Markets Shake Off Concentrations
Equity markets fluctuated during the week as Mag 7 names came under some pressure, but ultimately finished higher. Oil finished lower on the week on hopes of a Middle
East truce, but the U.S. has reportedly passed on an Iranian proposal.1 2 The yield on the 10-year Treasury increased 21 basis points last week, which is the second-highest weekly rise next to the week of May 11th of this year.3 Similar patterns have also appeared ahead of some prior market declines, as evidenced by the graph above. Prior to the Dot.com bust, the 10-year Treasury yield increased 263 basis points from October of 1998 to January of 2000. The increase prior to the Great Financial Crisis saw the yield increase 97 basis points over just a few short months in 2007 and was about 4 months prior to the beginning of that bear market. Things were different in 2022, as the Fed raised interest rates 7 times that year to combat rising inflation resulting from the supply shocks of the COVID era. So far this year, the 10-year has risen 117 basis points since the March low. These signals have not always been followed by a bear market and past patterns may not repeat. However, it might be a good idea to watch the development in yields and new equity lows as markets grapple with inflation, the Fed, and geopolitical conflicts.
The rise in Treasury yields has aided investors' appetite for equities this year to add to a healthy allocation to the asset class over the past couple of years.
According to the graph, investors' equity allocations are at highs not seen since 2006. At the same time investor allocations to bonds, also visible in the graph, are at lows not seen since 2007. We pointed out just a few weeks ago that investors deemed asset allocation as "dead" and loaded up in equities, while dumping bonds in 1999.4 That cost investors who became one-sided in their asset allocation as the following year saw a reversal in the returns of equities and bonds. As investors continue to add to equities, breadth in U.S. equities does not look promising. According to Peter Schiff, at least 430 of the stocks in the S&P 500 are 21.7% below their highs. That means on average 86% of the stocks are in a bear market.5
While there is little doubt AI technology is here to stay, there are questions about revenue growth and corporate financing that have investors apprehensive about the
future of AI-related stocks. Since peaking in June, the Goldman Sachs AI Basket of stocks is down more than 10% as the LLM Token Expenditure Index and GPU Rental Indices (as shown in the Fidelity graph above) have declined. In other words, the revenue derived from tokens charged by commercial API AI-related tasks and the rental rates for AI models to utilize Nvidia workhorse chips are all lower. So, the question becomes will revenue grow fast enough moving forward to justify the large expenditures of AI companies on data center buildout? As was evidenced during the Dot.com bubble, technology has over-taken the broad market in terms of capitalization. Of the top 10 names in the S&P 500 Index, 65% of the allocation is to technology companies and six out of the 10 names are involved in the financing or buildout of AI data centers.6 As we have alluded to recently, now could be an opportune time for investors to evaluate their respective portfolios to determine if their individual risk tolerance is in line with current allocations.
Disclosures
The information contained herein is for informational purposes only and is developed from sources believed to be providing accurate information. The opinions expressed are those of the author, are for general information, and should not be considered a solicitation for the purchase or sale of any security. The decision to review or consider the purchase or sell of any security should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional.
Forecasts or forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice.
Any market indexes discussed are unmanaged, and generally, considered representative of their respective markets. Index performance is not indicative of the past performance of a particular investment. Indexes do not incur management fees, costs, and expenses. Individuals cannot directly invest in unmanaged indexes. The S&P 500 Composite Index is an unmanaged group of securities that are considered to be representative of the stock market in general.
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