"It's The Hope That Kills You"

Ted Lasso a favorite show of mine, is fish out of water story of an American coaching soccer in England. The title of this letter is a quote from one of the early episodes that has stuck with me.  Fans of the fictious soccer team AFC Richmond repeatedly say throughout the episode, “it is the hope that kills you.” They remind themselves of this reality because having zero expectations of winning are preferred to having your dreams crushed in a cruel manner.  As a lifelong Chicago Bears fan, I can relate.  When your expectations are high, so are your chances of being disappointed.  

The S&P 500 is up approximately 12% this year and we can rejoice that the 248 day bear market has ended.  And yet it would be flat if it weren’t for the contribution of seven large technology stocks.  The stodgy old Dow Jones Industrial Average up 2% and still in bear territory.  Earnings for the first quarter of the year are complete and can be characterized as lackluster with companies providing cautious outlooks due to economic uncertainty.  To use non-sense Wall Street lingo, they were “better than feared.” Which is a polite way of saying results weren't that good but they could have been worse.  However, there was one earnings release that deserves mention.  The first quarter results by Nvidia a semiconductor company were outstanding.  Perhaps the best earnings report I have seen since the early days of Apple and the iPhone.  This leads me to the purpose of this letter. 
 

The surge in value by the big tech companies (Apple, Microsoft, Google, Amazon, Meta (Facebook), Tesla and now Nvidia) can be attributed to the hype and optimism of artificial intelligence.  After Nvidia’s earnings release, the company’s valuation soared to nearly $1 trillion.  More than $200 billion of value was added in a single day.  During the conference call, the Nvidia CEO declared his company had reached an “iPhone moment” for its suite of semiconductors and AI software.  He went on to estimate the infrastructure necessary to run AI at $1 trillion with an upgrade cycle of every four years.  These figures are certainly in the realm of the $450 billion in annual smartphone sales. These great expectations propelled Nvidia’s stock to new heights.  

There is an old adage known as Amara’s law which states: we tend to overestimate what a technology can do in the short run and underestimate what it can do in the long run.  Comparing yourself to the iPhone which is perhaps the most successful product in history, doesn’t leave much room for error and neither does a $1 trillion valuation when your sales and profits are fraction of Apple’s.  Aside from the “iPhone moment” quote, another comment stuck out to me as well. 

"Auto insurance company, CCC Intelligence Solutions, is using AI for estimating repairs.  And AT&T is working with us on AI to improve fleet dispatches so their field technicians can better service customers.  Among other enterprise customers using NVIDIA AI are Deloitte, for logistics and customer service, and Amgen, for drug discovery and protein engineering."  Jensen Huang, CEO Nvidia
 

What stands out to me is examples provided for this impressive new technology are for rather boring uses - apart from Amgen and drug discovery.  And that may just be the lack of imagination at this point of where the technology will ultimately lead us.  Of course, AT&T or an insurance company would be interested in applying AI to one of its largest expenses to see if it can produce savings.  It sounds benign.   But remember that the first iPhone was basically just a cell phone with a painfully slow web browser.  There were no apps, no video calls, no streaming, no Siri and no Uber.  The iPhone was however the start of something truly game changing, and it took a few years and additional technological advancements to become the ubiquitous device. 

I still find the trillion-dollar valuation and the comparison to the iPhone as setting a rather high bar for expectations especially when the CEO's examples for use of this cutting-edge technology are AT&T and car repair estimates.  Investors tend to spend a lot of energy trying to predict what is going to change.  It is exciting to discuss new technologies and new industries.  These expectations are built on future uncertainty.  One thing I am certain about is when expectations are high, so is the probability for disappointment.  

The real lesson for us however is the return year to date for the S&P 500.  Without the contribution of the seven largest tech companies, the return for the remaining 493 businesses is nil.  

And if we weighted all the companies in the S&P 500 equally instead of by size the return would be negative!  Remember that most of the earnings releases for the first quarter were lackluster.  Most of the economy is just trudging along with the challenges of slower consumer spending and tighter credit.  We cannot yet declare a victory on inflation, the Fed remains restrictive, which in turn has caused multiple bank failures and the highest level of bankruptcies in years.  If we have entered a new bull market it has started in a unique way.

 

It is a stark reminder that with investing, the tails of the distribution curve drive everything, not the averages.  By owning the S&P 500 index, we benefited from Nvidia's impressive rise, and the index will likely catch the next big thing too.  It can be easy to underestimate what can be achieved by a few companies or a short period of time.   It is yet another example of when the average isn’t always what it seems to be.  With a +12% return in five months, it would be easy to conclude that the economy is doing well, and many businesses are thriving.  It isn’t.  Instead, it is the result of excitement of a new technology for a handful of tech giants. 
 

Keep your expectations in check, 

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