Early in April, higher interest rates drove share prices roughly 5% lower up until the 2.8% gain in the S&P 500 last week. Yields were not the driver last week. Instead, it is another narrative, specifically artificial intelligence, that pushed the market higher in the face of an unhappy bond market.
To say the narrative around AI is powerful is understating the case. Until last week the market was happy to count the potential benefits from AI without thinking about costs. However, it is still not clear whether the AI boom will actually generate large returns on capital. What is clear: it will require a lot of capital. An unexpected estimate of as much as $40 billion in AI capex this year from Meta Platforms alone sent the stock down 10% in response last week. The market loves the benefits of AI, but the costs are starting to mount. The AI cost test of the market isn’t likely over yet. While this will add to share price volatility and also help differentiate winners from losers, it doesn’t take away from the overall AI theme. There are still years left for the AI boom to run.
Through last week, only 406 companies have reported earnings (out of thousands). This week hosts a heavy line-up of earnings announcements that will likely be market-moving again. So far this earnings season both top and bottom lines are solid, but guidance raises are down to 5% of reports. The good news is that guidance cuts are also low. Triple Plays are also, therefore, less common.
Even mega-caps are capable of breathtaking market moves after they announce. Last week, Meta Platforms (Facebook) plunged after forecasting a much bigger spend on AI investments than the market anticipated. The next day, Alphabet (Google) soared after announcing generally impressive results. This week promises to give investors more fireworks. The market volatility is a sign that the bulls and bears are fighting it out at this market level. Not every investor thinks we are in an ongoing bull market like we do.
The bears took the upper hand earlier in April with a 5% drawdown and looking for a full-blown 10% correction or more. There seemed to be plenty of bad news out there: higher interest rates and a regional war. But 10% corrections are the price of admission for equity investors and shouldn’t scare serious investors away. After all, they occur about once a year. Through wars, depressions, bankruptcies, and crashes, the U.S. stock market has always gone on to make new highs. We don’t expect this time to be any different.
THE IPO MARKET COMES TO LIFE
The initial public offerings market has been hot lately. More and more companies are deciding to go public. Is this the sign of a bull-ending bubble? Not at all in our view. This is more a sign that capital markets are working properly after a long dry spell.
A number of companies have gone public with big price gains in the first few days. For those investors inclined to see bubbles, this is reminiscent of the late 90s dot.com frenzy when questionable new stocks soared to new heights. Internet company valuations were even calculated using “eyeballs” which marked the height of craziness. Today’s IPOs are often profitable or can show a path towards eventual profitability.
The more successful IPOs are, the more companies will go public. We see this as a positive development after the IPO window has been largely shut down over the last two years. It is a sign of a healthy market.
As a matter of investment policy, we do not invest in IPOs. Here’s why: First, most don’t pan out as long-term investments. Of course, there are some that turn out to be spectacular investments (Microsoft, Google, and Facebook to name a few). But the odds are stacked against investors. Second, we don’t like being buyers when the “smart” money is selling. Third, we prefer to buy seasoned, profitable companies. Most IPOs don’t qualify in that regard. And for those companies that thrive and become market stars, we can always buy shares later when the prospects are clearer and the valuations have come down from IPO nosebleed levels.