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Friday charts

Stock markets staged a modest and orderly retreat this week — but like a proverbial duck, things are increasingly churning underneath.

AI, politics and even regular old IT all suddenly look like much bigger risk factors than most anyone had imagined.

A single IT bug had travelers everywhere stranded in airports (and disrupted trading in bond markets, too) — a reminder that it’s kind of amazing that everything just works and we probably shouldn’t take that for granted.

This week’s Republican National Convention highlighted that the next US administration is likely to be radically different from both the current Democrat one and previous Republican ones — the range of investment-relevant policy outcomes ahead of us seems far greater than in any election in living memory (possibly ever).

And concerns continued to mount over the AI stocks that have driven nearly all of investors’ returns this year and last — could we be headed for another dotcom-style crash?

These risk factors are large and seemingly getting larger, although you’d never know it from looking at the S&P, just 3% removed from its all-time highs.

The damage to indexes has been limited by a rotation into small-cap and other long-neglected corners of the stock market — the Russell 2000 is in the midst of its best run relative to NASDAQ since 2001.

But small caps are, well, small and therefore unlikely to single-handedly prop up our investment portfolios for long.

Instead, our investing fate will be determined mostly by whether or not AI proves useful enough to justify the $1 trillion of capex that the world’s largest companies are spending on it.

That’s not just a threat to our portfolios, of course.

As for the upcoming election, the range of possible outcomes for the AI that Big Tech is building is unprecedentedly high.

AI might make everyone more useful (by turning low-skilled labor into high-skilled labor) and/or relieving us from doing many of the things we really don’t want to do (like going to meetings).

But it might also make high-skilled workers redundant (we’re getting closer to AI software engineers), raise the prices that we humans pay (LLMs are prone to oligopolistic collusion), and/or turn the human economy into a sideshow (an economy of trillions of AI agents might dwarf the current economy of billions of humans).

And if that future AI economy ever has a bug, will it be as quick of a fix as this week’s blue screen of death?

Call me naive, but I remain optimistic about all these things: I think the political center will hold, I welcome our AI overlords and I fear no screens of death, blue or otherwise (just turn it off and back on!).

Still, though, I’m aware that the downside of any of those things going wrong is bigger than ever — and I’m not sure that’s priced-in to markets.

As investors, we’ve rarely had it as easy as we’ve had it over the last few years, and it feels like that could soon change.

Are rough seas about to make us great investing sailors?

Let’s check the charts.

Revenge of the nerds, week 2:

The Russell 2000 (small caps) has outperformed the Nasdaq 100 by 12% over the past two weeks — the biggest such move since the dotcom bust, at least. 

We’re not sold on LLMs:

This graphic from Benedict Evans shows that while a lot of people have tried ChatGPT, (over 30% in the US, for example) few of us use it (about 6% in the US). The latter number will have to be a lot higher to avoid a dotcom-style bust in AI stocks.

Different this time?

Even if AI turns out to be as revolutionary as we think it will, investors may still lose. "History shows the winners from new tech booms are often the broad economy,” a Bank of America strategist wrote this week, “not early investor[s]."

It’s not just narrative:

There is substance to the rising concerns on AI overbuild: Earnings estimates (above) are falling at the same time cost estimates are rising.

It actually is different this time:

The tell-tale sign of a broad market bubble is when the IPO market is wide open — it’s not. In 2024, the number of private-equity companies listing on the stock market (the turquoise bands above) hasn’t even matched the pace of recent years, let alone the IPO glory days of the late 1990s. So we’ve got that going for us.

But more of us have more to lose this time:

Thirty percent of Americans now have a stock-market portfolio worth over $500,000.

Feels like 100%?

Trump’s Polymarket odds of 64% are down from a high of 72% at the start of the week. It feels like the election is already decided, but betting markets say it’s not. The outcome is probably a little more in flux than it seems and the consequences (in either direction) are probably a lot more in flux.

Too easy?

The small cluster at the bottom of the above graphic is a visualization of how unusually easy investors have had it this year.

Unfortunately, it’s probably going to get harder. Fortunately, it’ll be a rare chance to become great investors.

Have a great weekend, duck-like readers.

— Byron Gilliam

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