Signs of the times

The interesting times continue.  To look at the major indices, you would think that little has happened in the last month.  Yet we all know that’s not the case.

Before I make some highly un-insightful comments about the Iran situation, I want to start with the market action that preceded it.

Rotation

Artificial Intelligence continues to progress rapidly.  It’s rather amusing to remember that a few months back, the “negative” case was that AI is a grift and a scam.

Then it seems the negative narrative completely shifted to “AI is going to eat the whole world” and destroy many businesses.

It’s important to consider that both these can actually be true.  Indeed, to an extent, I think they are true – AI seems sure to disrupt the world in many ways whilst there’s absolute certainty that various charlatans will profit handsomely from pedalling AI nonsense.

With this shift in narrative, we’ve seen some significant falls in various market sectors – sectors suddenly seen at risk of losing significantly from AI’s rise.  Software companies have been one major target. 

The concern is that AI is already making it so easy to “code” that almost anyone will be able to build themselves an app or database or the like.  It does seem somewhat plausible.  It makes sense that there’s going to be great demand for “software consultants” – people with some background in IT and coding but really just very well versed in using AI to create stuff.  With their help, creating your own in-house database perfectly tailored to your needs might be truly feasible whilst just last year it would have been a project utterly beyond reach given the costs involved.

The share market action flies in the face of one longer-term narrative – that the markets are being run by passive flows.  Indeed, the action screams of active allocators shifting course.  The narrative du jour is to own “real stuff” – commodities, hard assets as opposed to financial and technology stuff where the future is unclear – software companies, private equity. 

Active managers (hedge funds and the like) clearly still have plenty of sway. 

In terms of the selective selloff, all I really have to say about this is as follows:

As we’ve been banging on about for some time now, the average U.S. listed equity is extremely richly valued.  The future is very uncertain.  Therefore maybe… just maybe, the average stock deserves to trade at a lower multiple.  A bit of “margin of safety”?

I mean, Salesforce (one of the leading software companies) is down about 30% over the past few months but it still trades on a P/E somewhere around 26.  There’s not a lot of “margin of safety” in there, even after a 30% correction.

Iran

What can we say about this Iran situation?  Of course, we have nothing insightful to add to the conversation – we’re not geopolitical analysts or Middle East experts.

From what I can see so far, they’ve wiped out many of the senior leaders in Iran.  The new leader is another extremist cleric that seems to have widespread support amongst their population and military.  Oh, and we just killed his father, mother and sister… 

An enraged extremist out for revenge.  An enraged nation largely backing him.  A leadership void owing to the assassination of many of the leaders.  Sure, negotiating with who’s left to bring a quick end to this seems likely, right?

One thing they have succeeded in is destabilising the entire region.  The Emirates just got far less attractive as a travel destination, business hub or expat residential oasis.  What’s the financial impact on the region?  Will the Bahrain Grand Prix go ahead in April (or at all this year)? 

When I gaze around the financial markets, I see complacency.  There’s a real possibility this war drags on and inflicts meaningful amounts of economic damage on the entire world.  On an economic world already quite fragile.  I would have thought market participants would want to factor that into their investment stance – a bit of de-risking.  Indeed, some are.

But instead, the consensus seems to be the old “TACO” – Trump Always Chickens Out.  Investors aren’t concerned about the possibility of economic damage and a meaningful market correction – they are mostly worried about missing out on the rip higher when Trump comes out any day now and declares victory (again).

As usual, FOMO seems to rule (fear of missing out) whilst FONGO isn’t even a consideration (fear of not getting out). 

The starting point drives the journey

I’ve found myself frequently explaining to people that despite what they may read in many market reports and hear from commentators, they can be assured that the vast majority of experienced money-managers are very negative on the market outlook.  I explain that part of the reason you don’t hear more about this is few of these people express their views publicly and many that do are not widely publicised – confined to Twitter (sorry, “X”) or esoteric finance blogs like this one.

With this in mind, I caught an interview from January this year with legendary investor Jeremy Grantham.  At 87 years of age, he still likes to be in the spotlight, despite not having managed money professionally for many years (only his own billions!).  In fact, recent media appearances have been – in part – to promote his new book – “The making of a permabear”.  Gotta love that title – “own” the label bestowed upon you by your critics!

He told a story about the dot com bubble.  He was invited to sit on a panel debate at the Chartered Financial Analyst conference during the latter stages of the bubble.  He describes it as a “bull versus bear debate” – he, of course, was the bear. 

He was asked if he wanted to go first – he gladly accepted.  He then, as he says, played a “dirty trick”…

There were thousands of attendees – the CFA is the pinnacle of financial markets qualifications/industry groups – comparable to the “CA” for accountants.  He asked three questions of the audience:

First – “hands up who of you consider yourselves full-time professional stock players?” – by the count of his team, they had about 400 declare this.

He then said, “Right I have two questions for you only… one;  if the current PE, which is 31, comes down to 17 any time in the next 10 years, will it guarantee a major bear market?”

He continues “the vote was 100% – yes it would guarantee a major bear market… so I said right now we get to the jackpot… how many of you think it will come down?”

He then explains, “I was so shocked…I had to ask the question 3 times – rephrase it”…

“Only two people in the audience, of that 400, thought it would not come down to 17… and of course it did…but 398 people in the engine room of the Goldman Sachs and the JP Morgans and so on… the Morgan Stanleys, they believed in data that guaranteed a major bear market in the future…”

He continued – “the people up on the podium however, their bosses or their marketing bosses let’s put it that way were saying Jeremy, Jeremy let’s be serious the market is okay and will muddle through…”

This story is incredibly entertaining for any investor that’s been around long enough to experience a full cycle.  It highlights how the investment industry operates. 

You see, if you’re in the business of selling investment products, you cannot have a negative outlook on the market.  It’s bad for business.

Veteran money manager and commentator Ben Hunt recently reflected on an important piece of advice he got many years ago – “You don’t need sell-side analysts in a bull market, and in a bear market they will kill you”.

“The market is okay and will muddle through”…  I don’t know about you but that seems like a reasonable consensus today? 

Everyone acknowledges that valuations are at least a little elevated.

There’s concern about the disruptive forces of AI.

There’s great scepticism about all the AI investment – the likelihood billions are being wasted on data centres that will be obsolete within a couple of years.

Lots of teeth-gnashing about the size of the U.S. government debt and deficit.

Then of course there’s at least some concern about war in the middle east.

Yet the market is okay and will muddle through. 

I strongly suspect that if Jeremy Grantham conducted his same experiment today, he would get a similar result.  Experienced investors acknowledge valuations are historically-extreme and know this guarantees poor longer-term returns from this point in time. 

But hey – it matters when it matters, right?  What’s the old saying – if the music is playing you’ve gotta get up and dance…

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