As economic data weakens, the stock market is becoming increasingly concentrated, with the AI-driven stocks accounting for the vast majority of gains this year in the indices. A sign of bullishness is evidenced by the fact that in a Bank of America survey, 53% of money managers see no recession in the next 18 months. Only 5% see the risk of a hard, landing which is the lowest amount in nearly two years. On many days, the stock market is up slightly on the back of a handful of those giants, while the majority of stocks are actually down. In fact, in 7 of the last 20 trading days, the S&P closed positively even though most stocks were down. We haven’t had a 4-week span where the U.S. stock market has gone up so much with so many stocks within the market going down, going back to 2002. Fund managers are piling into the same names, pushing stocks such as Nvidia to new records. Nvidia has now overtaken Microsoft as the most valuable company in the world with a market capitalization well in excess of $3 trillion.
While it is undeniable that the potential for AI is astounding and transformational, very few companies are being treated as losers. Price to sales metrics have diverged meaningfully higher across the Tech-sector, mirroring other major bubble eras such as 2000 and 2022, which ended up very poorly for investors. Keep in mind the timeless investment adage, “price is what you pay, and value is what you get.”
It doesn’t take a rocket scientist to see that Nvidia’s profits are going up exponentially currently, driven by AI chip demand. However, do those margins last forever with all the competitors spending billions to encroach? Does their supplier Taiwan Semi push back and raise prices? Is future growth priced into the stock at the current valuation? Nvidia used to trade at a mid-single-digit price to sales ratio. Its current ratio is 42x, which is nearly unprecedented for such a large company. While not as transformative as Nvidia, many of the leading Tech companies have seen similar explosions in valuations. This means that investors are paying much higher prices on the earnings and cash flows, than they were willing to pay for previous decades.
Conversely, other areas of the market trade very inexpensively. Some of the highest quality real estate development companies trading at incredibly cheap multiples, offering dividends varying from 6-8%, with strong prospects to grow. These companies offer mid-double-digit annualized return potential over the next 5-10 year in our estimation, while the overall market is likely to do far worse. Market conditions currently are quite bizarre and disassociated from many normal valuation metrics. Often, this leads market participants to feel like they have to chase the “hot” thing, regardless of valuation. I’d urge against this. We need to stay focused on reaching your financial goals for retirement, education, income, growth, etc. Chasing the “hot” thing opens you up to 50% or greater permanent loss potential. We have seen that many times, which is why when we are dealing with retirement funds, we must be investors and not speculators or gamblers. The great investors such as Warren Buffett are staying disciplined with valuations, buying undervalued stocks such as energy companies and financials. We have been doing much of the same thing and I’m very excited about the expected returns we should generate as we keep focusing on the blocking and tackling of investing.