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“The most important single central fact about a free market is that no exchange takes place unless both parties benefit”.
Milton Friedman
Happy Presidents Day!
After a robust and active market last week we expect consolidation and things to settle down, here are the numbers. The S&P 500 lost 1.09%, the Dow Jones Industrial Average gave back 1.09%, the Nasdaq fell 1.77%. Internationally was the place to be, the FTSE 100 gained .74% and the MSCI-EAFE rose 1.4%. The 2-year treasury paid 3.408% and the 10-year yield was 4.048%.
Whether we like it or not, markets try to discount the future. As Gemmer Asset Management LLC. Comments:” What will the advent of motorized transportation mean for buggy whips? How much is whale blubber worth if lighting in major cities is converting over to coal gas or kerosene? Even beer prices in Ancient Egypt were probably sensitive to whether an incoming pharaoh was a pyramid builder or not. “Today, actual (and perceived) advancements in AI are creating modern-day versions of the same timeless trend. Copper, uranium, and South Korean stocks have been on a tear last year as they are perceived to be winners in an AI world. But conversely, anything exposed to even the slightest disruption from AI has been sold relentlessly. The biggest target so far in 2026 has been software stocks.” As Robert Armstrong in the Financial Times noted last Friday:
“The biggest story in stock markets in the past 15 or 20 years has been “software eating the world” — using “software” in a broad sense to include not just literal software vendors such as Microsoft but also internet services companies, including Google, Meta, Amazon Web Services, as well as software-intensive hardware companies such as Apple and Nvidia. It strikes me as possible that the biggest market story in the next 15 or 20 years will be “software eating itself” — increasingly autonomous AI machines displacing not only legacy software companies but the cognitive component of all sorts of industries.”
What do we know with some certainty? Well, after the big tech firms released their earnings over the last few weeks, we know they are plowing enormous sums into their AI initiatives. The chart below from the FT has Meta, Google, Microsoft, and Amazon slated to spend over $600bn in 2026. This goes a ways towards explaining why the Mag-7 type of stocks are lagging other sectors of the market in 2026. A lower level of buybacks means less of a tailwind behind their stock prices. This isn’t necessarily a net negative, but it certainly makes the job of an investor who is trying to discount the future doubly difficult.
Interest rates? Federal Reserve Chairman Powell has two more meetings left before his term is finished. The Fed last month left its benchmark overnight interest rate in the 3.50%-3.75% range. Nothing in the economic data released this week implies he will push to change rates at either the March or April meetings. First, the inflation data looks relatively benign. Prices increased at an annual rate of +2.4% in January, cooler than the +2.7% recorded in December. Economists surveyed by The Wall Street Journal expected inflation of +2.5%. Core prices, which exclude food and energy, were up +2.5% in line with expectations. Investors wrapped up an unusual week in the stock market, with surprisingly strong job gains for January, and an easing annual rate of consumer-price inflation offset by jitters about artificial intelligence’s capacity to destroy industries. Meanwhile, Wall Street’s “fear gauge,” the CBOE Volatility Index eased after briefly jumping to a one-week high of almost 22 on Friday, up from as low as 17.2 on Thursday and 18 at the start of last week.
So, all three major U.S. stock indexes finished with weekly losses, despite strong January job gains (The government reported this week that job growth accelerated in January and the unemployment rate fell to 4.3% from 4.4% in December.) and an annual core inflation rate that fell to a five-year low of 2.5% for last month. Investors rotated into utilities, materials and consumer staples, which had weekly gains of 7.1%, 3.7% and 1.4%, respectively. Some note that artificial-intelligence fears are based on expected disruption, not current reality.
A little deeper look at inflation reveals U.S. consumer prices increased less than expected in January, but underlying inflation firmed as businesses raised prices at the start of the year, which together with a stabilizing labor market could allow the Federal Reserve to keep interest rates unchanged for a while. The Consumer Price Index rose 0.2% last month after an unrevised 0.3% gain in December, the Labor Department’s Bureau of Labor Statistics said on Friday. Economists polled by Reuters had forecasted the CPI increasing 0.3%. When the CPI reading came in lower than expected largely because energy prices fell, with the overall energy index dropping around 1.5% and gasoline down about 3.2% in January, helping keep headline inflation soft.
At the same time, housing cost increases, especially for rent and owners’ equivalent rent, moderated compared with recent months, which also eased overall inflation pressures. Together, cheaper gas and cooling housing contributed to the softer inflation print. In the 12 months through January, the CPI increased 2.4%. The U.S. central bank tracks the Personal Consumption Expenditures Price Indexes for its 2% inflation target. Both measures are running well above target. Excluding the volatile food and energy components, the CPI increased 0.3% after rising by an unrevised 0.2% in December. In the 12 months through January, the so-called core CPI increased 2.5% after advancing 2.6% in December.
So, what do we do? Increase value stock exposure, continue our positions in international markets, and pay attention to lengthening our bond maturities, why? With the Fed resuming rate cuts, it’s likely the time to explore the possibility of locking in higher yields by going further out on the yield curve. Specifically, investors should consider targeting a portfolio duration closer to that of a core bond portfolio (4–6 years).
Mike
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