Here are three things I think I am thinking about:

1) The Concentration of the Mag 7 is Both Good and Bad. In a recent piece I discussed the risk of concentration in the US stock market. It’s really amazing. Almost every day now the Magnificent 7 add hundreds of billions of dollars in market cap value. It almost feels like the only game in town now as the market cap weighted stock indices trounce virtually everything else in large part due to this small group of companies. This is both good and bad.

It’s good because it shows how smart market cap indexing is. When you own a market cap weighted index like the S&P 500 you don’t have to worry about picking the best stocks in the index because you just own them all. And the ones that perform well rise to the top and drive performance. Over time the stock market’s performance will be driven in large part by a relatively small portion of the overall index. So you end up with what I’ve described as a sort of momentum strategy where good firms grow to become a bigger part of the index over time and smaller poor performing firms become a small part and eventually get kicked out automatically. In the case of the Mag 7 you get some exposure to this high flying group of stocks and thereby benefit from their gains without having had to risk missing them entirely like you might have if you’d relied on some other more concentrated stock picking strategy. This is why indexing works in a nutshell. As Bogle famously said, buy the haystack and don’t try to find the needles. That way when the needle grows and becomes obvious you’ll benefit without even having tried to find it!

It’s not all good news though. Part of the benefit of indexing is that you have massive diversification. This is a good thing because it means that you can benefit from the asymmetric upside of firms like the Mag 7 while still being diversified. But what happens when the Mag 7 become such a large part of the broader index that you no longer have adequate diversification from this single entity risk? Well, it creates a problem of sorts because you now have increased single entity risk despite being in a diversified index fund. Increased concentration means increased single entity risk which is the main risk you’re trying to eliminate when indexing.

What’s an investor to do? Ironically, if you own a diversified index fund like the S&P 500 I believe this is a good time to consider diversifying outside of the index. This is especially true if you don’t have a long time horizon. I don’t want to call this a bubble, but the Mag 7 creates concentration risk that is a lot of fun on the way up and could be a big downer on the way down.

2) Are We In a new Tech Bubble?

I am beginning to see more and more talk about a tech bubble and more specifically a bubble in AI narratives. The basic scenario is something like this:

  1. Artificial Intelligence is a corporate game changer that will significantly increase corporate margins by automating many costly human labor expenditures.
  2. The market is currently pricing in this significant change in the near-term.
  3. Firms are spending billions of dollars to get ahead of this potential change.
  4. The boost to margins ends up being smaller than expected, firms rein in AI investment spending, all of this causes near-term unemployment which reduces aggregate demand, stock prices correct significantly and if they correct during a recession they could overshoot as the euphoria turns into panic.

It’s not a sequence of events that is out of the realm of possibility. I always hesitate to use the word “bubble” because that word implies that the market has to pop, as if all the air in the rally will come out of it. That’s essentially a market crash from these levels since revisiting the pre-AI 2022 lows would equate to a 35% decline from here. Again, not out of the realm of possibility, but downturns of that magnitude are pretty unusual so using the B-word here implies a high level of confidence about what’s ahead of us.

How to navigate it?

I speak about this all the time now, but investing is really all about time. If you don’t understand the time horizon within which your investment strategy operates then you are creating unnecessary behavioral risks. This is especially true for people who treat the stock market like a short-term instrument when it is much more like a multi-decade instrument. Even multi-asset strategies like a 60/40 portfolio end up being the equivalent of a 10+ year instrument yet we tend to judge all these portfolios based on annual or short-term performance. And that’s where a potential “bubble” creates a lot of behavioral risk. If there is in fact a tech bubble blowing then this creates what I call a price compression. The market isn’t wrong. But it can be early. And if prices compress a lot in the near-term then they can decompress when expectations change. The Nasdaq bubble wasn’t wrong, it just compressed prices by pricing in huge internet gains much faster than they actually materialized so the prices had to decompress from 2000-2003. And if that’s happening here then buyers at these prices may have to wait a while for the fundamentals to catch up.

In my opinion the right way to navigate these sorts of environments is to be crystal clear about your time horizons. If you’re buying tech stocks here you have to accept that they’re multi-decade instruments that you might need to hold for a long time before they realize gains. If you don’t have the patience to do that then you’re playing with fire. It’s that easy in my view. There’s nothing wrong with buying stocks when they boom, but you have to go into that purchase with a realistic time horizon in mind. Buying stocks and then getting scared a year later makes absolutely no sense. If one year is your time horizon then T-Bill and chill. Get your time horizon right and the rest is easy!

3) Investing in Experiences.

I went to the Sphere in Las Vegas last weekend to see Dead & Company with my old college roommates. I am embarrassed to say that I couldn’t name a single Grateful Dead song before this, but I loved the experience and music. John Mayer is shockingly good playing as the lead and the original Dead members still put on a great show.

Now, I am not sure if it’s the technology in the Sphere or the performance, but I now understand why people become cult-like members of this music – it was nothing short of spectacular. The Sphere is a technological marvel that you cannot describe to people. It’s a concert hall with stadium seating surrounded by 360 degrees of LED screens. I was about 100 feet from the band and I barely looked at them because the graphical display is mesmerizing. Almost frighteningly so. It’s like going to the future where more and more things in life are just going to be this chaotic graphical display. It just feels different from anything else you’ll experience and I am pretty sure it’s ruined every other concert I will ever go to. Also, it speaks to the tech boom we’re experiencing. When you see things like this you can’t help but be excited (and frightened) about what’s coming.

But more importantly, it reminded me of how important it is to invest in experiences. Yeah, the Sphere was great, but reuniting with old friends over the weekend was the real experience.

I hope you have a great weekend and have some real-life experience that don’t involve staring at screens.