Gill Capital Partners March 2024 Market Update
Spring is upon us, and we are getting excited for warmer days and NCAA basketball. We recommend that you get your brackets and your gardening tools ready, as spring officially starts with the spring equinox today. What is the spring equinox? The equinox marks the first day of spring in the Northern Hemisphere. It's the day the sun's rays shine onto the equator while the Earth sits with its axis tilted neither toward nor away from the sun. This causes 12 hours of sunlight almost everywhere on Earth. Speaking of spring, economic green shoots came early this year, as winter was kind to global markets. Economic and corporate performance continued to surprise to the upside, allowing markets to place geo-politics and the constant barrage of negative macro headlines aside. We will provide updates on interest rates, Artificial Intelligence (AI), and the stock market, but first, the interesting chart of the month takes us to Japan.
The award for the longest stock market recovery goes to Japan. The Nikkei (Japanese Stock Market Index), as shown in the chart below, just broke above 40,000, a new all-time high, surpassing the last all-time high from nearly 35 years ago (1989). Japan has been the most aggressive country with respect to monetary policy; they have been in a zero or negative interest rate environment for decades.
Inflation, Interest Rates & The Federal Reserve
Last week’s inflation update showed that the Consumer Price Index (CPI), a broad measure of the cost of goods and services, increased 0.4% for the month and 3.2% from a year ago. The monthly gain was in line with expectations, but the annual rate was slightly ahead of the 3.1% forecast. Excluding volatile food and energy prices, the core CPI rose 0.4% on the month and was up 3.8% year over year. Both were 0.1% higher than forecast. While the 12-month pace of inflation is well off its peak in mid-2022, it remains above the Fed’s 2% target. Interest rate moves, as measured by the U.S. Treasury market, were mostly muted following the news and equity markets rose modestly. The Federal Reserve will hold its two-day policy meeting this week to discuss the future of rates.
Our view –Year-over-year inflation ticked up slightly from 3.1% to 3.2% in February. This was very much in line with economist forecasts and markets brushed off the higher reading for the month. Both economists and markets continue to anticipate that the pace of inflation will move methodically lower.
February saw a slight increase in energy prices as oil moved modestly higher for the month, and “sticky” shelter costs continued to be the single greatest contributor to inflation. Despite higher interest rates, relief has yet to show itself in housing costs.
Despite stubborn shelter costs, markets and economists remain optimistic that inflation is coming under control and will continue to move closer to the Federal Reserve’s target of 2%. This has provided optimism for equity markets that interest rates will move lower over the next several quarters. The bond market is pricing in a 50-50 chance that the Federal Reserve will cut interest rates in June, with a 70%+ probability of four quarter point cuts by January of 2025. We will get more information this week following the Federal Reserve meeting.
Artificial Intelligence (AI)
For some, the term AI conjures scenes from the movie The Terminator, and a world where nearly everything is automated and computers eventually replace humans in many critical functions. While we’re nowhere near that point, AI is dominating headlines and has become a major factor in corporate profits and equity markets. C3.ai CEO Thomos Siebel was recently quoted as saying, "Cloud infrastructure is scaling rapidly; NVIDIA grew 265% year-over-year. NVIDIA's data center GPU sales grew by 409% year-over-year. Now, some believe that this capacity is being built to use LLMs (Large Language Models) to write Christmas cards in the style of Charles Dickens and write college application essays to Yale. But that's simply not the case. This capacity is being built to run enterprise AI applications, stochastic optimization of the supply chain, supply network risk, predictive maintenance, demand forecasting, fraud detection, production optimization, customer engagement, predictive medicine, precision medicine, and government services." The explosion of AI technology and the demand for it are rapidly driving a new stage of technological innovation and growth.
Our view – Love it or hate it, AI is here to stay, much like the explosion of the internet in the late 90s. Companies and individuals are rapidly adopting AI into everyday life and learning how to use it to their advantage. Corporations are drooling at the prospect of what AI can do for efficiency and corporate profits. By way of an example, the company Klarna, which is a leading financial services company in the payment processing space, caught analysts’ attention in their recent earnings release that reported results of its AI assistant, which is powered by Open AI. It had been live globally for only one month, and the numbers were stunning:
The AI assistant held 2.3 million conversations, two-thirds of the company’s customer service chats.
It is doing the equivalent work of 700 full-time agents.
It is on par with human agents in regard to its customer satisfaction score.
It is more accurate in errand resolution, leading to a 25% drop in repeat inquiries.
Customers now resolve their errands in less than 2 minutes, compared to 11 minutes previously.
It is available in 23 markets, 24 hours per day, 7 days per week and communicates in more than 35 languages.
It is estimated to drive a $40 million profit improvement to the company’s bottom line.
This data gives you a sense of why companies are so enthralled with AI and why it is likely here to stay. As a firm, we are invested in AI through multiple investment positions and are assessing whether and how we may wish to invest in this theme more directly. AI, at its core, is driving a nearly unquenchable thirst for computer processing power, as huge data centers are needed to power the AI revolution. These data centers also have massive energy needs, which is another indirect consequence of this rapidly growing industry. More on this to come.
Market Update
Markets globally are breaking out to all-time highs, with small cap and emerging market stocks beginning to show signs of life. This is happening against a backdrop of the highest interest rates we have seen in over 20 years and a tense geo-political environment. Many economists had expected that we would be in a recession by now; however, we are seeing some of the strongest GDP numbers in decades… so, what gives? Is this all about AI?
Our view – We don’t believe that AI is the sole driver behind these all-time highs. It has helped, but the recent market strength is all about positive economic growth, expanding margins, and rising earnings; the 'E' in the P/E ratio is rising. Sure, the stock market would love to see Treasury rates back below 4%, and maybe we will get there if the shelter components of inflation cooperate. However, the market cares less about the Fed and more about missing out on all this great growth potential, as was evident with the stock market’s reaction to last week’s CPI report. Certain segments of the market are overdue for a correction, but the fundamentals are incredibly supportive. We are particularly intrigued by areas of the market that are well below their highs and are showing signs of life, such as small caps and emerging markets. These areas have underperformed for some time now, but their day may be coming. We remain surprised that the economy has been able to absorb higher rates so gracefully - our hats are off.
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.