The market may be rallying but that doesn’t mean it’s going to last for long. Here’s why… [Wednesday: The Independent Investor]
Miles Everson’s The Business Builder Daily speaks to the heart of what great marketers, business leaders, and other professionals need to succeed in advertising, communications, managing their investments, career strategy, and more.
A Note from Miles Everson:
We’re thrilled to share with you another investing insight in today’s “The Independent Investor.”
Every Wednesday, we publish articles about investing because we believe we can achieve true financial freedom through wealth creation.
In this article, we’ll talk about an economic indicator that tells you why you should tread lightly in today’s bull market.
Continue reading below to know why the rally in tech stocks might not last for long.
The Independent Investor
There’s not a lot to be excited about in today’s market.
Inflation isn’t coming down as expected despite the U.S. Federal Reserve’s fiscal measures. Additionally, the labor market and credit continues to be tight. As a result, the earnings outlook for this year is pretty bleak.
To further complicate matters, multiple controversies and problems disrupted the cryptocurrency industry and the banking sector this year. Investors are also becoming increasingly concerned about the state of commercial real estate and the new craze surrounding private credit.
One would expect these problems would have affected the stock market and investor sentiment by now, but that simply isn’t the case.
The reason for this?
The S&P 500 has rallied by more than 20% since its October 2022 low due to artificial intelligence (AI).
In fact, chipmaker and S&P 500 constituent NVIDIA Corporation is one of the hottest stocks at present since it’s up by roughly 180% this year.
This tremendous rise in price is due to the fact that the company is responsible for making most of the chips AI firms need for their operations.
On the other hand, NVIDIA isn’t the only firm that’s profiting heavily from AI. Microsoft saw its stock rise because it is a majority investor in OpenAI, the creator of the popular chatbot ChatGPT.
Aside from these firms, other tech companies like Alphabet, Amazon, Apple, Meta, and Tesla have seen their stock prices rally since October 2022.
These companies have added about USD 3.4 trillion in market cap since then. Meanwhile, the entire S&P 500 has added USD 6.5 trillion.
That’s an impressive rise in stock performance and market cap for sure, but according to Robert Spivey, the Director of Research at Valens Research and Altimetry Financial Research, “the market might be jumping the gun.”
According to a report from consulting firm McKinsey, the global AI industry might provide between USD 2.6 trillion to USD 4.4 trillion to the world’s gross domestic product in the next few years.
Spivey says that while AI may have lots of benefits, it still hasn’t found a way to prevent the U.S. economy from entering a recession. Furthermore, the tool cannot separate credit cycles from recessions and economic booms.
He also says the data point only shows how much value AI can create across the entire economy and not how much profit the previously mentioned companies can generate over the next few years.
Given his line of reasoning, it seems investors added all that potential value creation in the respective valuations of the previously mentioned companies. As a result, the pricing and the outlook for the entire market went up.
Technically speaking, we’re presently in a bull market. However, this may not be the case if we look at another economic indicator.
When we look at the current credit cycle, you’ll see that access to credit is still tight… and it’s getting tighter.
The chart below shows banks are tightening access to credit faster than any time since the 1990s, with the exception of the past 4 recessions.
Chart from Altimetry Financial Research
Simply said, corporate borrowing costs are going up, making it harder to finance growth. This is happening because the U.S. Federal Reserve’s interest rate hikes are starting to take effect.
Due to tightening credit standards, it has become more difficult for corporations to finance growth. Additionally, bankruptcies are on the rise since not every firm can keep up with rising borrowing costs.
As we’ve discussed above, investors cannot solely rely on market movements and rallies when picking stocks. It’s necessary to get a full understanding of the economic situation beforehand.
While AI could have real long-term benefits for the global economy, this doesn’t mean you should go along with the hype surrounding it.
Tightening credit standards are hurting corporate investment… and the latter is essential for AI’s growth.
Keep this insight in mind the next time you survey the stock market for opportunities!
Remember: Today’s credit cycle is worrying, so the best thing you can do for yourself and your investment portfolio is to be cautious with your money even if the market keeps on rallying.
(This article is from The Business Builder Daily, a newsletter by The I Institute in collaboration with MBO Partners.)
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“Wednesdays: The Independent Investor”
To best understand a firm, it makes sense to know its underlying earning power.
In two of the greatest books ever written on investing, the “Intelligent Investor” by Benjamin Graham and “Security Analysis” by David Dodd and Benjamin Graham (yes, Graham authored both of these books), the term “earning power” is mentioned hundreds of times.
Despite that, it’s surprising how earning power is mentioned seldomly in literature on business strategy. If the goal of a business is wealth creation, then the performance metrics must include the earning power concept.
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Hope you’ve found this week’s insights interesting and helpful.
Stay tuned for next Wednesday’s “The Independent Investor!”
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