Eyes On the Horizon

Global markets broadly fell last week as we head into a quiet period for economic news. In the US, the Dow Jones Industrial Average dropped 0.69%, the S&P 500 fell 1.26% and the Nasdaq lost 1.92% after the Labor Day holiday. Within the S&P 500, Energy (+1.48%), Utilities (0.91%) and Communication Services (-0.04%) were the strongest performing sectors. Industrials (-2.88%), Materials (-2.38%) and Information Technology (-2.34%) fell the most. European stocks fell 1.06%, with the UK being the only major index to end the week in positive territory (+0.20%). In Asia, losses were muted. The Japanese Nikkei fell 0.32% and the China’s Hang Seng lost 0.65%.

September tends to be a sleepy month in the markets so it is a good time to look ahead at broader trends shaping the global economy.

Interest Rates Are Likely to Fall

While we won’t know the exact timing, central banks have been signaling that we are nearing the top of the rate hiking cycle. With rate policies “sufficiently restrictive,” long term investors may want to shift their concerns from hunting for yield to looking for capital gains. When interest rates fall, existing fixed rate bond prices usually rise. For now, the Federal Reserve has signaled that they intend to sit on rates at the current level (possibly raising them one more time). Their wait-and-see approach is because they are concerned of a repeat of the 1970’s experience where inflation fell before taking off again. Lest this create some concern in today’s inflation print (where we saw a month-over-month increase of 0.6% and rising headline inflation), market participants are more concerned with core inflation. The rise in monthly inflation was largely explained by increases in oil prices due to OPEC+ constraining supply.

Innovations in Technology and Health Care Present Opportunities and Risks

Recent advances in generative AI have sparked a lot of excitement from investors. Some of this is noise (e.g., Kroger grocery store mentioning using AI numerous times on their earnings call). Other elements appear to have real tangible benefits to the economy (e.g., ChatGPT functioning as an editor, Adobe AI photo editing and marketing applications, more broadly). LOM has taken the picks and shovels approach, investing in the semiconductor manufacturers (e.g., NVIDIA and AMD) and data centers that are best suited to train large inferential models.

Unlike the dot-com bubble, the winners are more likely to be existing players with access to large data sets on which they can train. For example, self-driving cars are generally safer than traditional vehicles but they still run into edge cases in which the system does not know how to act. As firms gain more examples of these edge cases, their models will become more robust and avoid crashes. So early movers, like Tesla, currently have an advantage (at least for now) over other competitors.

In the health care space, we are optimistic about innovations in the GLP-1 antagonists but they present challenges for the broader health care industry. With 38% of the world’s population being overweight or obese, there is a large potential market for these drugs. Without insurance, drugs like Ozempic currently cost around $900 a month in the US. While those costs are high, we view the cost structure as being analogous to Viagra (which started at $8-10 a pill in 1998 but costs around $2 today). Outside factors, like the Inflation Reduction Act could accelerate that trend as the bill allows the Secretary of the Department of Health and Human Services to negotiate drug prices in the US after it has been on the market for 10 years (we are 3 years into GLP-1 drugs being authorized).

In trials, Wegovy saw a significant (20%) reduction in heart related problems in its obese users. While adoption creates opportunities for distributors like Novo Nordisk and Eli Lily, it also represents near term challenges for other health care providers and insurers. Widespread adoption lowers the need for invasive surgeries and increases the near-term costs for insurers. However, those trends should reverse in the long run as we would expect the broader population to have a longer life expectancy.

Friendshoring to Manage Geopolitical Rivalries

Fears over Russian and Chinese expansionism (or from their perspectives Western containment) have contributed to increased regional isolation. As countries are more likely to strengthen their supply chains in response to risk of direct conflict.

Diplomacy still has room to win out in this sector but we have seen initiatives to redomicile industries of economic importance (e.g., advanced semiconductor manufacturing) and some tit-for-tat banning of geopolitical rivals’ technologies (e.g., banning Huawei and Apple phones in the US and China, respectively).

What Should the Average Investor Do?

The best way to generate wealth is to spend less than you earn and invest for the long run consistently over the time. 

If you are looking to invest more tactically, current market conditions suggest positioning for a reduction in interest rates over the next 1-2 years seems prudent. That would typically help longer dated bonds and preferred shares with fixed rates as they are more sensitive to interest rate movements. Equities should also benefit in that environment because companies could deploy capital at a lower cost.

Within equities, growth companies should benefit more as their earnings are further in the future. We have observed some of this play out in the technology sector so far this year, suggesting that this prediction is at least partially baked into the returns. The healthcare sector has lagged the broader market this year. In part, we believe this is due to the advancements in certain sectors (like GLP-1 drugs). The sector outperformed the broader stock market during the pandemic and through the end of last year which likely accounts for some of its recent underperformance. Part of this is the industry just coming back down to earth. We suggest a tactical approach to this sector, investing selectively and focusing on market leaders trading at reasonable valuations… either be narrow and constrained in your exposure (investing a large portion of your wealth in individual companies can be dangerous) or invest more broadly in the sector weakness and hold for the long run with the expectation that the sector will move back towards its long run average return over time.

The information contained in this article is for information purposes only, and represent the views of the author. It is not intended as specific investment or financial advice, or a recommendation or solicitation to buy or sell any security. Any investments or strategies listed in this article may not be suitable for all investors. Past performance is not indicative of future performance, and as with any investment, prices may fluctuate. It is recommended that advice is sought from a qualified investment professional prior to implementing any financial plan. LOM has made every effort to ensure that the contents herein have been compiled from sources believed reliable, however LOM does not warrant the accuracy, adequacy, timeliness, or completeness of this information expressly disclaims liability for errors or omissions in this information.