Seven mega-cap technology shares account for almost all of this year’s market gains. These tech titans, which performed dismally last year, are now propelling markets as investors clamor for anything related to artificial intelligence (“AI”). This massive performance disparity reminds us of the importance of valuation and patience as market participation broadens out over time.
Artificial intelligence (“AI”) has become increasingly important in our technology-centric world. AI is transforming how we live and work, from self-driving cars to voice assistants on our phones. AI is a general-purpose technology (“GPT”) and is being incorporated into everything from cybersecurity, process automation, healthcare, and consumer technology. As a tool, AI will enable a wide range of industries, companies, and professionals to assume responsibility for repetitive tasks, enhance human performance, and unleash workplace productivity.
We have been closely watching the dynamic developments of AI. Two of our portfolio companies, Microsoft and Alphabet (a/k/a “Google”), have been in an arms race to develop and deploy the technology across their platforms. Microsoft’s partnership with Open AI, the creators of ChatGPT, has enabled the company to establish a strong foothold in the search market, where Google controls over 90% of the market share. Microsoft has also leveraged AI across its Office platform. Meanwhile, Alphabet has incorporated its AI chatbot, Bard, within its Google search bar. Both companies seek ways to commercialize AI capabilities and generate new revenue streams rapidly.
As a result of the excitement around AI, seven mega-cap technology stocks have been responsible for most of this year’s gains in the S&P 500 and NASDAQ 100. The “Magnificent Seven,” as they are known, include three of our portfolio companies, Apple, Microsoft, and Alphabet, but also include Nvidia, Meta, Amazon, and Tesla. These companies comprise 30% of the S&P 500 total market value and are responsible for 90% of the index’s performance. As of the end of May, without these seven stocks, the S&P 500 would be negative. The divergence between the performance of the Magnificent Seven and 493 other companies in the S&P 500 highlights investor enthusiasm riding high on the AI boom.
As we know, pricey stocks propelled by high expectations have more room to fall if those expectations aren’t met. That’s why we remain so focused on valuations when selecting stocks for investment. Nvidia is now an expensive stock by conventional metrics. History has shown that market anomalies like major divergences and parabolic moves in individual stocks eventually resolve, but the timing is nearly impossible to predict. A famous investing quote summarizes the current market divergence: “The definition of a bubble is when a stock keeps going up, and I don’t own it.”
Market participation will broaden over time as investors realize valuations are stretched in a few names and reallocate a portion of gains into more reasonably priced stocks. Further, the AI patina will shine on other companies and industries. For example, John Deere has created an autonomous tractor that uses cameras, processors, and, yes, AI to sort images and assess fields for planting and harvest. Being patient, focusing on valuation, and performing research can help us uncover these opportunities.
We sincerely thank you for your continued confidence and support of Cardinal Capital. Cardinal Capital is committed to delivering superior risk-adjusted returns over time through changing market environments. Once again, thank you for your support, trust, and confidence in Cardinal Capital.
Cardinal Capital Management, Inc.