Peaks and Wreck


You got this, it’s time to go.

Many years ago in the French Alps I was standing at the top of a steep slope trying to muster the courage to start my run. As I pointed the skis over the precipice, began to push my weight forward and let gravity do the rest, I changed my mind at the last minute. Ten minutes later I was still there. No further forward, but much colder. Fear had taken over, and rationality had taken a back seat. Just as I was about to call the emergency services and demand a helicopter airlift me off the slopes a tiny, but rather cocky, child flew past me and stylishly navigated his way down the piste. The shame was too much. I had to ask myself some tough questions. Could I summon the courage to go? Why have I stopped thinking rationally?  Is it inappropriate to follow that child and ‘accidently’ push them over in the chairlift queue?

When you are learning to ski you are taught never to stop at the top of a slope but instead ski a little way down, then stop. The reasons for this are psychological. Not only are you then committed to the slope (you can’t go back no matter how much you complain!) but looking back up the slope shows you what you have already achieved, plus, a slope always seems worse looking down than looking up. Perspective is everything.

Ain’t No Mountain High Enough

If you look at the current chart of the Nvidia share price it looks like the side of a mountain. The big question is, what part of the slope are we on. Are we at the top and the price is about to plummet, like Cisco in 2000. Or are we only part of the way up and the shares continue to defy gravity.

Source: Yahoo Finance, March 2024

Nvidia has been dubbed “The most important stock on the planet” by some plucky outfit called Goldman Sachs, and when you look at some of the stats you can see why. The Nvidia share price has increased by 435% since the start of 2023 and it is now the third biggest listed company in the world with a market capitalisation of $2 trillion. Last week’s bounce in the share price was the largest ever one day move, with the company increasing in value by $277bn. In one day! To put that in perspective, this move is bigger than the ENTIRE value of Shell, the largest company listed in the UK.

The primary reason behind this explosive performance is the company’s dominance in artificial intelligence (AI). As the flag bearer for AI, the chipmaker has attracted significant attention from investors. The company’s growth has been phenomenal but so has the hype, and the valuation placed on the company reflects the buzz around AI.

On pretty much any metric the company looks expensive. There is no doubt Nvidia is a great company, profits are growing by 20% a year but we need to take a step back and ask ourselves whether this level of growth can be maintained in the longer term. This is not a fledgling business, it is a $2trn global company.

These hype cycles are a real thing. Hedge funds trade the momentum of a hot stock and the rise of passive investing means flows into that stock tend to beget more flows, success breeds more success. This, of course, can also unravel in the opposite direction when sentiment turns. What will happen to the share price if the rate of growth stalls?

The ‘Magnificent 7’ tech giants were the only game in town last year but this year it has been more like the ‘Magnificent 4’. The S&P now has the highest level of concentration risk in over 30 years with technology and communication services now accounting for 40% of the US market. This is not as healthy sign. For investors seeking to reduce risk and diversify away from these big names this been a painful trade over the last year.

There have been a lot of comparisons with the tech boom in 1999. It was widely believed that the internet would change the world, which it has, but probably not in the way most people thought back at the turn of the century. AI will undoubtably change the way we live and work, but as with the early days of the internet, broader adoption of AI remains some way off.

We are now looking to reduce our exposure to the mega cap companies and reinvest the proceeds into a fund that invests in good quality companies that do not require undue optimism about the future.

Ain’t No Valley Low Enough

At the opposite end of the market sentiment spectrum, the Chinese stock market is down 60% in the last two years alone and now trades at a 25% discount to other emerging markets. The Chinese small-cap index had already dropped 30% since the start of this year. To say the market is unloved would be an understatement.

Source: Yahoo Finance, March 2024

Then, earlier this month, Chinese stocks leapt to their largest one-day gain in two years. The Chinese small cap index had its biggest gain since 2008. The main reasons for the bounce was news that the authorities might step in with measures to stimulate the economy and prop up the stock market.

What does this tell us? Not much at this stage. Its notoriously difficult to spot inflection points. When a market is as ‘beaten up’ as China’s stock market the question is whether this is an incredible investment opportunity, or whether it’s a value trap and the market continues to fall.

The issues around Chinese real estate blow ups and weaker growth have not gone away, neither has the trade tensions with the US or rising youth unemployment. However, China is a world leader in a number of industries and if investors become comfortable with China growing at a lower rate than it historically has, but still growing, then sentiment should improve.

Increasing our weighting to China at this stage feels like catching a falling knife, but the market is certainly attractively valued and an opportunity to invest may soon present itself.

Don’t, Don’t, Don’t Believe The Hype

One of our investment mantras is ‘don’t try to predict the future, but understand the present’. What is happening that shouldn’t be and what is not happening that should be? The goal is to make an assessment on which markets offer good value and can provide us with investment returns over the long term.

Most of us (less technical people) are still trying to get our heads round the potential impact of AI. When it comes to emerging technologies there is a concept regarding human behaviour called “Amara’s Law”. This concept states that when it comes to significant technology changes we overestimate their short-term impact and underestimate their effects in the long-term.

The transformation triggered by AI may take many years longer than today’s share prices are suggesting. When certain sections of the market go on a tear it is difficult not to suffer from FOMO. Similarly, when a market has capitulated and needs life support, it is easy to just ignore it and invest in other areas that might be deemed more ‘comfortable’.

We are back on the mountain and need to understand what part of the slope we are on.

Don’t be a prisoner to emotion, but wait for signal to move.

You got this, it’s time to go.


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