Investment Insights Newsletter - May 2024 Edition

Executive Summary

Market Overview: According to Evercore ISI's "Sum of the Charts" research (May 21, 2024), the S&P 500 is poised for significant growth, with projections indicating a climb to 5,500 this summer, followed by an ascent to 5,800 by the end of the year, and further reaching 6,000 in Q1 2025. This positive outlook is bolstered by robust momentum indicators, broad participation across sectors, and particularly favorable seasonal trends. Additionally, the weakening in crude oil prices and bond yields contributes to this optimism, offering a solid foundation for equity investment strategies.

Amid the optimistic market outlook, it is essential to recognize the markets are navigating several disruptive headwinds that are shaping the investment landscape. While persistent inflation rates above 3% have stirred concerns over interest rates staying “higher for longer”, there is confidence in the resilience of markets and the potential for adaptive monetary policies to stabilize prices effectively. Similarly, geopolitical tensions, including ongoing conflicts in the Middle East and the Russian/Ukraine war, underscore the need for strategic investment decisions. However, the strong anticipation of eventual lower interest rates along with diplomatic resolutions and subsequent stabilization in the conflict regions fosters a climate ripe for investment opportunities, potentially leading to a period of reduced macro risk and support for higher valuations and asset price appreciation.

Strategic Focus: The current technological landscape is undergoing a transformative shift, largely due to the AI revolution, which is reshaping the global economy, and the way businesses operate. The massive surge in capital spending on AI enabling technology represents not just a transient opportunity, but a foundational shift that promises to enhance corporate profitability and overall economic productivity across all sectors for years to come. Companies at the forefront of this revolution are experiencing significant gains, thanks to their pivotal roles in enabling and advancing AI technologies.

Key companies driving this transformation include NVIDIA, Google, Microsoft, Amazon, and Meta Platforms. Their contributions span from enhancing data center efficiency and developing autonomous systems to revolutionizing workplace productivity and digital interactions. The long-term economic impact of these advancements is profound, leading to enhanced efficiencies, reduced operational costs, and the creation of new business models and revenue streams. As AI continues to evolve, the ripple effects through the economy are expected to grow, making these companies central to the AI-driven economic landscape.

Portfolio Diversification

Highlighting Small Cap Value Strategy: The small-cap sector offers significant opportunities for investors seeking quality companies at discounted valuations. These companies often possess robust growth prospects and positive earnings revisions profiles, at significantly discounted valuations compared to the Large Cap Growth segment of the market. The inherent nature of small caps, with their potential for rapid growth and responsiveness to market changes, allows them to present unique investment opportunities distinct from their larger counterparts.

Moreover specifically, blending Small Cap Value with Large Cap Growth creates a powerful diversification strategy within an investment portfolio. The low daily price correlations between these two segments mean that when Large-Cap Growth stocks face volatility or sector-specific downturns, small-cap value stocks often behave differently, providing a stabilizing effect on overall portfolio performance. This diversification not only reduces risk but also enhances the potential for balanced long-term returns.

By including a Small Cap Value allocation, investors can mitigate the risks associated with an overly concentrated portfolio in Large-Cap Growth stocks, leading to a more balanced and potentially higher-performing investment strategy. Small Cap Value companies currently held include: Abercrombie & Fitch, Carpenter Technology and Goodyear Tire & Rubber.

Individual Company Focus

NVIDIA (NVDA) stands out as a cornerstone in this transformative era with its follow-up to the wildly successful Ai powering H-100 GPU - introducing the Blackwell GPU platform. This development marks a significant milestone in computing, as NVIDIA aims to democratize the power of real-time generative AI for organizations worldwide. The Blackwell platform is designed to handle trillion-parameter large language models, enabling up to 25 times less cost and energy consumption compared to previous generations.

The Blackwell GPU architecture is embedded with six revolutionary technologies that are poised to unlock new frontiers in various sectors including data processing, engineering simulation, electronic design automation, computer-aided drug design, quantum computing, and generative AI. These innovations position NVIDIA as a pivotal player in the emerging industry opportunities.

Key impacts of NVIDIA's advancements include:

Enhanced Data Center Efficiency: The new Tensor Cores and TensorRT-LLM Compiler in the Blackwell GPUs reduce large language model (LLM) inference operating costs and energy 

· consumption by up to 25 times. This efficiency is crucial for businesses aiming to scale AI applications while managing operational costs.

· Breakthroughs Across Industries: The Blackwell architecture's capabilities extend to accelerating data processing, engineering simulations, and even computer-aided drug design. These applications promise to expedite scientific discoveries and innovations across various fields.

· Widespread Adoption: Major cloud providers, server makers, and leading AI companies are adopting the Blackwell platform. Organizations like Amazon Web Services, Google, Meta, Microsoft, OpenAI, and others are expected to leverage these GPUs, which highlights the broad impact and acceptance of NVIDIA's technology in the market.

Alphabet (GOOG): “Google's” strategic AI initiatives, notably enhancing search and workspace functionalities, position the company for sustained growth. Google is revolutionizing search, digital marketing, and cloud computing with its AI-driven analytics and tools.

Microsoft (MSFT): Microsoft's integration of AI into its cloud services, particularly Azure, and its suite of productivity tools, such as Office 365, is transforming workplace productivity and collaboration. The company's AI initiatives are also enhancing cybersecurity measures and facilitating smarter business decisions.

Amazon (AMZN): Amazon's use of AI in its e-commerce platform streamlines operations, from inventory management to personalized shopping experiences. AWS is a major enabler of AI for countless businesses, offering powerful machine learning services and infrastructure.

Meta Platforms (META): Meta is pioneering in virtual and augmented reality spaces, with AI being a cornerstone of its strategy to create immersive user experiences. Its investment in AI-driven content moderation and targeted advertising is reshaping digital interactions and marketing.

Netflix (NFLX): Netflix leverages AI to enhance content recommendation algorithms and optimize streaming quality. This use of AI not only improves user experiences but also drives efficient content distribution and production strategies.

Economy and Interest Rates

The U.S. economy is showing robust resilience and now embarking on a phase of recovery, particularly within the manufacturing sector. This shift signals an end to the rolling sectoral recessions and the onset of a supply-supported growth phase. Notably, this recovery is focused on specific sectors like manufacturing, propelled by continued fiscal support and a strong labor supply, representing a strategic rather than a broad-based cyclical upturn.

The Federal Reserve is fine-tuning its policies to guide this delicate recovery without igniting inflationary 

pressures. While the Canadian economy faces the headwinds of mortgage renewals at significantly higher rates, USA economic activity has surpassed expectations.  This divergence suggests Canadian rate cuts are much more likely than in the USA which may result in appreciation of the US Dollar relative to the Loonie.

The technology and housing sectors have rebounded from their downturns, with technology now benefiting from an AI-driven boom, indicating a break from the pandemic-related imbalances. These sectors' trends, coupled with robust indicators like ISM manufacturing and retail sales, confirm solid demand for goods, underpinning the manufacturing sector's revival in the USA.

Conversely, the services sector maintains its strength but is starting to exhibit signs of moderation, particularly in areas affected by changes in consumer behavior and the shift to hybrid work models. This moderation is integral to the overall adjustment process, aligning consumer demand with strong supply-side capabilities.

The labor market reflects these economic shifts, with reduced tightness and a focus on achieving a balance that supports inflation convergence towards the 2% target. The labor market's recent strength, marked by significant payroll growth and solid wage increases, introduces some upside risks, especially in services and government spending.

An additional challenge arises from the Biden administration's fiscal policies, particularly the ongoing elevated levels of government spending, which complicate the Federal Reserve's efforts to bring inflation below the 3% threshold. The persistent government spending contributes to sustained demand pressures, making it more challenging for the Federal Reserve’s monetary policy alone to curb inflation effectively.

This evolving economic landscape presents numerous opportunities for investors, with potential implications for future interest rate movements and broader financial strategies. As the economy continues its transition, maintaining vigilance over sectoral developments will be essential for refining investment strategies in this dynamic environment.

Closing Remarks

As we look towards 2025, the market trajectory, supported by strong technical indicators and robust sectoral growth, suggests a positive outlook for investments, particularly in the USA. This period echoes the transformative energy of the mid 1990s when the technology revolution spurred a productivity-led economic expansion, fundamentally reshaping industries, and markets. Similarly, today's AI revolution is enhancing productivity across various sectors, ushering in a sustained growth phase reminiscent of that pivotal era.

Investors find themselves at a crucial juncture where engaging with these trends is essential. Companies leading in technological advancements are at the core of this economic transformation. With prudent focus on these innovators, investors can access the potential of AI to redefine markets and consumer experiences, much like the tech pioneers of the late 20th century did.

The anticipated easing of global conflicts and the movement towards lower interest rates as we enter 2025 further enhance this optimistic outlook. These developments are expected to contribute to market stability and open up additional investment opportunities, presenting a favorable environment for strategic market engagement.

Incorporating small-cap stocks provides a strategic balance against the risks associated with large-cap concentration, ensuring a diversified and resilient investment portfolio. This strategy not only mitigates risk but also takes advantage of unique market conditions that favor agile and innovative companies, especially those poised to leverage AI to disrupt traditional sectors.

In this period of growth and transformation, investors are advised to adopt a forward-thinking approach, aligning their strategies with the potential of AI and the evolving economic landscape. Drawing parallels to the 1990s, this balanced approach offers a compelling narrative for a diversified and resilient investment strategy, ready to capitalize on the emerging opportunities and mirror the success of that transformative period.