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Market Leadership Change

Market Musings

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


Has the market moved on from AI?  Probably not entirely, but there's definitely a new sheriff in town as other asset classes rise to the top.  This week's musings are inspired by the 1987 movie, "RoboCop".  Here's some trivia about the movie:

  • The film was a surprise financial success, earning more than $53 million at the box office on a budget of only $13 million.
  • Edward Neumeier wrote the script while he was on the set of "Blade Runner" in 1982.  When pitched to future director Paul Verhoeven (on more than one occasion), he dismissed the movie.  However, his wife picked up the script and convinced him the story was layered with satirical and allegorical elements, urging him to direct it.  And, the rest - as they say - is history.
  • The RoboCop suit was so heavy, Peter Weller lost 3 pounds a day from water loss.  The suit was eventually altered to include an air conditioner unit.  The suit was also the most expensive item on the set, costing up to $1 million after the final augmentations.
  • When the film hit theaters in Sacramento, California, a robbery suspect fleeing police decided to hide in a darkened theater playing "RoboCop."  He became so engrossed in the movie that he failed to notice police had evacuated other patrons and was subsequently taken into custody.

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

Dead Or Alive?  While there are still companies to like in the AI space, it would appear that the sub-sector is overdue to lag other asset classes as we're seeing a shift in market leadership.  Since the beginning of July, we've seen other "out-of-favor" asset classes out-pace the tech-heavy Nasdaq and semiconductors.  The Nasdaq is only up 1.2% since July 1st and semiconductors are down more than 6%.  Meanwhile, other equity asset classes - such as, Small Caps, Mid-caps, Large Value, & Bonds - have all returned north of 5%.  Why is this the case?  It's likely the market has gotten out over its own skis.  Stocks are driven primarily by earnings.  While expected earnings show a steady growth path, stock prices are elevated and are not aligned with expected earnings going forward.  If we strip out the Magnificent 7, the forward P/E for the S&P 500 Index is closer to 23, while the average forward P/E of the Mag 7 companies is approximately 37.  At these levels, it's likely the Mag 7 companies are over-valued, which would explain why investors are gravitating to other sectors that have been under-valued relative to AI-related names.  However, even relative to their own historical valuations, more than 80% of US equity sectors have a price-to-earnings ratio in the top quartile historically.  This means that most sectors are over-valued.  That doesn't mean these sectors are likely to correct in the immediate future.  Stocks typically don't hit over-valuation and immediately correct.  It may take some time for equities to revert back to normal historical levels.  For example, Utilities, Consumer Staples, & Energy are at normal valuations or just slightly elevated valuations.  As we have already pointed out, investors are gravitating to these sectors in lieu of Tech/AI.  As the movie "RoboCop" so aptly portrays, not all technology is good.  But, given the proper parameters and directives, can be useful.  As RoboCop says when he's about to arrest a would-be criminal, "Dead or alive, you're coming with me."

Prime Directive.  As analysts, one prime directive we live by (at least, ought to live by) is "what is the data telling us."  Not, how do our emotions make us feel or what do our internal biases indicate.  The data is telling us that while things might be fine at this very moment, there are flags beginning to flash in the data that should give us pause.  First, coming out of the consumer survey conducted monthly by the University of Michigan is the fact that consumers feel now is a bad time to purchase a home.  In fact, the survey shows the highest percentage of consumers indicating this since the high mortgage rates of the 1980s.  Home buyers of that era are probably laughing at current potential home-buyers, but regardless, potential home-buyers today do not look very motivated.  What should this be a concern?  The real estate market affects many other industries - legal, banking, construction, etc. - which means there is the potential for multiple job losses if conditions don't improve.  Second, Personal Spending and Personal Income appear to be in a general downward trajectory.  Spending (orange bars) wavered once in 2023 and once early this year, only to subsequently recover.  However, since March, spending has slowly moved lower.  After spiking in February, Personal Income (blue bars) appears to be on the same trajectory as Spending.  At the same time, inventories of goods seem to be more elevated in 2024 than they were in 2023.  This could possible signal a buildup in inventories due to a more choosy consumer who feels constrained by still high interest rates and exhausted savings. Finally, inside the latest Conference Board's survey results, a higher number of consumers are indicating that jobs are harder to get, while a fewer number of consumers are indicating that jobs are plentiful.  The labor market appears to be softening at the same time that consumers are more careful with their spending habits and concerned about flat income levels.  RoboCop was built with "prime directives" built into his programming - "Serve the public trust, protect the innocent, uphold the law."  We would be wise to remember basic rules of investing and be cautious about concentrations, especially in AI-related names.

Dead or alive, RoboCop gets his man...
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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.

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