2024 has picked up where 2023 left off with the trend of strong, momentum-driven equity markets. The TSX and S&P 500 continued their respective ascents in Q1. In fact, you could argue the trend in markets has actually accelerated in the first quarter. Rather than the jagged advance line you might be used to seeing on a stock chart, this one essentially goes straight up.

When viewed against the backdrop of interest rates, the stock market strength might raise alarm bells. Investors had been expecting central banks to have begun cutting interest rates by now, but instead those cuts have been pushed out to the latter half of Q2… and maybe longer. Inflation remains stubbornly high. This should be causing equity investors to worry, but instead, they have chosen to view the glass as half full.

Why? The US economy remains strong. Corporate profits are generally robust. And we might be in the early stages of a technological revolution that has the potential to change the world in a way that we haven’t seen since the introduction of email and web browsers in the 1990’s. Of course, we are talking about generative artificial intelligence, a buzzword that has fuelled some of the most speculative names in the stock market; but more importantly, has the potential to lower costs and increase productivity for all of us. One recent study estimated that the long-term potential productivity gains for AI were as high as 28% in areas such as research & development, sales & marketing, customer service, and general administrative expenses.

These are significant expenses for any corporation, and savings in these areas flow directly to the bottom line. Enhancements in productivity are a deflationary tailwind that can counterbalance the inflationary pressures we see in other areas. Any force that can increase corporate profits and lower inflationary pressure is unequivocally a good thing for equity investors. Perhaps this is part of what has investors so willing to buy stocks, despite uncooperative central banks and persistent inflation.

The question for investors is to parse the hype from reality. Are we in the early stages of a productivity boom? This is certainly possible, but as is often the case with technology, investors are buying first and asking questions later. When will these products and profits come to fruition? How sustainable is each company’s competitive advantage? We are not prepared to gamble our clients’ capital on exciting “concepts” and frenzied spending. If it’s truly a revolution, the benefits will be seen throughout the economy. This includes the blue-chip companies we tend to favour and will be a long term positive for equity investors. As always, downside protection and capital preservation remain our priorities.

The story will also take a long time to play out. While recent advances in AI are impressive, it is still very early in its evolution. Trusting the new technology to make critical decisions will take time. Similar to the internet revolution which gripped financial markets in the 1990’s, hype and investor enthusiasm tend to precede actual economic impacts by several years (if not longer). The way to play technological change is to remain mindful of the same investment principles that we witnessed in the late 90’s – be wary of extreme valuations paying for distant (potential) growth. As always, we remain focused on safety before speculation, keeping in mind long term opportunities and growth which are prerequisites for protecting and growing wealth.