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Investing Lessons

Market Musings

By Scott Poore, AIF, AWMA, APMA
Chief Investment Officer, Eudaimonia Group


Investors sometimes have to learn the hard way that "easy money" isn't always so easy.  The journey of accumulation to retirement and beyond is difficult and may involve costly lessons.  That's the inspiration of this week's musings.  This week's musings delves into the story, "Lord of the Rings".  The adaptation of J.R.R. Tolkien's books were brought to the silver screen from 2001-2003.  Here's some trivia about the films:

  • The three primary films are among some of the highest-grossing movies of all-time.  Their budgets, altogether, only amassed $281 million, while the movies grossed...well take a look for yourself:
    • Lord of the Rings:  Fellowship of the Ring ($887.6 mil)
    • Lord of the Rings:  The Two Towers ($937.8 mil)
    • Lord of the Rings:  The Return of the King ($1.14 bil)
  • Tolkien first wrote a book called "The Hobbit".  He never expected the book to become popular, but an employee of a London publishing company persuaded Tolkien to publish it.  He was subsequently urged to produce a sequel after The Hobbit's success.  The Lord of the Rings trilogy took him more than a decade to write.  
  • The band Led Zeppelin included lyrics about "middle Earth" in their song "Ramble On" in 1969.  Robert Plant later admitted that the lyrics made no sense as a "fair maiden" wouldn't be found in Mordor and "Gollum" wouldn't want anything to do with her, as his sole concern was THE RING.
  • All three movies had double-digit Oscar nominations each, capturing 17 Oscar wins in total.  The third movie, "Return of the King", finally afforded Peter Jackson an Oscar for "Best Director."
  • Christopher Lee, who plays the role of Saruman, was the only member of the cast and crew to have ever actually met J.R.R. Tolkien.  He supposedly read "The Lord of the Rings" novel each year since it was first published in the 1960s until his death in 2015.

Here's what we've seen so far this week...

When Rings Of Power Are Bad.  For the better part of 9 months, high-growth momentum stocks, especially the Mag 7, have dominated market returns and investors' imaginations.  The massive market caps of those companies pushed indices higher, but left diversified portfolios in the dust.  We may be seeing the shift in sector out-performance finally approaching.  While the Mag 7 was up more than 78% from the market bottom in late 2023 to early July of this year, it would appear momentum is running out.  Over the last several trading sessions, other asset classes have moved to the front in terms of returns, while Mag7 is significantly under-performing.   Hedge funds are now cutting exposure to AI-related industries, such as Semiconductors and Semiconductor equipment.  If we were to look at a similar chart for the Technology sector as a whole, we would see that hedge funds are cutting exposure to the tech sector in the same manner.  Why is this the case?  We believe that the momentum for AI has finally slowed as there is less enthusiasm for the AI niche.  Nvidia reported Q2 earnings this week that beat market expectations 6.46% as of yesterday.  Yet, the stock is down more than 5% since the release.  The expectations for AI-related names is so high that the companies can no longer match said enthusiasm with results that are outsized or large enough.  In fact, companies like Nvidia are beating estimates by smaller margins each quarter.  This isn't a good recipe for continued out-performance.  Investors would be smart to trim positions in AI-related names for a more diversified approach.  As is evident in the market returns, the S&P 500 Equal-Weighted Index is starting to out-perform as more defensive sectors make up a larger part of that index than the cap-weighted S&P 500.  Investors who stay over-allocated to AI in their portfolios may find themselves akin to poor Frodo in "The Lord of the Rings" who told his friend Gandalf, "I wish the ring had never come to me.  I wish none of this had happened."

History Becomes Legend, Legend Becomes Myth.  At the onset of the "Lord of the Rings:  The Fellowship of the Ring," the elf elder Galadriel tells the story of the ring and its tragedies.  With the death of those who fought against Sauron, she states, "And some things that should not have been forgotten were lost.  History became legend.  Legend became myth."  That's what happens to us as humans - we forget the lessons of investing, only to repeat previous investing mistakes.  At this point we know that the Fed is highly likely to cut next month.  So now the question is, what do we do with this information.  Over the past couple of weeks we've covered how different, commonly out-of-favor, asset classes out-perform when the Fed begins cutting rates.  The graph above shows previous rate cutting cycles (red lines) beginning leading to a steepening yield curve, poorer economic conditions, higher unemployment, and lower equity returns.  Money managers know their history and are already beginning to position their portfolios ahead of the shift in momentum.  Relative to historical positioning, money managers have allocated more to Bonds, Utilities, and Healthcare in August in an effort to get more defensive ahead of an economic slowdown.  The rate on a 30-year mortgage has dropped more than 85 basis points over the last 3 months, but mortgage applications haven't picked up that much.  Why?  The majority of existing mortgages are at interest rates lower than 4% and the current price of the average home is the highest in history.  It's likely that the Fed has waited too long to begin cutting rates and the consumer is too stretched.  The yield curve has still not fully steepened yet as the 2yr Treasury Bond yield and the 10-year yield are still 2 basis points from uninverting.  So, the good news is that investors still have some time and an economic slowdown may still take some time to materialize.  However, the lessons of the past should inform our decisions going forward.

The explanation of the ring...
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Disclosures

The information contained herein is for informational purposes only and is developed from sources believed to be providing accurate information. The opinions expressed are those of the author, are for general information, and should not be considered a solicitation for the purchase or sale of any security. The decision to review or consider the purchase or sell of any security should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional.

Forecasts or forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice.

Any market indexes discussed are unmanaged, and generally, considered representative of their respective markets. Index performance is not indicative of the past performance of a particular investment. Indexes do not incur management fees, costs, and expenses. Individuals cannot directly invest in unmanaged indexes. The S&P 500 Composite Index is an unmanaged group of securities that are considered to be representative of the stock market in general. 

Past Performance does not guarantee future results.