The Question Investors Should Ask Themselves Now

The nearly 8-foot waves pummeling Chicago’s Navy Pier on the first day of Morningstar’s Investment Conference this month provided an apt metaphor.

Just as turbulence outside stirred amazement and consternation inside the pier’s Grand Ballroom and Festival Hall without impeding the annual gathering, worries about war, inflation, valuations, and artificial intelligence’s ramifications have buffeted, but not swamped markets, yet. Even after last week’s postconference swoon, US and international stock markets are up for the year through June 26 and over any trailing period.

Attendees seemed warily optimistic—happy the markets and their portfolios have, so far, surfed a variety of shocks and threats, hopeful they can stay afloat, but beginning to wonder how long clement conditions will last.

“At some point, this is going to end,” said Carl Kawaja, a longtime manager of American Funds Growth Fund of America AGTHX.

Different This Time?

Conference goers heard again how this bull market rhymes with the internet stock bubble that burst in 2000. More than one speaker quoted a version of Sir John Templeton’s maxim: “the four most expensive words in the English language are ‘This time it’s different.’” No one, however, would or could say when the AI infrastructure spending that has quickened corporate profits and market returns will abate.

Even skeptics admitted AI is more than hype. It is transforming society, economies, and markets, which explains the US stock market’s full valuations and slight difference between the yields of low-risk US Treasuries and riskier corporate bonds. “It takes a lot of things going right for credit spreads to be where they are now,” said American Funds Bond Fund of America ABNDX manager Pramod Atluri.

Yet maybe these conditions should give us pause. Templeton also said, “The time of maximum optimism is the best time to sell.” We may not have reached peak sanguinity, but it could be close. Scott Brayman, veteran manager of Champlain Small Company Fund CIPSX, said when a shoemaker turns itself into an AI infrastructure provider, as Allbirds did earlier this year, “That’s a tell.”

So are AI executives’ boasts that they can cure cancer, said Wasatch Core Growth WGROX manager Mike Valentine. “They are selling dreams of what might happen instead of what is likely to happen,” he said.

The trillions of dollars of AI capital spending are going to require equally stunning profits to achieve even a mediocre return, said Causeway International Value CIVIX manager Conor Muldoon. “Is that realistic?” he asked.

Private Matters

One may also ask if it’s realistic to expect retail investors and their advisors to keep buying interval funds that invest in private assets. These vehicles that give shareholders only periodic and limited opportunities to sell so that they can invest in harder-to-trade assets have been an area of growth and emphasis for asset managers. Redemption requests at several of them, however, have surged in recent quarters as concerns about the quality and prospective returns of their portfolios have mounted.

Executives from Blackstone, BlackRock, and Cliffwater contended that private semiliquid funds’ investment thesis remains sound. They offer average investors the kind of diversification and return potential that large institutions and wealthy families have enjoyed for years.

Yet, these vehicles remain complicated, opaque, and expensive. Furthermore, some of the managers admitted the liquidity premium, or extra return you should expect from hard-to-trade private assets, has diminished in recent years. Competition and better disclosure could bring costs down over time, but asset managers seem in no hurry to reduce fees.

Even Vanguard, whose cheap index funds and exchange-traded funds have played a big role in driving down mutual fund costs, expects to launch an interval fund mixing public and private market exposure with Wellington Management and Blackstone that should cost less than the average private markets fund, but still more than the typical Vanguard offering. The family’s head of private markets portfolio research, Ankul Daga, said private markets investors “should be prepared to pay for a manager that adds value”—something I never thought I’d hear from the firm whose founder preached “The Cost Matters Hypothesis.”

Risk-On/Off Switch

Where are managers finding value? Pimco Diversified Income’s PDIIX Sonali Pier said investors don’t have to venture into private credit; some corporate bonds offer generationally attractive yields and higher quality. Causeway’s Muldoon said European financials offer higher returns and lower valuations than their US counterparts. Royce Small-Cap Total Return RTRIX manager Miles Lewis said profitable, value-leaning small companies trade at a wide discount to large caps, when historically they have often traded at a premium.

Take these opinions with a measure of salt. Few managers fail to recommend what they’re paid to invest in. Tweak your portfolio only after due consideration of the risks involved.

An anecdote about risk shared by retiring Fidelity Contrafund FCNTX manager Will Danoff resonated. He recalled a conversation early in his remarkable 35-year career with George Vanderheiden, who ran Fidelity Destiny (now Fidelity Advisor Diversified Stock FDTOX) for 20 years and was a legend in his time. Vanderheiden told Danoff that the first thing he asked himself when he arrived at work each day was: What was his biggest risk of losing shareholders’ money? Danoff said he did the opposite each morning; he wondered how he could make clients money.

I found the story portentous. When Vanderheiden retired 26 years ago at the peak of the internet stock bubble, some interpreted it as the capitulation of an old-school manager who could not or would not adapt to the new economy. It turned out to be the beginning of Vanderheiden’s vindication. Old economy value beat new economy growth over the next seven straight calendar years.

The swells that washed over Navy Pier on the conference’s first day subsided, but the threat remains. Longtime Chicagoans know Lake Michigan’s breakers can reach more than 10 feet and inundate Lake Shore Drive. There’s a market metaphor in that, too. Last week’s AI stock turbulence could ebb, or, like Lake Michigan, roil and churn anew. It’s a reminder to ask ourselves Vanderheiden’s question once in a while.