Reflecting on the first quarter, January and February were mostly unremarkable, then March came in like a lion. The hostilities with Iran commenced on February 28th, and the marketplace has been worried about escalation and disruption since then. When might it go out like a lamb? One can only answer, “Eventually”. Expecting an immediate fix seems unrealistic, while expecting long-term disruption also seems unlikely. For a Strategic Investor, this is not a threat that merits a change in strategy, nor a tactical adjustment. Wait out the detour and stay focused on the best, high-quality opportunities.
We are focused on risk management during this volatility. Our emphasis on reasonable price has spared our portfolios from the more significant of valuation correction that has hit the formerly frothy stocks. Asset allocation into our bond strategies has delivered a better defense. This matters to our approach.
The prominent complex problem of the year, and perhaps of the years to come, relates to the potential disruptions cascading from the advances of AI – prominently, the disruptive risk is focused on the software sector. The question being: will current software companies incorporate AI to be more effective in their existing niche, or will new AI models make them obsolete?
A dramatic example of this quandary played out in the Tech sector holdings of our Large Cap portfolio. Our Tech Sector outperformed the S&P 500 Index Tech sector by about 6%, usually an indicator of success. In this instance, however, we were down -3.4% to the sector’s approximate -10%. In our portfolio, the software stocks were down, and the hardware stocks (primarily the semiconductor equipment companies) were up nicely. This is the issue being played out in real time.
We are optimistic regarding the economic impact of AI, and we find the message from Nvidia’s CEO Jensen Huang to be insightful. He argues that going forward, “compute=GDP.” With the advent of machine-driven agentic AI, computing power driven by the data center will be the defining capacity of economic power. It is a new type of arms race, centered on building the capacity to compute.
Tying these two topics together: First, what happens to software as an industry, and second, creating the necessary infrastructure for growth. It is too soon to know the answer to the software question, but a relatively middle ground seems the likely outcome, with plenty of disruption along the way. The middle ground being that some incumbents adapt and make it work, and some adapt too slowly or are made obsolete. As for the infrastructure question, being invested in the build out and operations of the compute factor, within the parameters of our high-quality investment discipline, looks to align with opportunity.
Strategically, we continue to see the risks attending the massive scale of U.S. debt to be the looming issue. The probability that we play ostrich and do not forthrightly tackle the problem, portends for printing our way out of the short-term fiscal issues and contributes to longer-term inflation and higher interest rates. Defending your principal and your purchasing power against this threat is a constant theme in our investing.
For the near future, focusing on both offense and defense will be critical to adding value. The forty-year cycle of declining rates created a simpler environment, the complacency of counting on that tailwind is now complicated by a new secular cycle of challenges. We are prepared for those challenges.
For your fixed income allocation, managing risk by keeping maturities short will be essential. For equities, selecting into quality will be a defining strategy.
While the conflict in Iran and its attendant volatility in oil prices dominates the narrative now, let us see when we report on second quarter in three months if we are still as concerned. We expect that the crisis du jour will rotate into a different story in which the noise will distract from the signal.
