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I still want to bring Sam back into our conversation. Let's take a look at the markets with Max Wasser, Senior Vice President and Portfolio Manager of the Miramar team. Max, we are glad to welcome you. I'd like to know how you assess the markets now and their overall resilience amid all these concerns about AI related to capital costs, higher interest rates, and a possible slowdown in AI development and cost reduction.
How do you view the situation now? Thank you for inviting me. I think we're looking at the situation in the short and long term. In the short term, expectations for AI spending have been at extremely high levels, we're seeing companies issuing around $300 billion in debt, and people are starting to question the return on investment and the cost of capital.
So, when analyzing this market, we return to fundamental indicators. If companies have to borrow a lot to finance and grow, higher interest rates make it more expensive, which is perfectly acceptable as long as expectations of continued growth persist . But now you're starting to see some pressure from the credit markets.
You start to see doubts about whether they will continue to grow at this rate, and with high interest rates, it makes AI spending and the valuations themselves quite questionable, especially ahead of the reporting in the next week or two, when everyone is expecting some stunning numbers. So, Max, as a portfolio manager , does this change your vision and thesis on asset allocation now, given what's working, because it seems like everything but AI is showing results, even fixed income instruments.
Yes, it is, but we have been seeing these changes over the past few months. I mean, we're using the "barbell" strategy. So we have about 15% of the portfolio in healthcare and pharmaceuticals, and about 13-14% in energy. So we balance this 25% in the technology sector. But, you know, we like other parts of the market too.
We think there's a better risk-reward ratio there because nobody wanted them. Now, over the last week, everyone has rushed into defensive assets, and people are starting to question that . Therefore, I advise private investors to be cautious with drastic changes in their portfolios over the next week or two, but I expect a significant increase in volatility due to higher inflation.
There is no solution in the Middle East regarding oil prices, and right now everyone's expectations for AI spending are really too high. So, speaking of AI, how do you assess the long-term prospects of this story? Do you have concerns about the bubble? Are you generally optimistic about the long term?
Yes, we like AI in the long term. You know, we have investments in Microsoft, Alphabet. We have Broadcom and even a little bit of Qualcomm in our portfolio. So, we are optimistic, but we are in no hurry to enter full force. Note that three or four months ago, no one wanted to buy Microsoft. The stock was in the 400 range, and now it's around 540 per share.
Everyone is trying to buy them up. So, you know, people's and market sentiments are changing. We like large companies that generate a lot of cash flow. They'll need to spend them, right? So we see this happening. We are cautious, although we have a large investment in Broadcom and we like it. You know, they're issuing $60 billion in debt.
So, you know, we're worried. But again, we reduced the share of technology companies during the year and increased investments in healthcare and energy. So, we like these companies, but we wouldn't chase them right now. Now everyone has rushed to defensive assets. This could change tomorrow or the next day.
So I will say this: know what you have and own good companies. We love dividend stocks, but I would be very cautious right now because this market could fall sharply. What about the " bottlenecks"? Do you have positions and access to areas where we see limitations? I mean, when you talk about AI infrastructure, but also related industries like utilities that will power everything, and industry that has itself become part of the AI market.
Of course, this is more of a derivative of what you are talking about, a secondary agreement. Yes, we like utilities. We don't have them now because prices have increased. We would like to see a drop in interest in them before we enter. We like pipelines, natural gas, and oil because they provide fuel for data centers.
So we have investments in this area. But we are selective about industrial companies. You need to be very selective here, because the pressure on costs and margins is very noticeable right now. We are not sure what will happen with interest rates. You saw today's PPI, which turned out to be higher. The Fed, in our opinion, is slowing down a bit, and we are not sure they will not surprise everyone with two rate hikes by the end of the year.
And you know nothing about the Middle East. So we are very careful now. That's why we choose larger companies with strong cash flows, the ability to self-finance, so as not to turn to the debt market, which is currently problematic. Max, I want to dig deeper into what you just said, which is that you see the possibility of two raises this year.
So do you expect an increase also based on the results of the October meeting ? December is almost set in stone, but it's October that raises questions for us . Of course. Well, you know, we think they should have raised the rates a long time ago , but we were in the minority with that opinion. So yeah, but I don't think they're really stepping up the politics anymore.
I mean, this Fed composition is unlikely to want significant tightening. I think they just want to slow down a bit. So will they do it in October? I think it would be a good idea for people to calm down a bit. But this is uncertainty, and right now all we know for sure is that oil prices are high, inflation is not falling, profit margins are shrinking everywhere, consumers are starting to feel it, and we are waiting for leadership from the Fed.
Are they going to tighten monetary policy? Are they just going to slow down ? What exactly are they going to do? Everyone is speculating now, and speculation is bad. So, if you're a growth investor playing for the long haul, do you like anything outside the US? You know, that's an interesting question.
Most of our American companies, for example, derive their primary income from abroad. So you still get that kind of market impact. We like reporting and trading here in the US. We mostly stay with domestic companies. But I would look for companies that have growth potential in the market. And if you depend, for example, on China for significant growth, you should be careful.
If you are counting on parts of Europe, you need to consider how their economy affects them . So, when going international, you need to be very selective about your risks. And when you go into emerging markets, remember that a lot of things there are hedged by credit debt. So, if the credit crunch intensifies, and we are already seeing signs of it, it could seriously hurt you.
So emerging markets make us a little nervous. This is not our field, not our competence. So we will mostly remain in the segment of large and mid-cap US dividend companies. So, Max, looking at all the areas of concern in the markets right now, what do you think investors are underestimating the most that could hurt the markets?
I think they are too focused on the stock markets and not enough on the debt market. In fact, for us it is the debt market, the cost of capital. And if the cost of capital continues to rise, it will impact AI spending. If the cost of capital increases, it is due to high inflation, and this harms the consumer.
So while everyone loves to talk about the stock market, we also pay a lot of attention to the bond portion of the portfolio. And we think that now, when you have a 5% yield on, say, 5-year or 7-year bonds, that's an attractive alternative for many investors. You couldn't get this before. This is a risk-free bet.
So we look at it the way you saw what happened last night. You see what's happening, people are worried about the debt market. So any hitch, serious concerns about the impossibility of entering the debt market or the increase in the cost of capital to 10-12% for AI spending. This is a big problem for us.
So, make sure your companies are able to service the debt they issue. Max, thank you so much for joining us today. Thank you for sharing your knowledge on our broadcast. It was Max Wasserman, Senior Vice President and Portfolio Manager of The Mather Marshall team.
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