THE TIMES THEY ARE A-CHANGIN'

      Bob Dylan wrote this song in the fall of 1963 and recorded it in 1965 as a 45RPM single in Britain where it reached #9 on the UK singles chart that year. The song was later recorded on Columbia records in New York as the title song of his third album. The song's lyrics transcends time because change is always a constant in our lives. Many artists have recorded the song with great success and it was ranked #59 on the top 500 "All Time Greatest Hits" by Rolling Stone magazine.

     I believe the changes seen in 1963 will pale in comparision to what is about to happen in 2024 and beyond. The changes that artificial intelligence will bring will be life changing for nearly everyone. First, business will become far more effecient with fewer people. Unfortunately many will lose their jobs to AI automation. Machine learning has the ability to replace call center agents, clerical workers, accountants, paralegals and many other jobs currently performed by humans. One only has to look at the hundreds of billions of dollars being spent on AI to realize that the payoff for companies is to operate leaner. 

     The fuel that AI runs on is data. I have read that the Internet has nearly been exhausted of its data to feed the large language models being trained to run on Nvidia's GPU processors. So is this AI story about to run out of steam? I don't think so. Just imagine the massive amounts of data stored by research labs of drug companies, universities, goverments, technology companies, banks, and many other organizations. Suddenly, all this otherwise useless data now has value. It can be sold, traded, and added to the balance sheet of companies, making them much more valuable. Instead of wasting time and money on duplicate research, a drug company can buy the data already produced and bring products to market faster. AI has the ability to unlock bottlenecks in almost every industry. Maybe this is part of the reason that the S&P index as expressed by the index fund SPY is trading at a very rich PE of 27.8X.

     Once the training phase of teaching the "Large Language Models" is completed, the next phase will be the inference stage. This where the models actually generate answers to the questions being asked. I have read that this stage may be better handled by some of Nvedia's competitors such as AMD, Intel, or even custom chips by Amazon. Every one of the magnificent seven companies are trying to unseat Nvidia as the supplier of GPU chips to equip their data centers. At this time Intel is the laggard in the development of GPU's. They just fired their CEO in the hope that new leadership will right the ship but most analyists are skeptical that they can catch up. It  seems like all companies are being valued through the lens of their position in the AI race for dominance. At the current time, Nvidia has nothing to worry about because they have a lock on the GPU market for both the training and inference phases. 

     The flurry to build new data centers equiped with Nvidia's GPU's is rapidly draining cash from the seven major tech companies. Nvidia is the benificary of most of the spend but not all. Data centers will require lots of electricity, more than is currently available on the grid. This has caused many utility companies' valuation to skyrocket. Backup power is also critical for these new data centers. Diesel generators made by Cummins will give that stock a boost because not only will they supply the hardware but service of the equipment will be a long term revenue stream. Memory storage for data will also be required and Micron and Samsung should benefit from that. GPU's run hot so cooling is necessary for each server. A company called Vertiv sells liquid cooling systems but the stock has run up to nosebleed levels. Another beneficiary of the buildout of data centers is the large engineering companies who are tasked with the design and construction of huge new buildings.

     AI isn't the only transformative investing theme going forward. The development of GLP-1 agonists drugs have the potential to change the landscape of medicine forever. It is estimated that over one billion people worldwide could benefit from them. Currently they are only available in injectible form but a massive effort is under way to market an oral version. The pharma sector is currently out of favor due to the new administration taking office next year, making this an excellent time to pick-up some exposure to the best-in-class. The promise of deregulation over the next four years should benefit financials like banks, insurance companies, credit card issuers and consumer credit companies. 

     People my age don't really like change but it's coming anyway. The only difference between the change Bob wrote about in 1963 and now is the speed that it occurs. If you can't stop it you might as well profit from it. A little time spent researching these themes and acting on them might help you adapt to the changes a-comin'.

  

WHEN THE CHIPS ARE DOWN

     Ricky Nelson recorded this song in 1965 on Geffen Records and it appeared on the album "Mean Old World". Ricky became famous from his role on his parents' TV show "The Adventures of Ozzie and Harriet". His musical career took of due to the fact that on every third show he was allowed a musical performance to end the show. While the song never made it to the Hot 100 chart, his most famous hits included "Poor Little Fool", "Travelin' Man" and "Garden Party". Ricky became a teen idol in the 1950's and went on to act in motion pictures with top actors of the time. Sadly Ricky died in a plane crash on 12/31/1985. During his career he recorded 94 singles and 24 studio albums.

     After a huge run-up in price this year, the chip stocks are being sold off. Apparently, the valuations just got too high to handle so profit taking is happening now. Money is flowing into areas like drugs, realestate, utilities, defense contractors, and consumer staples. Companies like Nvidea, Microsoft, Apple, Amd, Tesla, Amazon, and Alphabet are giving back some of their gains for the year. The grandaddy of them all is Nvidea because they make the chips that drive the AI revolution.With a current trailing PE ratio of 51X Nvidia on the surface is priced to perfection. However, it is estimated that over $300B will be spent on AI over the next few years and most of that goes to Nvidia.

     Unfortunatly, I don't own Nvidia but I think I will get my chance soon. Today alone it lost 10% of its value and that trend will probably continue because some investors have made so much money they will lighten-up on tech and redeploy assets to safer, more value oriented stocks. Over the last 5 years, early investors in Nvidea have increased their principle over 30X so it only makes sense to take some profits. Also September is historically a volatile month for stocks and the set-up with a stressed consumer, disapointing earnings forcasts, and a Fed that is late to cut rates could add to the volatility.

     While others are redeploying cash to other areas of the market (which have run-up in price) I will wait for a chance to enter the AI theme which I believe is only still in the first inning. With a stock market that is not expected to perform well for the rest of the year, it is important to stick with the best companies in each sector. I think Nvidea fits that narrative. I have never done well chasing a high flying stock so I'm watching for when the chips are down.

Twilight Zone

The Dutch band Golden Earring released the song "Twilight Zone" in 1982 on their album "Cut". The song was the group's only top 10 hit on the Billboard Hot 100 list. The album fared better by reaching #1 on the Billboard Top Album Track chart in 1982. The song was written by guitarist George Koormans and was inspired by the spy movie "The Bourne Identity" and not the TV show "The Twilight Zone". I recommend my readers to listen to the song before reading this blog so as to "get" the analogy. As I write this blog, the chairman of the FOMC rate setting committee is announcing his intentions for interest rates for the rest of the year. It is also that time of year to plan your asset allocation for the rest of the year. It seems like we are in the twilight zone when it comes to just what interest rates will do for the last 6 months of 2024. Chair Powell left rates unchanged today {6/12/24) and indicated that he might lower rates one time later this year. The stock market took this news in stride and sent several indices and large cap stocks to new highs. This is surprising because most market analysts expected up to six rate cuts earlier this year. Any rate cut is good for stock prices and also for bond prices. A spike in inflation could torpedo any rate cuts this year because the Fed is looking for a 2% inflation rate which may be unattainable given the stickiness of nondiscretionary inflation in items like insurance and home prices. In the song, the lyrics talk about "When the bullet hits the bone" and thats the point of this blog. The bullet is higher rates that the goverment has to pay on its debt. We have come off record low rates that allowed the goverment to easily service their debt but much of that debt is going to be refinanced with much higher current rates. The fact is that the U.S. cannot afford to pay interest on an increasing deficit at these higher rates. Unlike a personal household budget when a person finds themselves up to their ears in debt, the goverment has an ace in the hole- they simply print a bunch of money to bail themselves out. Ordinary people just declare bankruptcy and start over. What's the result of running the printing presses nonstop? Inflation and lots of it. What's the fed fighting? Inflation. It's like chugging magnesium citrate and chasing it with a shot of Pepto Bismol. My plan for the rest of the year is largely unchanged from last January. Some of the CDs I hold are maturing and I am happy to replace them with CDs at higher rates and longer maturities. If rates do fall, I want to enjoy the higher interest payments longer. I am also only buying CDs from larger banks for saftey and I avoid any callable securities. It also pays to look at how often interest is paid because interest payments can be directed to high interest money market accounts for an extra boost to overall yields.The stocks and mutual funds in my portfolio continue to perform well, especially the large cap tech names like Apple, Microsoft and Lam Research. I still like the AI story but will invest indirectly in AI through things like utilities, renewable power plays and energy. In conclusion, the Fed has set its path for interest rates. I have planned to profit from rate hikes and stocks are poised to continue their long term rise. Artificial Intelligence will transform businesses for years to come, making them more efficient and profitable. The Goblin in the room that only a few analysts are talking about is the national debt which will lead to either tax increases, inflation, or recession. The market climbs a wall of worry, so enjoy the zone while it lasts.

My Guy

Mary Wells recorded the song "My Guy" in 1964 on the Motown label. It was written by Smokey Robinson of the Miracles and quickly rose to the top of the Billboard hot 100 singles by May of 1964. Wells became Motowns first female recording star but she never again reached the success that "My Guy" achieved. During the recording session, the studio musicians were having trouble getting the intro right and they decided to cobble together some rythms from other songs like "Canadian Sunset" to get the job done. They finished "My Guy" within their allotted studio time and the rest is history. The song returned to the Hot 100 list three more times: by Petula Clark in 1970, Amii Stewart & Johny Bristol in 1980, and Sister Sledge in 1982. As the end of tax season approaches, I am reminded of this song because I see a lot of brokerage statements from clients that I serve. Most of the clients that I serve are widows who lost their husbands many years ago and have a "guy" who manages their investment portfolio for them. This guy is usually an employee of a large national chain of wealth managers who simply executes a computerized program of trades during the year. Most of the investments are mutual funds with high management fees and a sales charge around 5%. After I input the dividends, interest, and capital gains into their tax return, I make it a point to ask if they have read their 1099 statement. The answer I usually get is "no, I wouldn't understand it anyway". I then proceed to show them the management fees they are charged and the "performance" those fees have generated. In almost every case the net result of all the excess trading done during the year is a net loss to the customer. Clients are also usually suprised when I show them how much they paid for such lousy investment returns. As an IRS certified tax counselor, I am not supposed to give clients investment advise, but I can point-out how badly they are getting screwed by their "guy". I understand that these wealth managers must make a living but I wonder why an actively managed mutual fund has to also be managed by some local guy who is just generating trades in the name of rebalancing. An actively managed mutual fund, as opposed to an index fund, is already being managed by a professional money manager. Why not just hold these mutual funds in a discount brokerage firm like Charles Schwab or Fidelity and save thousands in locally generated fees? Sometimes, clients consider these wealth managers their friends and are reluctant to confront them because they might be offended. Maybe the client is afraid to be left without someone to watch over their assets if they transferred their account. Having the fox protecting the hen house is never a good idea. Mutual funds are supposed to be a buy and hold investment and don't need to be constantly manipulated. Are all wealth managers just greedy opportunists sitting around waiting to steal your money? The answer is no. Just last week I had a client who had a very impressive portfolio and some nice gains for the year. I pointed out the fees he had paid and his reply was yes, he knew about them but the performance was worth it. I agreed and congratulated him for choosing a qualified money manager. The lesson here is that there are actually some good "guys" out there, you just have to find them. Don't be afraid to ask questions, ask for their qualifications, years of experience, performance history, education level and any certifications earned. If your not comfortable with their answers, look elsewhere. Any time you must hire someone to perform a task for you there is a cost. Car repairs, home repairs, yard maintenance, and money management. All are costly if you must hire it out. My point is simple, hire the best and monitor their performance to get the best "guy" for your money.

Stuck in the Middle with You

This song was recorded in 1972 by a Scottish group named Stealers Wheel. It reached #50 on the Billboard Album chart that year. The song was written by Gerry Rafferty and Joe Eagan and released by A&M records. It was a parody describing how the musicians felt at a cocktail party surrounded by recording studio executives (clowns to the left, jokers the the right). The band was formed in 1972 and broke-up in 1975 but unsuccessfully tried to reform in 2008. The song is a little strange but the video is said to be downright weird. I also feel like I'm stuck in the middle in my investing activities. The recession so many analyists predicted for 2023 never did arrive, is it coming or not? Interest rates have peaked (so they say) so here we are waiting for a rate cut. The greatest thing since the PC is here in the form of AI (Artificial Intelligence) and I'm still waiting to see how it will change my life-what's left of it anyway. The electric vehicle revolution is upon us but here in Indiana I almost never see a Tesla or any charging stations. So what is an investor to do to make money this year? My take on the situation is that: 1. Interest rates have peaked at least for now; 2. AI is going to be a huge benefit to most if not all industries; 3. The much anticipated recession is on hold for now. Since the market believes rates will decline this year, banks and financial stocks rallied over 30% in the fourth quarter of 2023. Since the market believes that AI will transform the way we use computers, Nivedia, Intel, AMD, and other chip makers have skyrocketed, not to mention software companies like Salesforce, Microsoft and Meta. And since the market does not buy into the imminent recession story, the market rallied 11% in the fourth quarter of 2023. Because I feel like a tween (caught between child and teenager), I am struggling with my next move. Should I buy stocks that will benefit from lower rates and new technology or bide my time to see what plays out? Should I take some profits in tech stocks that have been strong lately or let them ride? Should I buy long duration bonds that will generate current income and possible capital gains if rates do come down as expected? I really don't know the answers to these questions so I will have to take my clues from recent market behavior. First of all, there's no hurry. With money market funds paying 5% on liquid cash, it's OK to just sit and enjoy a risk free return for a while. Secondly, the market needs a little time to cool off and settle into its valuation. There is a lot of cash on the sidelines just waiting for an entry point and earning a decent return too. When the time is right I plan to buy stocks that benefit from lower rates, new technology, and a strong economy. As long as CD's pay more than the rate of inflation, I will also maintain a healthy position there also. A cautious balanced approach is best in times like this. I will always have a portion of my assets in stocks but buying at market highs and not taking some money off the table will make me look like a clown down the road.