market breadth and causing these sectors to underperform the overall market.  Notably, the S&P 500 has become increasingly top-heavy, with its five largest constituents – all technology firms – now representing 28% of the index.  This starkly contrasts with the equal-weighted S&P 500 Index, where the top five holdings constitute less than 1.5% of the index.

The world has seen its share of failed technological promises, such as 3D television, Google Glass, and virtual reality in gaming, to name a few.  AI has clearly evolved far beyond its early days of simple automation.  While some may dismiss it as mere hype, we believe its impact is undeniable, and that it is here to stay, but with an important caveat.

The Segway: once hailed as a game-changer for personal transportation, but never achieved the widespread adoption that was initially predicted

Historical trends suggest that the current fervor will eventually temper into a more measured approach.  The early dot-com era, with its excessive investment and subsequent stock bubble, serves as a cautionary tale.  While the internet was – and continues to be – a revolutionary development, the initial hype led to unsustainable investments.  Similarly, while AI technology is undoubtedly powerful, the current pace of investment is unlikely to be sustained indefinitely.  As the focus inevitably shifts from unrestrained investments to tangible returns on investment (ROI), we anticipate that companies will eventually moderate their AI expenditures.  This will likely result in a period of consolidation and more rational valuation of AI-related assets. 

For now, industry behemoths like Meta, Apple, Amazon and Google continue to pour massive resources into AI, with no signs of slowing down.  Smaller companies are also striving to keep pace.  We have yet to hit the inflection point of these investments, but we are closely monitoring for signs of a shift.  Predicting the exact timing of this change is nearly impossible – it could be months or years away.  Anyone claiming to know the future with certainty is merely speculating. 

While our earlier mention of the “B-word” (as in bubble) may have raised some concerns, it is crucial to avoid impulsive reactions.  Positive sentiment can persist for extended periods, and the AI cycle is still very much in its early stages of infrastructure buildout.  Certainly, there are other challenges associated with the rapid growth of AI, such as potential strain on power grids, the need for comprehensive regulation, and AI’s ethical and social implications, but these are topics for another discussion.  As long as substantial investment in AI persists, companies focused on AI are likely to maintain their strong performance, barring short-term fluctuations.  Rather than attempting to time the market, we prioritize analyzing management commentary and capital expenditure trends.  These insights offer valuable clues, and will provide early indications of potential shifts in the investment landscape.

Closing Remarks

The timing and magnitude of potential interest rate cuts remain a focal point for markets.  The final stretch of taming inflation has proven challenging, with the Consumer Price Index (CPI) seemingly stuck in the mid-3% range since the year began.  While not alarmingly high, this rate still exceeds the Federal Reserve’s target of 2%, tempering expectations for aggressive rate cuts.  Initial market projections of six rate cuts for the year have been drastically scaled back, with only one rate cut now expected in 2024.  Policymakers are proceeding cautiously, seeking more definitive proof that US inflation is firmly on a downward path before implementing further easing measures. 

The market, however, doesn’t seem overly concerned.  Largely fueled by enthusiasm for AI, equities have continued their positive start to the year, building upon the impressive bull run since October 2022.  While valuations are certainly elevated compared to historical norms, they haven’t reached extreme levels, thanks in part to accelerating earnings growth.   

In our flagship Ascent Dividend Focus strategy, we’ve added several companies that operate with low capital intensity, recurring revenue streams, and a serial record of compounding growth.  These include Mastercard, Arthur J. Gallagher (a highly esteemed global insurance broker), and MSCI Inc. (an essential provider of index and analytics services to the investment community).  Meanwhile, in our Global Growth strategy, we exited our Shockwave Medical holding following its acquisition by Johnson & Johnson.  We replaced it with Mercado Libre, the “Amazon of Latin America”, and increased our holdings in Eli Lilly and ResMed.   

Across our strategies, we are internationally underweight the market in terms of direct AI exposure, having reduced our Nvidia position earlier this year.  We are comfortable with this positioning, and are instead focused on gaining indirect exposure to the AI boom through overlooked or lesser-known companies trading at relatively modest valuations.  Examples include companies involved in essential infrastructure for AI, such as data center cooling (AAON Inc.) and backup power generation (Cummins International).  We are also actively exploring investment opportunities in a utility company that serves a region with a high concentration of data centers.     

The investment world is a complex and ever-changing landscape, and we are committed to navigating these opportunities and challenges together with you.  Our dedicated investment team places our clients’ interests above all else, ensuring their financial success remains at the forefront of our strategies.  We are deeply grateful for your continued trust and confidence in us.