Market Comment - August

It’s important to think in terms of decades, not months. It’s also essential to get the big picture right. Communicating every month is a tricky task. Too often, our industry’s thinking succumbs to the tyranny of the urgent, mistaking fleeting headlines for enduring trends. Equity indices flatlined for most of the month, eagerly awaiting the Federal Reserve's annual conference, hosted by the Kansas City Fed in Jackson Hole, Wyoming. Fed Chair Jerome Powell used his keynote speech to signal the Fed is headed for an interest-rate cut as soon as its next policy meeting in September. The news was good enough to give the market a boost that did not hold up perfectly until month end, but still good enough to give the MSCI World Index the fifth consecutive positive monthly close. There was a slight bias towards sector rotation, as investors took profit in the technology sector, while healthcare for once performed the best (XLV + 5.37%). The big surprise came from small caps, where the Russell 2000 ETF IWM gained 7.17%. We would not rule out more of small cap outperformance in the near term, although the big picture remains complicated.

In the past monthly comment, we laid out the framework for a bubble, from a liquidity standpoint which is one engine to achieve it. Now, we want to address a second precondition, technical revolutions. In 2002 Carlota Perez published a book called Technological Revolutions and Financial Capital, where she explains the dynamics of bubbles and golden ages. Her theory consists of four cycles: Irruption, Frenzy, Crisis/Turning Point and Deployment (Synergy and Maturity). It goes without saying that the AI revolution fits perfectly into her theory. Some economists argue that the technological revolution of artificial intelligence is the most important economic dynamic we have ever seen. No offense to the wheel.

The frenzy phase corresponds to George Soros’s reflexivity theory and marks an important inflection point. According to Perez, it ends the installation phase, while leading to a turning point, that starts the deployment phase. In short, every revolution starts chaotic (frenzy) but ends with a calmer phase where society reaps the benefits (deployment). The frenzy phase ends with a crash, the bubble bursts. In our view, the AI revolution distinguishes itself very much from the internet revolution, as it is much more capital and energy intensive. The primary ‘gating’ factor in AI now, at least in the US, is power. It takes an average of 24 months to build a data center facility, but there is an astounding six-year interconnect queue to connect that facility to the power grid. Building a power and cooling infrastructure has become just as critical as the chips themselves in enabling AI to scale.

If we compare the internet bubble of 2000 with today’s AI economy, it is crucial to mention that during the internet boom, most of capex was financed by debt. Today, we see first signs of debt-financed investments, but the major part has been financed by cash flow, provided by the hyperscalers (Microsoft, Meta, Amazon, Alphabet and Oracle). In our view, we could be just at the beginning of the frenzy stage, which long-term investors should avoid. But we have to be aware that we will enter the deployment phase in the coming years, which will be ultimately interesting to invest. A bursting bubble is just a normal behavior during a technological revolution.

By the end of the month, the S&P 500 moved out of a small accumulation phase, targeting max. 6502.78. While the maximum target of 6700 remains in place, it is worth mentioning that all recent price targets stemmed from short-term price action, which is usually not our preferred setup. September is the worst month of the year, in terms of seasonality, but we have no price action that is calling for a substantial correction.