On this episode of The Long View, Callie Cox, chief market strategist at Ritholtz Wealth Management, discusses how she helps investors suss out signal from noise, how AI is affecting the market and economy, the role of social media on investor behavior and psychology, and how she herself has learned to become the investor she is today.
Here are a few highlights from Cox’s conversation with Morningstar’s Christine Benz and Ben Johnson.
How Market Concentration Around AI Stocks Could Be Affecting Your Portfolio
Ben Johnson: Callie, I want to stick with the topic of AI and maybe just more broadly investors’ enthusiasm for all things AI and by extension, technology, the Mag Seven tech stocks. We’re recording this conversation on Oct. 29, Nvidia has just become the first-ever $5 trillion market-cap company. I checked it’s actually in and of itself bigger than the market cap of the entire Japanese stock market at this point, which is interesting. But is this an area where maybe the spend has gotten a little too loose? Expectations have gotten a little too lofty? You wrote about this recently on your own outlet, where your prolific OptimistiCallie and finished that piece with what I thought is really the money chart in this area, which just shows the increasing gap between the representation of these big firms with respect to their price representation in big indexes and then their contribution from an earnings perspective. And generally speaking, those things have tended to move in lockstep historically, but that gap indicates that maybe investors are getting ahead of themselves. What are you worried about, or maybe why should we not be worried?
Callie Cox: So, here I think you have to think about AI in concept and in theory and in practical ways to apply to your portfolio. So obviously, AI, again, a compelling story, I’m not an AI doomer. I think AI is going to have a lot of benefits for society and is already injecting those benefits into society, even if we’re not seeing it come through in economic data and profits just yet. But I think that’s what investors are struggling with right now. We hear all these exciting things about AI, all these exciting projects that seem to be happening among the tech hyperscalers, among infrastructure firms and data centers. But we’re not seeing the payoff there yet. It’s really easy to hear about a story and then dream about where it could go. But there isn’t much data to show what this could mean.
And right now, the data that we’re getting is how much these companies are spending on these projects, which I want to be clear: Tech companies are supposed to spend money on ambitious projects. They are tech companies. You’d rather them do that than pay you back in a dividend, which some tech companies do. But that’s not their main strategy. That’s not their main strategy. They are money spenders.
But at this point, we’re seeing spending ramp up among the biggest tech companies so quickly at a time when profit expectations are high, and valuations, think price/earnings ratio are also quite high. So, you have to wonder what the give and take is there. And I explain this in my newsletter. If these companies are spending so much money on AI projects that have yet to flow into profits and free cash flow, then your perception of these companies as Wall Street’s golden child of profitability and these big spenders that are trying to establish their next business strategies don’t really fit with each other. High spending, spending at these levels will ultimately cut into free cash flows. For some companies more than others, they’ll cut into cash on hand. They’ll force these companies to raise debt and then suddenly you can’t call tech the quality part of the market anymore. And it’s really hard to suss out how much of this valuation or how much of the prices they trade at are because they’re considered the quality profit generators in the market. So that’s the theory.
Practically, when we have clients who say, OK, well, what are you going to do about that? Like, interesting idea. Why does it matter to me? Practically, this is a sign for investors to look at value. It’s a sign to take profits, and I’m not talking about every tech stock you hold here. I’m talking about very gradual moves. But it’s a time to think about taking profits within tech and other highly valued stocks, especially knowing that underneath these tech companies we’re contending with a slowing economy that’s flashing some worrying signals at the moment. Take some profit in your tech stocks, rotate them into other value stocks, don’t divest completely from the stock market because that’s your engine to building wealth over time. Just be smart and practical about where you’re allocating your money. Maybe set some sector targets, for example, that help keep your portfolio looking like the amount of risk that you’re comfortable taking for your goals. And just be grounded about where we are right now. AI, again, incredibly compelling. You want exposure to it. But maybe things have gotten a little out of hand, and you can adjust and bubble-proof your portfolio to respond to that.
What Assets Should Investors Add to Their US Equity Portfolio?
Christine Benz: Well, I wanted to follow up on that because when we look at fund flows, we see more and more investors are getting their US equity exposure through just a total market index where they are obviously very concentrated in those names that you think maybe they ought to be a little bit cautious about right now. So, what would be the other assets that you would add to a US equity portfolio? It sounds like value loud and clear, but how should investors be approaching their US equity exposure?
Cox: This is such a good question because like you mentioned, a lot of investors are passive index fund investors. I see it all the time in my work. One thing you should know, and it’s hard to put your finger on an exact number here because every ETF is different and they follow different strategies or every fund is different. But what you should know, if you’re invested in a no-fee hypothetical S&P 500 fund that just tracks the market caps of the stocks in the S&P 500, about a third of your portfolio is invested in these Magnificent Seven stocks at the moment. You are very, very tech-heavy whether you realize it or intend to be or not. And just having that piece of information can help inform you as to what you need to add in or what you need to tweak in your portfolio to make it a little more attuned to your own risk tolerances.
What you do there is ultimately up to you. There are value funds that you can look at. There are dividend stock funds you can look at. There are defensive funds you can look at. So, what that could look like in your portfolio is maybe trimming a little bit off the top of those S&P funds or those passive funds to an allocation that you pinpoint beforehand. I wouldn’t do this by feel. Maybe rotating it into more defensive and value stocks. As time goes on using calendar-controlled strategy, I’ll sell a little bit this month and rotate it into this fund. And also considering that there are assets outside of the stock market. There are bonds, there are gold, there’s cash. If you have short-term spending needs coming up, then it can’t hurt to take some chips off the table and sell a little bit of your S&P fund to move it to cash to pay for those spending needs. But just know that you have a lot of options outside of the S&P fund, and right now, the S&P by nature it’s getting riskier at a time when the economy is slowing. So, it’s probably smart to be a little more tactical and active on that front.