Buy in May

The month under review was largely concentrated on two important topics in the USA.

First there is the game of cat and mouse, as well as political brinkmanship, surrounding the roll-over of the US debt ceiling. At the time of writing, no material rapprochement has been accomplished as financial markets wait for a conclusion before broadly resuming their upward trend or breaking out on the downside for other reasons. Commentators generally assume that a deal can be reached in the way that deals were always reached in the past on such occasions. Meanwhile, and for good order’s sake, Fitch, one of the main ratings agencies, has placed US government debt on negative watch pending an outcome to the negotiations.

The second brick to strengthen the wall of worry is the risk of further US banking crises potentially stemming from falling prices in the local commercial real estate markets. Although residential prices are stable, the vast array of regional banks across the US continent are involved, in one way or another, in the business of lending money to borrowers and using commercial real estate as collateral. As the value of this collateral declines, so borrowers need to seek and present other forms of collateral. If this is not possible, the lending bank runs into trouble and, potentially, folds.

One side effect of the vacuum created in the US treasury market and the concern relating to further bank runs is the shifting of trillions of dollars into money market funds, away from bank deposits and bonds. Such investments probably represent the least bad option amongst those available to yield-seeking investors. Contrary to similar moves during the global financial crisis of 2008, nominal yields are positive and substantially cover fixed costs. Thus, the risk of a money market fund “breaking the buck” – a situation in which the yield does not cover the fund’s fixed costs – is currently not in evidence.

Real estate tensions are often the precursor to recessions. As opposed to the high-profile US banking failures of the past few months, most of the thousands of regional US banks are not listed on public exchanges and gaining insight into their books is not an easy task, if at all possible. What is not doubted, however, is that in addition to the high-profile bank failures this year, tensions behind the scenes in US regional banks will add, or already do, to the deteriorating liquidity picture which, in all financial markets, is key.

That is why the latest minutes from a past Federal Reserve meeting have caused central bankers to question whether further aggressive rate rises are the way forward or whether the deterioration in liquidity from the banking tensions is doing the Fed’s job for it. According to the latest minutes, the Fed is “less certain” about the need for higher rates, whatever “less certain” means.

Be that as it may, the month of May has seen a reset in the outlook for share and bond prices and this uncertainty is likely to prevail unless and until the debt ceiling debate is concluded through a political deal. Both Republican and Democrat positions are relatively entrenched regarding both the spending spree President Biden embarked on by throwing money at US consumers during the Covid restriction months and, further, his outright protectionism through the Inflation Reduction Act, to name one obvious indication. However, past deadlines for a debt ceiling rollover were concluded by a last-minute deal and this is likely to be repeated, if by no means certain.

Once again, bond prices have been key to the performance of financial markets. However, bond yields in May were largely affected by the political brinkmanship surrounding the debt ceiling as well as lingering inflationary pressures, even if the outlook remains relatively benign as inflation continues to fall. For bond market observers, the glass is currently half empty and this has influenced share prices of companies perceived as long-duration assets whose value is superficially affected by the discount rate applied to future earnings in perpetuity. Added to this has been the tendency for taking profits on share price rises relating to companies that have benefited from the (to many perplexing) interruption in rising bond yields.

What has attracted worldwide attention is the growing influence of artificial intelligence (AI) across the world of business and the discussion of how it can affect future jobs across vast swathes of industry and services. A glimpse into the share price year-to-date of Nvidia, the US technology group, will show how AI-related demand for powerful microprocessors, capable of training the gargantuan sets of data necessary for these models has exploded as AI takes centre stage. But although AI has taken centre stage once again, the idea of machines imitating or overtaking human intelligence is anything but new, as the snippet below shows. Even ancient Greece’s “hoi polloi” were concerned about the threat posed by artificial intelligence.

Figure 1: Silver didrachma from Crete depicting Talos, an ancient mythical automaton with artificial intelligence (c. 300 BC).

Source: Cabinet des Médailles, Paris. (Wikipedia, 2023)

By now, up to 200 million users have experimented with, or are regularly using, ChatGPT as well as many other AI providers. Equally, up to 25 per cent of US businesses have plugged into such services and this is expected to expand dramatically as time goes on and familiarity with the facility increases. The race to be in the forefront of this game-changer can be accompanied by vociferous exchanges, as the war of words between Microsoft and Google shows.

For the time being the jury is out on the effects, both positive and negative, of artificial intelligence on the daily lives of consumers, businesses and the political elite. Much will be discovered as this phenomenon develops over time.

Meanwhile, the mood in stock markets is likely to be influenced by the old adage of “sell in May and go away…”. But this does not count for highly profitable long-duration assets accompanied by an unlimited time horizon that forms part of the investment approach of Quality Growth investors.

Time is on their side.

P. Seilern

May 25^th, 2023

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