The media continues to be filled with forecasts about the investment – and societal – implications of AI. Some of these forecasts are moving markets. On Monday the S&P 500 and Nasdaq sold off over 1% which was at least partially attributed to a dystopian vision of the future by Citrini Research.
The report outlined a scenario where heavy white-collar layoffs and a decimated software industry cause a cascading financial contagion hitting credit card companies and private credit lenders. Software, credit card and private credit shares got hit in the sell-off. There is clearly widespread AI anxiety.
Forecasts are notoriously inaccurate and even the most dramatic are quickly forgotten. Chances are the same will happen with this report by Citrini Research.
Most predictions don’t lead to bold actions – perhaps a subtle tilt of a portfolio in this way or that.
But not every prediction is forgotten and not everybody avoids bold moves...
The poster child for a bad prediction and terrible outcome
Irving Fisher was a professor of political economy at Yale University and at the forefront of his profession. Given his notoriety Fisher led a busy life, and October 1929 was no different.
In a speech on 15 October Fisher proclaimed, “Stock prices have reached what looks like a permanently high plateau… I expect to see the stock market a good deal higher than it is today within a few months.”
In response to some market jitters Fisher declared on 21 October that the market was "only shaking out the lunatic fringe."
According to the NY Times in a speech to a group of bankers on 23 October, Fisher told the audience that prices remained low and hadn’t caught up yet with real values.
Black Mondy occurred on 28 October with the Dow dropping 13%. The next day the market dropped another 12%. Fisher remained upbeat and rushed to write a book.
The Stock Market Crash — And After was published in February of 1930. Fisher doubled down on his optimistic view of the market. By 1932 the market was 89% below the peak.
Fisher has become infamous based on the inaccuracy of his prediction. But you can’t accuse him of not backing his own call. Fisher invested most of his portfolio in Remington Rand.
The company sold office equipment including a visible filing system that Fisher patented in 1913. He was so confident in the company – and presumably his visible filing system – he bought his shares with borrowed money.
Using margin lending wasn’t unusual at the time but it didn’t help Fisher’s situation. Ever the optimist he covered his margin call and bought more shares after the initial market drop. Remington’s shares fell from $59 in 1929 to $1 in 1933. Fisher had to sell his house and borrow $750,000 from his sister-in-law to cover his losses.
Lessons from Fisher
Investing is challenging because it requires a balance between optimism and skepticism. Fisher went all in on the optimism. But he forgot that investing is a probabilistic exercise. No single result is certain and there is always a range of potential outcomes.
All investors are using imperfect information to predict what will happen in the future. The market tends to forget that when overly confident about a particular result. The reaction to the report from Citrini Research shows the confidence in the AI trade is breaking and the market is jittery.
I can’t tell you what the future is going to look like. I don’t know how AI will ultimately impact humanity. But I can give you some advice I first offered after the tariff meltdown in April. If you are feeling anxious about what is next and tempted to act boldly it might be worth considering the work of a Harvard professor.
Proceeding with humility
Amy Edmonson is a professor of leadership management at Harvard Business School. She has created a spectrum of failure. On this spectrum is a classification of failure which Edmonson calls ‘task challenge.’ Task challenge refers to an activity which is too challenging for reliable, failure-free performance.
Think about American ice skater Ilia Malinin. With the nickname "quad god" he was a heavy favourite at the Olympics. He trained hard for a routine that was too challenging for any of his opponents to replicate.
The problem is that a challenging routine means mistakes happen. And that is what happened to the quad god who finished in 8thplace. Often the winner is not perfect - they’ve just made fewer mistakes.
Failures from task challenge go up when you forget about how difficult an activity is. Perhaps going all in for a gold medal was a good decision for Illia Malinin. It is rarely a good decision for investors.
Investing is hard and you will make mistakes. That is ok. The goal is to minimise mistakes because that is how you win.
The chances of task challenge failures in investing go up when emotions are at play. Especially after a long bull market when complacency sets in. For many investors now is one of those times.
Approach the market with the humility it deserves. However you are feeling, consider the impact of being wrong. Something that Irving Fisher never did.
Mark Lamonica
Also in this week's edition...
I find many of the housing ‘affordability’ measures coming out of Canberra bewildering. But I think the 5% deposit scheme is not just counterproductive but actively making things worse. Read my thoughts on why the 5% deposit scheme is bad for homeowners and Australia.
Turning against the AI giants last year got GQG a good deal of press attention. There are now signs that their thesis is playing out. Read about why they think defensive shares are an underappreciated opportunity.
The RBA has faced criticism from all quarters. Ashley Owen reminds readers of the RBA mandate and drills into the central bank’s track record.
Yield hungry fixed interest investors are taking on increasing leverage to maintain returns according to Phil Strano at Yarra Capital Management. This can be a double edged sword as both positive and negative performance is amplified.
David Williams argues that a national longevity strategy is well past due and outlines how greater awareness can benefit individuals and the country.
According to Brendan Ryan savvy buyers are taking advantage of more than 50 government schemes to help Australians with housing affordability. He outlines an approach for potential homebuyers.
Steve Bennett and Sasanka Liyanage from Charter Hall explore the recovery in Australian commercial real estate. Improving fundamentals have thus far been underappreciated by the market.
Curated by Mark LaMonica and Leisa Bell
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Weekend market update
Two articles from Morningstar this weekend. The first is on Bapcor after shares fell close to 50% on Friday. Our analyst Angus Hewitt has put the share under review but shares his initial thoughts on the troubling earnings result.
Given the widespread expectation that the US dollar will continue to weaken many investors are exploring hedged ETFs which remove the impact of currency changes. My colleague Sim took a look at these products.
From Shane Oliver, AMP:
The rotation from tech to non-tech continues. This is evident in the continuing outperformance of the equal weighted US S&P 500 which is up 6.7% year to date compared to the tech heavy market cap weighted S&P 500 which is up just 0.9% and in the relative outperformance so far this year of non-US share markets with Eurozone shares up 6.4% and Japanese shares up 16%. Tech has a 32% weight in the US share market but its nearly 50% if tech like stocks are included.
Australian shares are a key beneficiary of the rotation trade helped by the now concluded December half earnings reporting season confirming that listed company profits are rising again. So far this year the Australian share market is up 5.3% against 2.8% for global shares, which are dominated by the US with a 64% weight. Rich valuations, the hawkish RBA and global uncertainty around tech shares, US policies and geopolitics are the key constraints. But rising profits led by the miners and banks are propelling the market higher. The rotation trade is likely to continue to help Australian and non-tech shares – providing tech shares don’t fall too much!
Gold (and silver) prices rose again on the back of geopolitical risk around Iran. Bitcoin remains in the dogbox though waiting for winter to end again. Metal and iron ore prices rose. Oil prices fell slightly but remain on edge regarding the risk of another US/Iran conflict. The $A rose above $US0.71 again with the $US little changed.
The US Supreme Court’s strike down of Trump’s emergency powers tariffs and Trump’s replacement strategy has added to uncertainty around US tariff policy. Our rough estimate is Trump’s 15% flat tariff rate (under section 122 of the Trade Act) combined with other tariffs that were not struck down will mean that the average US tariff rate will be around 12% and once section 301 trade reviews are undertaken it will move back to around 15% or so which is around where it was before the Supreme court decision. So ho-hum! But uncertainty remains around: whether the section 122 rate is 10% or 15% as only the former has been signed off, whether it will also survive legal challenges and what will happen to agreed deals. For Australia, the new replacement tariffs mean its worse off in the short term (now 15% versus 10% with no benefit versus other countries) but may be better off longer term as it will be hard to justify tariffs on Australia under s301. More broadly our view remains that the Supreme Court decision marginally reduced the risks around the US by reinforcing that it acts as a guardrail on Trump’s power and we have likely seen “peak Trump tariffs” for now as he refocusses on affordability issues ahead of the midterm elections.
Worries about AI valuations and disruption continue to throw shares around with a gloomy scenario report about AI’s impact on jobs and growth from Citrini Research combining with more reports about how AI can disrupt existing software and related jobs (eg WiseTech laying off 30% of its workforce and Block nearly 50%) along with a negative reaction to a solid beat by Nvidia (which saw sales up 73%yoy and earnings up 80%yoy). The gloomy Citrini scenario looks too negative though as it appears to ignore economy’s ability to adjust, the likely enduring desire for human engagement, likely limits to AI, no boost to the economy from higher AI and higher blue-collar income and no policy response. That said the sort of concerns we are now seeing and increasingly less favourable market responses to strong profit growth from AI related companies is the sort of thing you would expect to see going into a correction.
Finally, the risk of a US strike on Iran remains very high. Once again there were claims of “significant progress” in US/Iran talks with more talks for the week ahead, but the US military build-up is continuing. Oil prices could spike above $US70 if there is a strike, which might add 5 cents a litre or so to Australian petrol prices. But if Iran retaliates by disrupting neighbouring countries oil exports or blocking the Strait of Hormuz through which 20% of global oil supplies flow, then a spike above $US100 would be likely which could add around 40 cents a litre or more to Australian petrol prices. And this would be taken badly by global share markets. Predicting this remains difficult though – it could be just another example of Trump’s “maximum pressure” negotiating approach and he is likely to be wary of anything that causes a sharp spike in oil prices ahead of the midterms.
In Australia inflation surprised on the upside again in January – but we still see the RBA remaining on hold albeit the risk of another hike is very high. Contrary to expectations for a fall inflation remained at 3.8%yoy partly due to an 18.5%mom surge in measured electricity prices. And trimmed mean inflation rose further to 3.4%yoy with a 0.3%mom rise threatening to negate a possible downtrend in monthly increases since a spike last July. This in turn reinforces concerns about capacity constraints in the economy and increases the risk that the RBA could hike as early as its March meeting.
However, we expect the RBA to remain on hold for now. There are several reasons for this: for the first time in several months there were more items with annual inflation below 2%yoy than above 3%yoy; there is some tendency for new monthly trimmed mean to come in a bit stronger in the first month of each quarter; and so far it looks like inflation this month is coming in at or a bit below the RBA’s forecast for trimmed mean inflation for the March quarter of 0.9%qoq or 3.5%yoy. The RBA has continued to indicate that it will primarily focus on the quarterly inflation data and for these reasons it makes sense to do so now. RBA Governor Bullock’s comments after the inflation release – that “I don’t think it [inflation] is taking off again” and it’s not “very clear what we have to do” suggest that the RBA is in wait and see mode for now. The money market is putting the chance of a rate hike in March at just 11%, rising to 93% for May.
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