The financial markets are rebounding from the 2022 market correction, but this year’s rally has been about a handful of MegaTechs driving market indices to double-digit returns. The advent of a new “Artificial Intelligence Era” explains the move with six companies accounting for almost 70% of the Nasdaq 100’s rally (Apple, Microsoft, Meta, Amazon, Google and Tesla). Because these same companies are in the S&P 500 index, the S&P’s move higher was also skewed by their rally. Such congested market breath is concerning given that stocks are priced on what’s known as a discounted cash flow model where the present value of company (valuations) usually resets to the reality of a higher cost of capital. This is a bad omen for smaller companies needing to raise capital, but an opportunity for larger companies who may acquire them at bargain prices. And while valuations of the Megatechs have room to go higher, even beyond their 2021 highs, we are monitoring the following factors to tactically manage accounts to preserve wealth.

Open AI’s ChatGPT platform was launched with Microsoft as their largest shareholder. Having invested $10 billion for a 49% ownership stake. Microsoft saw the potential to one-up Google in on-line search (Bing), while also providing intelligent, time-saving features to enhance Office 365. But Open AI’s allure doesn’t stop there. It is on the offense inviting both Retail and Developer subscribers’ access to ChatGPT’s large language, pattern recognition algorithms. Paired with Nvidia’s AI designed for gaming, autonomous driving, crypto mining, and easily adapted with predictive algorithms, a new epoch in computing has started—one that catapulted Nvidia’s stock above $1 Trillion in market value to sport a Price Earnings (P/E) ratio of 250 (Tech P/Es are high when in the 35-50!!). Reminiscent of “Dot Com” valuations we are on watch for Round 2 of “Irrational Exuberance” surely to arrive as AI’s capabilities become widely communicated.

De-Dollarization. Brazil, Russian, India, China, and South Africa (BRICS) plus a growing faction of Middle East and Africa nations are joining forces to trade amongst themselves using a new currency expected to be formally announced tomorrow (8/22). According to news sources, the currency will not be a “wallet currency” for consumers to buy and sell goods & services, but rather an international “trade settlement currency” tied to the weight of gold. Weight as a metric rather than Price is to be used because of its tactical appeal to anchor trade while eliminating Derivative manipulation (options, futures, and short selling). This approach is deemed beneficial to the commodity producing countries who lose nothing when price falls and when price rises they profit as the value is greater. While the BRICS currency announcement certainly does not end the US Dollar’s dominance as the world’s reserve currency, it surely means less demand for Dollars in international trade and puts pressure on continued highdeficit spending going forward. Moreover, as we argued last year, it explains the Fed’s “higher for longer” forecast for US interest rates because higher rates support a strong Dollar which attracts investors to our “safe haven” currency.

Interest Rates. The Federal Reserve is at their annual summit in Jackson Hole Wyoming this week and will again provide their current outlook on the economy, interest rates, and inflation on Friday. Expectations are that while the Fed has room to further raise rates because inflation is coming down and economic growth is strong, the prudent course is to continue to continue to pause. But because the transportation (Fed Ex and UPS) and auto workers unions (GM, Ford & Stellantis) are demanding 30-40 percent 3-year wage increases which is inflationary, and because the Fed has said they will stay their course until price stability is attained, we are closely following the Fed’s decisions. It must also unwind its balance sheet by stopping bond purchases and selling bonds, these “QT” actions also raise interest rates which lower inflation. It could be the Fed may alternate its use of monetary tools but either way rising rates raise the cost of capital and slow growth which can adversely impact stocks.

US Credit Downgrade. Fitch, one of the 3 US Credit Rating Agencies (S&P and Moody’s are the others), downgraded the US debt from AAA to AA+ last month. The rationale cited was the dysfunction in Congress regarding deficit spending. This downgrade has Congress reconsidering priorities. Democrats refuse to renegotiate what has already been agreed upon, while a faction of Republicans want to reallocate spending to protect our borders and increase Defense spending. Because neither party is arguing to reduce spending while almost half of our debt will mature and be refinanced at rates double what it was in 2021 and amounting to a Trillion dollars within 5-7 years, this outlay is troublesome. The US needs growth and greater productivity to outrun recession. Combine paying 5% debt service with less reliance on deficit spending and it spells higher taxes and slower growth. Should inflation remain stubbornly persistent because of re-shoring and tariffed trade with China and the likely outcome of Fed policy will be to deflate debt owed so it can be paid back in cheaper dollars, aka financial repression where purchasing power of savings is eroded gradually. Of course, AI may greatly increase productivity, but it will come at the cost to unskilled jobs which increases the odds of Recession as companies attempt to cut expenses to maintain profitability. This is not a near term issue, but a factor in the length and size of recession.

China meantime has made in-roads into the Middle East and Africa offering to help them build infrastructure and factories to create jobs. The pitch they are making is that they make everything and can help countries build seaports, railroads, airports, refining & chemical plants in exchange for energy and raw materials which they need and will pay for using the new ‘BRICS trade currency’—a trade deal these countries compare with their history that appears comparatively more attractive. Empowered to supply end-products versus supply only the commodities, may lift incomes but almost certainly will elevate commodity prices for energy, certain chemicals, and by-products of natural gas.

Energy. Middle Eastern oil & gas producers have needed to find new markets for their oil & gas ever since fracking amplified US production. Now coupled with the Green Energy push, they must transform and diversify their economies in fifteen years’ time. These realities plus the weaponization of the US Dollar has sent a seismic shift throughout the world. When nations saw the Bank of International Settlements kick Russia off the SWIFT message system for international banking and the US seize Russia’s reserve deposits following their invasion of Ukraine it was a wake-up call to the BRICS that this very thing could happen to any country should the US not like what you do. Enter China with their strong manufacturing economy that needs energy and buyers. Playing to their strengths they have parlayed this threat into new trade agreements and created long-term supply chain consequences for the US and Europe. While they are not abandoning trade with the US, China is creating new markets offering deal terms for commodities and energy with a currency regime that favors trade amongst them. While the US is rich in natural resources, we have legal, regulatory, environmental, and labor costs considerably greater than less developed countries. Our higher costs and “white collar” bent does not bold well for US manufacturing nor prices of goods & services looking forward.

The confluence of all these factors means a soft-landing may come with a higher-than-normal cost as stagflation seems predestined. Needing to refinance our debt, service it, and grow our economy without heavy dependence on deficit spending, combined with the incentive to deflate debt rather than pay back expected value, portends slower US Growth ahead. This year and next Congress has already passed legislation to spend $1.7 Trillion on infrastructure, reshoring and climate change initiatives so stimulus spending should carry us through the 2024 elections. Thereafter navigating the markets will require a more tactical approach as some sectors will languish while others flourish.

ProActive’s investment discipline is just that, tactical. A hands-on, rules-based, and data-driven process with on going review. We begin with a Health of the Market assessment to evaluate the economic landscape to determine what investments have the best Reward-for-Risk opportunity. This analysis includes a mathematical scoring model of upside and downside potential of sectors which defines the range of current portfolio asset allocation—one that is flexible not fixed. Next security selections are made by ranking quantitative and technical metrics of our select universe of favorite companies to find value at favorable prices. Portfolios are then constructed with holdings weighted by their comparative return potential while striving to optimize diversification. Following portfolio selection, Value-At-Risk parameters are set to guide portfolio risk exposure in order to combat market risk. These VARs are matched to client objectives and set to manage volatility.

Finally, portfolios are regularly monitored versus appropriate benchmarks and performance goals. Real time Indictors inform us of our need to review holdings and account performance which restarts the investment process seeking to maximize compounding.

In summary, our investment approach is geared towards investing in-sync with major market changes by pivoting towards income, value, growth, safety, and tax advantages as we strive to own the best opportunities while keeping costs low and combatting market risk.