Inside the ‘BIGGEST risk’ for markets

Key Concepts

• AI Slowdown Risk: Potential market downturn due to slower-than-expected AI infrastructure buildout and realization of AI-driven growth.
• Federal Reserve Chair Nominee: Discussion of potential candidates (Kevin Hassett, Rick Reeder, Cave, and others) and market reactions to a new appointment.
• Small-Cap Rotation: Recent outperformance of small-cap stocks and strategies for investors to participate.
• S&P 600 vs. Russell 2000: Differentiation between the two small-cap indices based on profitability criteria.
• Diversified International Exposure: Utilizing low-cost ETFs (Vanguard) for broad international market access, split between developed and emerging markets.
• IJARE ETF: An ultra-low cost ETF providing exposure to the S&P 600 small-cap index.
• Vanguard ETFs (VXUS): A low-cost ETF used for diversified international equity exposure.

Market Risks & AI Expectations

Jason Ware identifies a significant risk to the market: a slowdown in the buildout of Artificial Intelligence (AI) infrastructure. While AI has been a major driver of market growth for the past three years, overly high expectations pose a threat. He clarifies this isn’t a base case scenario, but argues it’s “arguably the biggest risk for markets” given the substantial excitement and investment already priced in. He notes that AI-fueled growth has significantly boosted the most important stocks in the market, and a failure to deliver on expectations could trigger a substantial correction. As Ware states, “If that were to slow and break, I think that that represents probably the biggest foreseeable risk in the marketplace.”

Federal Reserve Chair Succession & Market Volatility

The conversation shifts to the upcoming selection of a new Federal Reserve Chair. Kevin Hassett is discussed as a potential candidate, with some suggesting President Trump may favor retaining him. Ware describes Hassett as a “classical economist” with a willingness to consider lowering rates, but acknowledges concerns that his policies might be perceived as “up for sale.” Rick Reeder is also mentioned as a strong contender.

Ware anticipates market volatility following the appointment, stating, “Whenever we have a new Fed chair, you know the market likes to test the new Fed chair… wouldn’t be surprised to see volatility in the spring and early summer around whoever takes the job.”

Small-Cap Investment Strategies

The discussion then turns to the recent performance of small-cap stocks, which have experienced a notable rally. Ware emphasizes the difficulty of “picking winners and losers” in the small-cap space. He advocates for a diversified approach through ETFs, specifically recommending the IJARE ETF. This ETF tracks the S&P 600 index, which he prefers over the Russell 2000 due to its stricter profitability requirements. He points out that the S&P 600 has higher quality constituents, with 40-45% of companies being profitable, compared to the Russell 2000. He explains, “The best way for most of your viewers to get exposure is not to try to pick winners and losers small-cap because that is really hard but just on the complex and on the complex with quality.”

International Equity Exposure

Ware addresses international investment opportunities, mirroring his approach to small-caps. He advises against attempting to select individual international stocks and instead recommends utilizing low-cost ETFs for broad diversification. Albion captures international exposure for its clients through a Vanguard product (VXUS), allocating approximately two-thirds to three-quarters of the portfolio to developed international markets and 25-30% to emerging international markets. He stresses the importance of a “diversified beachhead” in the portfolio for international exposure, stating, “Having a diversified beachhead in the portfolio for international exposure, size that entered appropriate the lead that makes sense for most people.”

Logical Connections & Synthesis

The conversation flows logically from macro-level market risks (AI slowdown) to specific investment strategies within different market segments (small-caps and international equities). A consistent theme throughout is the emphasis on diversification and utilizing low-cost ETFs to mitigate risk and achieve broad market exposure. Ware consistently cautions against active stock picking, particularly in the more volatile small-cap and international markets, advocating instead for a passive, index-tracking approach.

The main takeaway is that while opportunities exist in both small-cap and international markets, investors should prioritize diversification and quality, leveraging low-cost ETFs like IJARE and Vanguard products to achieve broad exposure and manage risk effectively. The potential for volatility surrounding the appointment of a new Federal Reserve Chair is also highlighted as a factor to consider in the near term.