Three things investors ought to be thinking about right now

Key Concepts

• Market Broadening: The recent positive performance of a wider range of stocks beyond the large-cap tech sector.
• Small-Cap Stocks: Companies with smaller market capitalization, potentially offering higher growth but also higher risk. Russell 2000 & S&P 600 are key indices.
• AI Impact on Software: The disruptive influence of Artificial Intelligence, particularly AI agents, on the software industry.
• Bank Sector Divergence: The differing performance between consumer and investment banks, influenced by factors like interest rate proposals and earnings expectations.
• Interest Rate Cap Proposal: President Trump’s proposal to cap credit card interest rates at 10%, and its potential impact on banks.

Market Performance and Broadening Participation

The market this week presented a seemingly paradoxical picture. While the S&P 500 was down 0.4%, a significant 60% of its constituent stocks finished higher. This signals a broadening of market participation, a development investors have been anticipating for some time. This is viewed as a positive economic indicator, suggesting overall health across a wider range of companies. Specifically, transportation and small-cap stocks are performing well, indicating a potential heating up of the US economy.

Small-cap stocks, which have underperformed significantly – by 655 percentage points over the past five years – are now potentially undervalued. Their current valuation is cheaper, with a median price-to-earnings ratio of 15 compared to the Russell 2000’s 22. Investors can access this sector through the Russell 2000 ETF (IWM), though it includes many unprofitable companies. Alternatively, the S&P 600, which excludes unprofitable companies, or actively managed funds like DFA Small-Cap (DFSTX) and FPA Queens Road Small-Cap Value Fund (MIX) offer more selective approaches. The combination of indexing and active management is highlighted as a potentially effective strategy.

The Rise of AI and its Impact on Software Stocks

The discussion shifted to the growing influence of Artificial Intelligence, building on Marc Andreessen’s observation that “software is eating the world.” The current update is that “AI is eating the world,” and specifically impacting software stocks. The introduction of new AI agents capable of performing tasks like booking flights is disrupting the software landscape. Companies like Salesforce and Adobe have seen their stock prices decline by around 30% over the past 12 months due to this competitive pressure. The ability of AI models like Claude to generate code further exacerbates this trend. Barron’s is identifying potential bargains in the selloff, highlighting Coreweave and Global Holdings as promising companies.

Banking Sector Dynamics and Regulatory Concerns

The banking sector displayed a notable divide between consumer and investment banks. Investment banks, like Goldman Sachs and J.P. Morgan, experienced a pullback after a period of strong performance, as expectations were already priced in. Consumer banks were impacted by President Trump’s proposal to cap credit card interest rates at 10%. This proposal sparked significant pushback from bank lobbies, with CEOs and CFOs actively communicating concerns to reporters and analysts. The industry argument centers on the potential for reduced credit access for borrowers and a negative impact on bank profitability. While the ultimate outcome is uncertain, this proposal represents a major concern for bank executives. The point was made that “nothing people ought to be borrowing money at 27% and when you need it you need it.”

Analyst Picks and Bank Transformation

Citigroup (C) was identified as a top pick among bank analysts, particularly Mike Mayo of Citigroup, due to its potential for improvement. CEO Jane Fraser is leading an internal transformation, and analysts see significant opportunity for growth. This was described as a “backhanded insult” – implying Citigroup has the most room for improvement.

Upcoming Focus – Macro to Micro

The upcoming week will feature earnings reports from United Airlines, GE, Johnson & Johnson, and Procter & Gamble. The focus will shift from macro-level concerns to micro-level analysis of individual company performance and stock reactions. Ian Bremmer will be discussing macro trends, while the emphasis will be on evaluating company-specific fundamentals.

Synthesis

The discussion highlighted a shifting market landscape characterized by broadening participation, the disruptive force of AI, and evolving dynamics within the banking sector. Investors are encouraged to consider small-cap stocks, but with a discerning approach, and to be aware of the potential impact of AI on software companies. The banking sector faces regulatory uncertainty, but opportunities exist for banks undergoing internal transformation. The overall message is one of cautious optimism, with a need to focus on both macro trends and micro-level company fundamentals.