July Newsletter 2023
July 4, 2023
“Artificial Intelligence”
As we celebrate our Independence, we can also celebrate the Artificial Intelligence (AI) Revolution that will certainly define our lives and investments for decades to come! Futurists are predicting that the AI explosion will be greater than personal computers, the internet and cell phones combined. As hard as it is to imagine, remember when Henry Ford said: “If I had asked people what they wanted, they would have said Faster Horses”!
That explosion has already had a significant impact on the results of our managed domestic equity portfolio of diversified large, mid, and small cap funds which collectively account for roughly twenty-five to thirty percent of most clients’ total managed portfolio of equity and income allocations. James has calculated that within the total equity allocation (including Alternative equities), technology accounts for about twenty-five percent of the overall equity category. Within that category, the large-cap diversified funds which include meaningful allocations to such large-cap technology names as Nvidia, Apple, Amazon, Alphabet (think Google), and Microsoft have increased in market value over the six months ended June 30th by an average of over twenty percent; bringing the total domestic equity portfolio return to over ten percent for the six-month period of 2023. As a rule, we do not report results for such a short period, but we have had clients ask if we have participated in the recent market rally.
The AI driven rally has not spread as much to the broader market (with less than 10 large-cap stocks accounting for the lion’s-share of the rally), as the Fed’s continuing push to quell inflation with higher interest rates continues to give market watchers and economists reason to believe that a recession may still be on the horizon. The equity allocation to Alternatives has therefore been impacted by the higher interest rates causing valuations of real estate to fall (at least temporarily). Even so, the underlying rents received, and dividends paid to investors have been maintained for the REIT securities included in our portfolio of diversified alternatives. In addition, the REITS involved in technology properties (think logistics, cloud storage and related operations) returned over ten percent each for the six-month period. The graph below prepared by Laura reflects the combined results of both the Domestic and Alternatives Equity positions in our aggregate managed portfolio.
The Income portfolio (both the CD/bond Ladder and the alternative income funds) did eke out a positive return for the six-month period as it appears that inflation may have curbed as the Fed has taken a “pause” in its efforts to apply the brakes. The total income allocation returned over four percent for the period (with the Alternative Income allocation returning over 7%), as illustrated below.
Note on both graphs the uptick at the end reflecting the recent market surge and the reported slowing of the year-over-year inflation rate. It now appears that an impending recession at home caused by the higher interest rates may not be as severe as once thought. Only time will tell, but recent reads by the Fed on 2023 GDP growth indicate First-Quarter growth of 2.0 percent; and as of June 30th, Second-Quarter GDP growth of 2.2 percent. However, the market strategists at Schwab are predicting a global recession after analyzing a combination of demand stats, job cuts and labor shortages.
As active managers, James and I are constantly monitoring the positions in the portfolio and making decisions based on changing economic conditions and future expectations. As previously reported, we moved out of several asset categories and put the proceeds back into positions deemed to be “winners” going forward. The results of those moves are reflected in the results of the technology exposure discussed above and the higher interest rates available on maturing fixed income positions. We recently moved out of an additional domestic equity and alternative equity position that were “not keeping up”. Those proceeds were also put back into the portfolio where each client’s asset allocation was “out of balance”. To that end, we are adding to the CD/bond ladder for all clients needing that exposure. Laura has recently identified highly rated opportunities to buy corporate notes maturing between 2024 and 2028 paying six percent or more in interest. All clients in, or near, retirement and distribution have participated in such opportunities. In effect, we have “annuitized” those portfolios for a minimum of ten years.
So, looking forward, what do “faster horses” have to do with Artificial Intelligence? To try to understand all the fuss over AI, we need to go back to Moore’s law. Gordon Moore was an engineer and co-founder of Intel, who in 1965 observed that the number of transistors in an integrated circuit (IC) doubles every two years. If you “do the math” you will see that the doubling of tech power has grown exponentially beyond even my imagination. Terms like megabyte, nanometers and microns are used to describe the speed and size of the tiny computing chips. So much for my limited knowledge of such things! I do understand “faster horses”! No doubt about it: AI will certainly be the next “Great Disruptor”.
It has been projected that the “faster” technologies, with unbelievable numbers of calculations per second, will be able to analyze all the “data” from our history going back as far as data exists. That phenomenon has already resulted in over two billion ChatGPT queries as of June 15th. GPT stands for Generative Pre-trained Transformer (sometimes also called General Purpose Technologies). Transformers are specialized algorithms for finding long-range patterns in sequences of data. These transformers were developed by Google in 2017 and have since become pervasive across dozens of technologies. By now, we have all experienced the results when using Google searches, buying on Amazon, using GPS maps, etc., etc.
From an investment standpoint, the resulting AI opportunities are huge: Think large language models; the application of models with Generative AI to write reports, prepare analyses, etc.; and new and expanded hardware (even quantum sensors for expanded GPS systems). I cannot think of a single industry or economic segment that will not be included in the resulting growth of value in our economy and the companies that embrace it. The large-cap companies referred to above are leading the way and those companies have already seen meaningful expansion of their market values. The next surge in value will most likely come from the mid and small-cap companies that will either supply the parts needed or the many new applications that are already in the R&D stage.
Our diversified portfolio of funds includes such companies benefiting from machine-learning technologies as: mid-level chip makers, software developers, finance companies, health care professionals, defense contractors; to name a few. Included in the portfolios of many clients is The Private Shares Fund which invests in companies that have not yet gone public. A sampling of those companies include: Carbon, Inc. (3D Printing), NextRoll,Inc. (Advertising), Space Exploration Technologies Corp. (Aerospace), SingleStore,Inc. (Analytics/Big Data), Brain Corp. (AI), Automation Anywhere, Inc. (Enterprise Software), Eruditus Learning Solutions Pte.,Ltd. (Education), Color Health, Inc. (Biotech), Lookout, Inc. (Security), Discord, Inc. (Software), and Flexport, Inc. (Transportation). These, and more companies, are so transformative that collectively they could supercharge productivity and grow our GDP at unprecedented rates of growth.
As exciting as all this looks and sounds, there are some concerns to assure control over the use of all the new AI applications. Brad Smith (President of Microsoft) has warned that guardrails will be needed to detect fraud and lies; however, “we need to keep up with China!” At Berkshire Hathaway’s shareholders meeting, Warren Buffett shared his thoughts on AI from his recent interactions with Bill Gates: “It can do remarkable things, but it can’t tell jokes! But, you know, things like checking all the legal opinions since the beginning of time…it can do all kinds of things.” That, he explained, leads to fears about the technology. “And, when something can do all kinds of things, I get a little bit worried. Because I know we won’t be able to uninvent it.” Warren’s long-time partner, Charlie Munger concluded by saying: “Personally, I am skeptical of some of the hype that’s going into artificial intelligence. I think that old-fashioned intelligence works well”.
There’s no doubt that AI will be a game changer. We have great respect for the managers of each of the equity funds we invest in, and we know that our Intelligent Investment strategies will continue to produce meaningful long-term results, meeting clients’ long-term goals.
With all Best Wishes as we celebrate our Independence on this Fourth of July!
Sincerely,
Intelligent Investment Management, LLP
