September 6, 2023
Rockbridge Institutional – August 2023 Market Review
“Irrational Exuberance” and Market Pricing
The price of Nvidia stock, a software design and development firm that manufactures chips integral to the gaming industry and, consequently, a proxy for Artificial Intelligence (AI), skyrocketed from $142 per share on December 30 to $494 per share today – a gain of over 230%. Does this increase in value reflect irrational exuberance or the markets’ pricing of the unknown future of AI?
Unlike cryptocurrency there is substance to AI. It has the potential to profoundly impact society and the economic landscape. While exciting, much of this potential is unfolding. Market prices discount today all that is known about this uncertain future. As new information becomes available, it is quickly incorporated into prices and results in ups and downs, which can be dramatic. Today’s prices of AI stocks, especially Nvidia, gives us a hint of what market participants expect for AI. While dramatic, it can reflect “rational exuberance.” Where these prices go from here depends on unknowns, which can be both positive and negative for AI.
Stocks were down across the board this month. With little change in the outlook for inflation and economic growth, this month’s drop seemingly reflects less appetite for risk. Yields moved up, making less risky bonds relatively more attractive. While we would like to explain monthly ups and downs in stock market behavior, oftentimes it is simply random noise. Quarter-to-date results, except for the slightly negative results in the International Developed Market Index (EAFE), were positive, however.
The year-to-date numbers remain upbeat. Even after the August falloff, a stock portfolio diversified sufficiently to span global markets is up nearly 9%, led by a 19% uptick in the S&P 500, which is heavily influenced by domestic Tech companies that are primed to participate in the future of AI.
A portfolio of stocks traded in the China markets was off nearly 6% since the first of the year, a distinct outlier from other markets. This performance, no doubt, reflects the economic slowdown and the implosion of its real estate market. The significance of China notwithstanding, many analysts observe that because our trade with China is not large and our financial markets are not correlated, this slump will have a minimal effect on the U.S. economy. While China is an outsized contributor (26%) to our emerging market allocation, it represents less than 4% of our global stock portfolio.
Yields on longer maturing bonds were up, resulting in negative returns (price reductions offsetting coupon payments). Yields on 10-year Treasuries climbed more the 0.3%. This uptick is in real interest rates, not inflation expectations, as the spread between nominal and inflation-adjusted yields has remained at a little more than 2%.
While the Yield Curve (pattern of Treasury yields across several maturities) continues to slope downward, with increasing yields at longer maturities, it has “flattened” to some extent, but still consistent with falling future interest rates. Reduced inflation expectations and an economic slowdown continue to be the popular explanations. We’ll see.