The performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than their original cost and current performance may be lower or higher than the performance quoted. Performance current to the most recent month-end can be obtained by calling (833) 417-0090. The gross expense ratio for the fund is 1.24%.
View LBAY standardized performance here.
The Fund’s NAV is the sum of all its assets less any liabilities, divided by the number of shares outstanding. The market price is the most recent price at which the Fund was traded.
GENERATING CONCENTRATION
Driven by insatiable demand for artificial intelligence (AI) stocks, and, to a lesser extent, optimism about interest rate cuts, the S&P 500 Index1 rose by over 4.2% on a total return basis in the second quarter of 2024. The returns during the period were narrow on both a sector and thematic basis. Of the 11 sectors that comprise the Index, only 4 sectors posted a positive quarterly performance in the quarter, with Information Technology up 8.8% and Communications Services up 5.2%. These sectors contributed the bulk of the quarterly performance. Utilities rose 4.6% during the second quarter as electricity demand from AI data centers boosted stock values. Consumer staples rose a modest 1% with all other sectors in the red3.
For those who seek the S&P 500 Index for diversification, investors have never gotten more concentration. The top five market capitalization (market cap) companies now comprise nearly 29% of the S&P 500 ranging between 4% and almost 7% of the index, with 6.95% for Microsoft Corporation (MSFT), 6.75% for Apple Inc. (AAPL), 6.36% for NVIDIA Corporation (NVDA), 4.72% for Alphabet Inc. (GOOGL), and 4.21% for Amazon.com Inc. (AMZN). This, according to Bianco Research, is the most extreme concentration in 60 years (1964)4. According to NDR Research, the top 10 names in the S&P 500 make up 37% of the S&P 500, the highest concentration since 19725. The common theme in almost all the largest trillion-dollar and multi-hundred billion market cap outperformers is that they are generally considered to be some of the primary beneficiaries of AI.
As we enter what we think will be a very eventful second half of 2024, we caution investors to canvas market valuations with a prudent lens. Most market multiples are at or near the highs in their valuation ranges from a historical context. With recent guidance from the Federal Reserve, we think it is very likely we will finally have one or two interest rate cuts by year end. The political environment could be very topical as we witness the election cycle picking up steam. While AI is an impressive narrative, we believe there are ample opportunities elsewhere. We think the setup is constructive for long/short strategies.
FOMO-FUELED AI RALLY
“In the short term, stocks can trade at extremes relative to fundamentals, both on the low side and the HIGH side. At 23x 2024 expected earnings, the market-cap weighted S&P 500 is froth with excess and in my judgment uninvestable. Under the hood, the majority of stocks are not overvalued. The bifurcation between the dear and the cheap reminds me of March 2000. From that point the index has returned 7% per year, spending much of the subsequent decade in the red. You can have extremes of over or undervaluation in the short and even intermediate terms. But in the long run, Mr. Market gets it right6.” - Chris Bloomstran, June 19, 2024
As shown in the performance metrics above7, momentum and growth investors have been rewarded in 2024 while value-oriented investors have relatively struggled. Market returns year-to-date have primarily been driven by a handful of trillion-dollar market cap stocks with tentacles into the AI hype, and we think the below table is interesting8:
Investors with no exposure to AI in their holdings, specifically NVIDIA Corporation (NVDA), have likely underperformed the S&P 500 Index over the most recent period. The S&P 500 has added approximately 691 points to its index average rising from 4770 at year end 2023 to 5460 at the end of the 2nd quarter 2024. Notably, NVDA, up 36.7% in the 2nd quarter, contributed 218 points to the S&P 500 thus far in 2024 through the end of June9. NVDA is up 149.5% over the first six months of 2024; and up 746% through the second quarter since the end of 2022!
“We can’t keep up because we don’t own Nvidia. If you don’t own that one stock, it really hurts. Every day feels like a root canal without novocaine.10” – Max Wasserman, Miramar Capital
The next largest contributor to the S&P 500 in the first half of 2024 has been Microsoft Corporation (MSFT) which has added 64 points to the index after rising 19.3% total return year-to-date9. NVDA and MSFT comprised over 40% of the S&P 500 return through June. Interestingly, MSFT is NVDA’s largest contributor to revenues and according to David Cahn from Sequioa, “Microsoft alone likely represented approximately 22% of Nvidia’s Q4 revenue.11”
HUMAN INTELLIGENCE
While AI momentum dominates the investment landscape and equity markets, the investor research community has begun to question the long-term impact of AI from an economic and investment perspective. In a recent Goldman Sachs report entitled “GEN AI: Too Much Spend, Too Little Benefit”, thought leaders have cast doubt on the AI narrative.
“AI bulls seem to just trust that use cases will proliferate as the technology evolves. But eighteen months after the introduction of generative AI to the world, not one truly transformative—let alone cost-effective—application has been found… The big tech companies have no choice but to engage in the AI arms race right now given the hype around the space and FOMO, so the massive spend on the AI buildout will continue. This is not the first time a tech hype cycle has resulted in spending on technologies that don’t pan out in the end; virtual reality, the metaverse, and blockchain are prime examples of technologies that saw substantial spend but have few—if any—real world applications today.12” – Jim Covello, Goldman Sachs
“Given the focus and architecture of generative AI technology today... truly transformative changes won’t happen quickly and few—if any—will likely occur within the next 10 years.12” Daron Acemoglu, Institute Professor, MIT
With such concentrated market returns, this year has likely caused some investors to question their own human intelligence. We encourage market participants to take the 30,000-foot view of the current investment landscape. While NVDA’s prospects appear exciting, we would note that NVDA’s current market cap is more than 10% of United States Gross Domestic Product (GDP)13. Meanwhile, the Buffett Indicator, which is the total value of all publicly traded stocks in the US divided by US GDP has reached a level higher than the dot com and global financial bubbles of 2000 and 2007. In July it hit the highest-level in history and now rests over 195% as shown in the chart below from Longtermtrends.14
PORTFOLIO REVIEW15*
While the last several months have been frustrating for fundamentally focused investors, we do believe that patient investors will be rewarded in the long run. Below we provide a snapshot of our largest long positions, all of which we believe to have reasonable moats, attractive valuations, and generate income. Notably, we have no mega cap technology long exposure. In our opinion these companies maintain reasonable valuations, include very defensible businesses, and could enjoy upside potential from current levels.
Presently, our largest short theme consists of companies tied to US Consumer spending. We have noted in prior discussions our concerns with exploding credit card balances and a stretched middle-to-lower-income consumer. We currently maintain short positions in companies that include Planet Fitness, Inc. (PLNT), Delta Air Lines, Inc. (DAL), and Royal Caribbean Cruises Ltd. (RCL).
View LBAY top 10 holdings here. Holdings are subject to change. Characteristics and metrics of the companies shown are for the underlying securities in the fund’s portfolio and do not represent or predict the performance of the fund. There is no guarantee that a company will pay or continually increase its dividend.
FINAL THOUGHTS
We hope our investor partners enjoy our monthly perspectives. We are finding many compelling ideas both long and short and we look forward to continuing our dialogue in the weeks and months ahead.