While mania and panic often follow one another, it’s difficult to recall experiencing both in one quarter, such as we did in the second quarter of 2023. From the regional banking crisis to the current artificial intelligence (AI) mania, during the quarter the market swung from fear to elation. We have several dispassionate opinions on these issues and a few of us here at Asio Capital date back to the last banking calamity during the 1980’s and 90’s, the Savings and Loan (S&L) crisis, which cost taxpayers an estimated $124 billion.1 This period was followed by what the former chair of the Federal Reserve, Alan Greenspan, coined the “irrational exuberance” of the mid-1990’s.
First, the regional banks and their rumored obsolescence. We do not believe the regional banking system is going away but would expect smaller institutions to be challenged. Deposit insurance limits likely need to be revisited and revised due to the incredible ease of moving money. Having a diverse and robust banking system in the United States helps avoid the concentration of systemic risk and makes our system more structurally sound. Small and medium size banks also are critical to lending and keeping our economy vibrant. The chart below illustrates the sentiment towards regional bank stocks. The country’s largest bank, JP Morgan, has a market cap greater than that of the entire regional bank index.
With regards to artificial intelligence (AI), it has been unfolding for some time now, but only more recently has become the center of attention. The evolution of large language modeling via products like ChatGPT, Bard, and Bing is the most recent chapter to be written. This new technological shift will be immense in its importance to productivity and our broader society. The AI mania has led to many investors chasing hot story stocks, which is merely a first order effect of the mania.
Looking forward, we are thinking through the second order effects and which companies may be the less obvious beneficiaries of AI. AI should provide many benefits from improved productivity, accelerated scientific advancement as well as margin improvement for those companies who successfully implement it. These benefits should have a positive impact on economic growth and potentially improve living standards. The speculative money chasing AI names today have driven up valuations in the short-term, which is leading our team to be selective and patient as we’d expect there to be ample opportunities over the coming months and years to invest in this long-term, secular growth story.
As we look back on the quarter ended 6-30-2023, it was a better quarter for risk assets. Positive catalysts included the debt ceiling resolution, the banking system finding its footing as deposit outflows slowed, and the continued strength in the labor market. Inflation continued to decelerate, but does remain well above the Federal Reserves desired target of 2%. Given the persistence of inflation, the market is expecting the Fed to raise interest rates an additional 0.25% at the July meeting and potentially further at future meetings.
One of the most distinct traits of the market year-to-date has been the concentration of investors and the index composition in a small subset of stocks, predominantly technology stocks. The top 5 stocks in the S&P 500 (Apple, Microsoft, Amazon, Nvidia, and Google) account for 24.1% of the total market cap. 2 Furthermore, these 5 stocks drove nearly two-thirds of the return of the S&P 500 through June 30th, 2023.3 This concentration is both befuddling and worrisome for investors as historically this level of concentration is not sustainable. Our approach has been to continue to build diversified portfolios and seek to take advantage of opportunities offered by the market. Examples of areas where we believe we continue to identify value are cyclical stocks, such as energy and industrials, small cap equities, and high-quality fixed income.
Challenges and questions certainly remain as we move into the second half of 2023. How much further will the Fed go? How long can the consumer hang in? Will corporate earnings continue to beat expectations? All these are tough questions to answer, but we remain encouraged by the resiliency of the labor market and consumer. The Fed has come at the consumer with a flurry of body blows via higher interest rates, but the consumer continues to hold its ground. While it’s fair to expect volatility to persist into year end, we believe our focus on quality and risk management should allow our team to take advantage of the inevitable dislocations in the market.
As always, it’s a pleasure to serve you and we appreciate your trust. Have a safe, healthy end of summer.
Chief Investment Officer
Portfolio Manager & Wealth Strategist
 https://www.federalreservehistory.org/essays/savings-and-loan-crisis “Savings and Loan Crisis”
 www.strategas.com “Quarterly Review in Charts Wed. July 5, 2023”
 www.gs.com/research/hedge.html “US Quarterly Chartbook as of 6 July 2023”
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