Q2 2024

The stock market registered another strong quarter. The strength continued in the pattern I spoke of last quarter: a small number of large companies driving the results.

As you scan the index performance figures we sent, you’ll see what I’m talking about. The index most skewed to large technology companies is the Russell Top 200 Growth Index, and it was up 10.02% for the quarter. The S&P 500 is mostly large-cap stocks but more diversified; it was up 4.28% for the quarter.

As you move to indices with no large-cap technology, performance falters. The mid-cap indexes we report, the S&P 400 and Russell 2500 Growth, were off -3.45% and -4.22% respectively for the quarter.

Market themes do not change unless unexpectedly disrupted. Nothing happened in the 2nd quarter to disrupt either investors’ general cautiousness (i.e., most stocks are not going up), or the euphoria about artificial intelligence.

It is amusing to see the company’s management scramble to rebrand their businesses to the mania de jure. Once, not too long ago, I would listen to the quarterly conference calls from companies in the “software” industry. Software companies no longer exist. In their wake, we only find artificial intelligence companies.

What is your AI strategy? Answer that, and the market will add a few points to your stock’s multiple. I’ll come back to all this in a moment.

One of life’s truths is that “time accelerates”. We discover this as we experience hours becoming days, days-months, and months-years. Once we’ve recognized it happening, it’s too late, time is (as they say) “flying by”.

I toss that little bit of insight into the mix here because my understanding of what is happening today is colored by my experience investing during the Dot-Com Bubble (the 1990s). Does the fact the Dot-Com Bubble started 30-years ago invalidate it as an analogy to what we are seeing today? Of course not, as I view the 1990s as “not all that long ago”. Because it wasn’t.

Contrast that with what the “old timers” told me back then; about the “Nifty-Fifty”. The “Nifty-Fifty” was the term given to the stock market in the late 1960’s. It referred to the stock market’s performance being driven by the top fifty stocks.

In the 1990’s I was unable to appreciate the similarities. 30 years seemed too far back to be relevant. Because it was.

What I learned from the Dot-Com Bubble was that company valuations can get wildly out of line when transformative themes arise. What’s interesting is if we look back on the themes surrounding the Dot-Com Bubble, they were largely correct.

The internet has fundamentally changed every industry. Modes of distribution were transformed, information became readily available, and all of it has driven incredible efficiencies.

The Dot-Com “bust” happened, not because the themes were wrong, it’s because company valuations were driven to levels that required changes to happen immediately. Time is money and high valuations require things to be, or soon be, very good, and that it all happens quickly.

It has taken decades for the benefits of the internet to flow through the economy.

Another thing I learned is the early stock market winners are not necessarily the long-term winners when transformative change is underway. I know some of you still have “@aol.com” emails, but the market’s perception that America Online would dominate the internet revolution has fallen short, just a bit.

The final thing I learned during the dot.com boom is that extended valuations can last. It was in 1997 when Fed Chairman Allan Greenspan referred to the stock market’s value as “irrational exuberance”. At the time, I was finding my models for valuing stocks to be completely out of whack with where stocks were trading. Despite all this, the bubble didn’t burst for almost 3 years.

The things I have learned from experience will not keep us from investing in AI, they’ll just keep me cautious. I believe there are already some excesses showing up in valuations. We are also seeing the market stretching to redefine certain companies based on their AI footprint. This is all very similar to what we have seen in the past.

As for the rest of the market, there are good signs and not-so-good signs. Inventories are working towards being in line, which is good. Yet consumers and businesses are cautious. This is what is keeping a lid on growth. We are hoping for a rotation out of the AI theme to broaden the market’s performance. That would be healthy but requires some better overall economic news.

Have a wonderful summer with your friends and family.