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If you have not invested in AI-driven Nvidia and/or you are not in an S&P 500 fund, then odds are you are underperforming the overall equity markets this year. The domination of the S&P 500 by a few giants has skewed the historical risk-reward ratio of being in the S&P 500, to the benefit of those portfolios that are weighted towards those companies that are overweighted in that index. The ride up has been glorious, but the ride down will likely be brutal. The elation of a roller coaster climbing to the top and the fear of tipping over the crest and heading down at breakneck speed may be where we are headed. Investors poured a record amount of inflows into technology funds this past week, hoping to participate in the AI bandwagon, which is never a great sign.
Index investors are presently at the mercy of Nvidia, Apple, Microsoft, and Amazon. If these stocks turn down, then the overall S&P 500 will take a brutal hit. Each one of these companies’ valuations are being driven solely or in great part by the notion that AI is the future of the world and that these behemoths are poised to be the biggest winners. Without a doubt, AI is real, perhaps good, perhaps dangerous, probably both. This piece is not meant to argue for or against AI but to focus on its effects on the broader market. Historically in the equity markets, we have seen that whatever the catchphrase of the moment is, companies try to adopt it as an entrance to a higher valuation. It seems as if every startup and many public companies are currently using the catchphrase AI to promote interest in their companies. Alas, we are once again being manipulated. For many years the catchword was, and to some extent still is, algorithm. Seemingly every company talked about its algorithms. That has now elevated to AI, which I am in no way disparaging, as long as the claim of AI is true. The worry is that many companies that claim they have and use AI are, in fact, exaggerating their technology. These companies are setting false expectations on growth and valuation and will most likely end up being viewed as the Emperor with no clothes. This is also true in the private start-up market, where accessing capital has been very difficult.
The Federal Reserve needs to step up and protect the rest of us.
Why am I hammering on this one point? Because if you look underneath the true AI companies, the equity markets are actually quite tenuous, and if you add the potential for fatigue and a downward correction of the AI giants, it could get ugly. What we need is help to lift the rest of the market and broaden the net that will benefit all who have earned investor recognition. AI is sucking all of the air out of the room. We need the Federal Reserve to stop acting so defensively and most likely too hesitant to make a move as we get closer to a Presidential election and just cut interest rates. Don’t promise and then fade—just cut rates. We need an impetus to make the cost of living for all more affordable, which will simultaneously put money into the economy. Yes, interest rates have been high for a reason, but with inflation finally creeping downward, the Fed needs to step up and take its own risk—just cut rates. Not dramatically, but enough to mitigate the notion that only AI is the future and create an economic environment that allows other companies to thrive. We need a more even playing field. It is time for the Fed to take its hands off the necks of the many companies that simply cannot thrive in a high-interest rate environment.
The index that concerns me most is the Russell 2000, the small-cap index that has traded into complete complacency in 2024. Microcap and small-cap companies are bearing the brunt of high interest rates and lack of available credit. They are starving for capital. We will see many good companies fade away if changes are not made. New credit funds seem to be announced daily, mostly by private equity funds as they seek their own diversification as alternative asset managers, but these funds are not built to cater to smaller companies. So, while Nvidia and the other AI giants propel the S&P 500 to new highs and make great returns for those in the index funds or those particular stocks, there is a significant part of the market and therefore our economy that is raising its hand above the water and screaming for help. The market is once again acting like drunken sailors, paying most of its attention to AI to the detriment of other important and entrepreneurial companies.
What I have recently discovered, after spending 41 years living in the highest rungs of the mid to large-cap world, is that there are many very good yet vastly undercapitalized companies within the microcap and small-cap world, as well as the private market. Healthcare, biotech, technology, cybersecurity, and consumer companies, for instance, may have great products, many of which can benefit our society, yet need funding. And yes, many of these companies possess true AI. These companies are being led by smart entrepreneurs with great ideas that aren’t being given the chance to execute. We need to recognize these companies and figure out ways to find them non-predatory capital. For the most part, this is not an institutionally-led market. The equity is typically held by retail investors looking to make a quick return. What needs to be identified is a universe of longer-term retail investors who will hold the stocks for a longer period of time. We need the smaller investment banks to find pools of capital that will not put a chokehold on issuers with onerous structured equity. We need the press to spend more time writing about the quality, lesser-known companies that could be the next big thing. We need the Fed to feed the economy and cut rates. We need credit funds to issue non-predatory debt to companies that have the supporting financials. It was not really that long ago that Nvidia was trading below $5 per share. Pay attention, folks, there are great opportunities in the microcap to small-cap world. You just have to find them and support them.
