Weekly Market Update

Given the performance of US equities over the past 15 years and the strength of the dollar, US investors wonder whether there is value in international diversification. Many non-US investors who have built US portfolios feel similarly.

For the most part, we think US firms have earned most of the premium in valuation that has arisen over the past decade.

A “bottoms-up” approach to asset allocation in a global portfolio leaves us overweight US equity sectors by 5.5% compared to a -3.5% position for non-US shares today.

If you simply extrapolate past performance into the future, some trends become unsustainable. Looking at data since 1970, US equities have never been a larger share of the world equity market as measured in US dollars.

US equities have risen from about 40% of world equity market cap in 2010 to 65% today. But to repeat the outperformance of US shares, domestic markets would have to rise to 90% of the world equity market in the next 15 years. This seems highly unlikely.

Last year, the “Magnificent 7” propelled the Nasdaq 100 to a 55% return. This year, with the tech momentum trade shifting to Artificial Intelligence (AI) Infrastructure, the Philadelphia Semiconductor Index (SOX) has surged nearly 17% in three months.

Many investors are left wondering if it is too late to buy tech.

In a global economy that is increasingly propelled by technological innovation, we believe investors should seek to keep tech exposure in their portfolio. And there is still value to be found in tech on a relative basis.

Plenty of tech stocks have lagged the high-flying mega caps since the start of 2023.

We think investors are beginning to dig deeper to find AI winners among medium and small companies. The AI boom is also coinciding with a rebound in the “traditional” technology cycle.

We see clear signs of a bottoming in demand for basic chips that go into PCs, smartphones, and industrial machinery. While recent market momentum has favored anything tied to AI, a durable recovery in everyday electronics demand should also be supportive for small- and mid-sized tech firms who are vital parts of complex supply chains.

What does this mean for investors?

Small- and medium-sized tech companies and especially those with an AI focus, present a potential opportunity for buy-and-hold investors. When it comes to AI, we believe investors should focus specifically on three thematic areas:

• Semiconductor equipment: While global semiconductor equipment stocks have rallied 29% this year, they have still lagged the world’s leading chipmaker by 53%. Leading fabs in Taiwan and equipment players in Europe, Japan, and the US continue to point to full order books out several years.
• Select software players with strong moats and lots of data: As AI models get trained and deployed, we will see beneficiaries among leading software names who most effectively integrate AI into their existing products. But selectivity will be key in areas of software like cyber security, fintech, and software as a service (SaaS) where competition is heating up.
• Robotics and tech hardware: The key difference between the engines that power chatbots and robots is the input data. AI-powered chatbots digest lots of text while robots analyze data from cameras or sensors. As AI chips become more powerful and available at scale, sellers of industrial robots and automated driving software will soon be able to complete complex, human-like tasks. These advancements have the potential to revolutionize manufacturing and drive a surge in productivity as our commutes suddenly become “work time.”