The excitement over Artificial Intelligence (AI) continued to boost massive capital spending on tech infrastructure helping to drive big tech growth stocks and the S&P 500 up 4.28%. The Equal Weight Index declined 2.63%. Performance at the sector level was much more mixed with only 5 of the 11 S&P 500 sectors finishing the second quarter in the green. The best performing sectors were technology, communications, utilities, consumer staples and consumer discretionary. Bonds as measured by the ICE US Treasury 20+ Year Index declined 1.97%.
One of the factors leading to a more volatile quarter for markets was the uncertainty over interest rates and what the Fed plans for this year. June's CPI came in at 3% which was the lowest level since April 2021. At the start of 2024 the Fed was expected to cut interest rates three times, but after their June meeting they announced that they expect to only cut rates once in 2024 as inflation has not cooled as fast as they would like. Despite no rate cuts so far this year, markets have continued to rise thanks to factors like AI fever and the hope that it brings a new age of technological innovation. While stocks have been pushing all-time highs, bonds continue to extend the longest bear market in history. At the end of the quarter, the bond market had been in a drawdown for 47 months; the second longest drawdown in recent memory started in 1980 and lasted for 16 months.
Retail Investors Taking Big Risks
As markets continue to break all-time highs, retail trading has increased with investors making riskier bets. Individual investors are looking to cash in on a new tech boom and have been jumping on the most popular stocks. According to data from Vanda Research in May Nvidia held the highest weight in the average retail trading portfolio at 9.3%, whereas a year ago Nvidia made up only 4.2% of the average portfolio. Digital brokerage firm eToro revealed that tech comprises all of the top 10 most widely held stocks for retail investors. Funds like this focus on providing investors with single day returns on their trades. Zero-day options have skyrocketed in popularity. When they were originally launched, they allowed investors to sell only once a week. In 2016 the ability to sell on Mondays and Wednesdays was added, and as of 2020 investors could buy and sell these single-day options every day of the week. According to Cboe Global Markets, zero-day options now account for nearly half of the daily volume of S&P 500 options, up from 4.7% in 2016. These derivatives are appealing to investors who seek lottery-like wins; however their increased volatility can lead to massive losses. Investors who are too slow to take gains can completely lose their entire investment by the end of the day. Currently zero-day options can only be used for the major indexes and some related ETFs, but some brokerages are considering allowing them to be used for individual stocks. This could take speculative trading to new levels as investors could make enormous bets on companies like Nvidia. A rush of new options could increase volatility for the largest stocks and has ushered in warnings from entities like the European Central Bank and Bank of America. Zero-day options have yet to be tested in a “black swan” event such as the 2008 financial crisis or the dotcom crash so it is unknown how the volatile nature of the derivatives will react in a big drawdown. Wildy popular stocks with unrealistic expectations run the risk of torpedoing investors' gains if earnings disappoint. Cisco went parabolic during the 1999 dotcom era, only to fall over 80% in the next two years. During the same time, Pets.com went from its IPO to bankruptcy in less than 9 months. Protecting against downside risk is one of the biggest challenges of investing. A 50% decline requires a stock to double just to get even. A 90% drop requires 1000% to recover. An investment that gains 8% annually for three years would beat an investment that gains 50% in year one and 50% in year two then declines 50% in year three. With speculative trading at record highs, it remains important to keep focused on the fundamental earnings, cash flow and valuations. Emotional speculating in times of euphoria is dangerous and often leads to permanent capital loss.
Critical Demand for Skilled Trades
Demand for skilled labor continues to rise in the post-pandemic era, partly spurred on by a change in peoples' priorities over the last four years. Disruption from the pandemic led many Americans to leave their jobs, with 47.8 million quitting in 2021 and 50.6 million quitting in 2022. Remote work has become a growing desire, making it harder for employers to maintain long-term employees as people search for improved work-life balance and flexibility. According to Deloitte the manufacturing skills gap could lead to 2.1 million unfilled jobs by 2030. Healthcare continues to suffer as well, with the American Hospital Association estimating a potential shortfall of up to 3.2 million of those workers by 2026. The US is also experiencing a shortage of electricians which could make it hard for the country to achieve its goal of an all-electric future. One beneficiary of the trend is Lincoln Educational who trains electricians for Tesla. They also provide training and programs for fields such as automotive, healthcare, IT and more. Lincoln partners directly with end market employers to tailor programs to the needs of these businesses with an eye toward improving the success rate of their graduates. Lincoln's stock has advanced over 500% since March of 2020.
Supreme Court Overturns 40-Year-Old Ruling on Interpreting Statutes
On June 28 the Supreme Court issued a new ruling to overturn the 1984 Chevron USA v. Natural Resources Defense Council decision (aka “Chevron Deference”) forcing federal courts to defer to specific government agencies' interpretations of laws and statutes that were silent or ambiguous with respect to a particular situation. Many believed that this decision gave organizations like the Environmental Protection Agency (EPA), the Department of Health and Human Services (HHS) and the Securities and Exchange Commission (SEC) significant legislative power through their own interpretations of specific laws and statutes. While courts can still consider an agency's interpretation, they ultimately have the final say on what an ambiguous law means. Companies will now be able to more effectively challenge agency decisions which should benefit heavily regulated industries like tobacco, energy and healthcare. Advantages could also extend to many companies that face environmental, social and governance regulations from the Department of Labor (DOL) and the EPA, allowing them to challenge these rules. This could incentivize Congress to be less broad or less vague when bringing new legislation forward. More precise language in future laws could ultimately help companies and investors better navigate complex regulatory environments.
Market Concentration a Growing Concern
The AI investment boom has contributed to greater market concentration in the Magnificent Seven stocks. Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia and Tesla make up about 31% of the S&P 500 according to June 24 data from FactSet. The top 25 companies in the S&P 500 have about the same weight as the rest of the index combined and also drive most of the index's growth. Without the outsized weightings of these companies the index would not have performed as well, with the Equal Weight S&P 500 down 2.6% during the quarter. Big tech companies tend to create their own weather with massive capital spending and stock buybacks. Some investors fear that the rapid growth of these companies is similar to the excitement surrounding internet businesses during the dotcom bubble. The main difference we are seeing today is that stock appreciation is better supported by earnings growth from significant investments in the cloud, data centers and AI hardware. This is leading to profit growth, helping to keep valuations from reaching the lofty levels seen in the early 2000s. According to data from Nasdaq Inc., the peak of the dotcom bubble in 2000 saw the Nasdaq Composite and S&P 500 trade at price-to-earnings (P/E) ratios as high as 200 and 34, respectively. At the end of 2001 the S&P 500 P/E ratio reached a high of 45. This multiple expansion was caused by stock price growth not being supported by actual earnings. Despite the significant rise in the Magnificent Seven stocks this year the S&P 500 P/E ratio is still lower at 29.34 as of July 12. Nasdaq Inc. is estimating an S&P 500 12-month forward P/E of 21.2.
According to data from venture capital firm Sequoia Capital cloud service providers could invest $300 billion into AI hardware this year. They estimate the AI industry would need to generate $600 billion in annual revenue to justify the current infrastructure spending. Whether this level of investment proves to be justified remains to be seen, but the largest US companies are still accelerating their capital spending in the space. Alphabet plans to increase their spending to $13 billion a quarter over the next year and Microsoft, $19 billion per quarter. So far the biggest winners from the enormous capital outlay have been infrastructure stocks like Nvidia.
Contributors
Technology was the strongest performing sector in the Fund during the quarter. Top stories this year have been centered around companies that are developing and can benefit from new advancements in AI. Technology was the only sector in the S&P 500 to achieve double-digit growth in the second quarter. Nvidia (NVDA, Financial) has been the focus of most headlines with earnings per share in their Q1 fiscal year 2025 advancing 629% off the back of new AI demand. Nvidia was not the only beneficiary in the tech space this quarter with Fund holdings such as Alphabet (GOOG, Financial), Meta Platforms (META, Financial) and Microsoft (MSFT, Financial) all performing well. Each of these companies achieved record earnings per share in their most recent quarters. The industrial sector also contributed to the Fund's growth during the quarter, led by strong performance from Corning (GLW, Financial), followed by aerospace and defense companies like RTX (RTX, Financial).
Detractors
Consumer staples was one of the worst performing sectors in the Fund, mainly due to fears over obesity drugs. Elevated inflation continues to impact both staples and quick serve restaurants as well. Companies like Molson Coors (TAP, Financial), Monster Beverage (MNST, Financial), Coca-Cola (KO, Financial) and PepsiCo (PEP, Financial) struggled during the quarter when compared to Fund holdings overall. Declining purchasing power could start to strain spending as consumers try to balance needs with wants. Credit card debt in the US was $1.12 trillion back in March and has remained high since it first surpassed $1 trillion in 2023. In addition to inflation, beverage companies in particular are facing other challenges such as a shift in diet as many choose healthier alternatives. Fewer young people are drinking alcohol. A Gallup study found that the number of young adults who say they drink has fallen from 72% to 62% over the last 20 years. Soda consumption has also declined as the negative health impact of too much sugar becomes clearer. The younger generation has been more conscientious of what they drink which could lead to further weakness in beverage companies. So far, the fundamentals of many of these companies have yet to be impacted too severely, but investors are looking to the future with a more pessimistic view on the sector.
Second Quarter 2024 Performance Update
Auxier Focus Fund's Investor Class declined 1.90% in the second quarter 2024. The S&P 500 cap-weighted index returned 4.28% for the second quarter, while the equal weight sank 2.63%. The Russell 1000 Value Index lost 2.17%. Fixed income investments as measured by the S&P Aggregate Bond Index gained 0.34% while the longer dated ICE US Treasury 20+ Year Index declined 1.97%. Smaller stocks as measured by the Russell 2000 retreated 3.25%. Stocks in the Fund comprised 92.2% of the portfolio. The breakdown was 83.3% domestic and 8.9% foreign, with 7.8% in cash and short-term debt instruments. A hypothetical $10,000 investment in the Fund since inception on July 9, 1999 to June 30, 2024 is now worth $62,508 vs $62,036 for the S&P 500 and $51,635 for the Russell 1000 Value Index. The equities in the Fund (entire portfolio, not share class specific) have had a gross cumulative return of 982.32%. The Fund had an average exposure to the market of 82.3% over the entire period. Our results are unleveraged.
In Closing
Our approach over years studying a plethora of businesses in various industries gives us important cumulative knowledge on a wide number of management teams that execute. We believe founder-run businesses with gritty leadership can make a meaningful difference to long-term shareholder returns. We favor companies that tend to be capital light, both large and small. A dedicated, rational research effort is the key to anticipating and mitigating risk which is so important in maintaining the compounding of returns. We strive to understand the earnings potential and operating reality of each individual business. Our shareholders tend to be older; more risk averse. Therefore we always seek a margin of safety with high odds on each carefully researched selection. Today we are finding much better value in smaller companies with the potential for legitimate double play returns based on improving earnings and P/E multiple expansion. Investing is the “craft of the specific” and our goal is to know more about our businesses than the market. We are optimistic about the long-term outlook for the Fund with its exposure not only to industry leading businesses but also well-managed smaller businesses. The forward P/E on the Fund is 15, a 25% discount to the S&P 500. I have 100% of my own retirement investments committed to the Fund and have maintained that since our 1999 inception. In contrast, most funds have very little (and indexes can't have any) skin in the game.
We appreciate your trust.
Jeff Auxier (Trades, Portfolio)
Before investing you should carefully consider the Fund's investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by calling (877) 328-9437 or visiting the Fund's website. Please read the prospectus carefully before you invest.
Fund returns (i) assume the reinvestment of all dividends and capital gain distributions and (ii) would have been lower during the period if certain fees and expenses had not been waived. Performance shown is for the Fund's Investor Class shares; returns for other share classes will vary. Performance for Investor Class shares for periods prior to December 10, 2004 reflects performance of the applicable share class of Auxier Focus Fund, a series of Unified Series Trust (the “Predecessor Fund”). Prior to January 3, 2003, the Predecessor Fund was a series of Ameriprime Funds. The performance of the Fund's Investor Class shares for the period prior to December 10, 2004 reflects the expenses of the Predecessor Fund.
The Fund may invest in value and/or growth stocks. Investments in value stocks are subject to risk that their intrinsic value may never be realized and investments in growth stocks may be susceptible to rapid price swings, especially during periods of economic uncertainty. In addition, the Fund may invest in mid-sized companies which generally carry greater risk than is customarily associated with larger companies. Moreover, if the Fund's portfolio is overweighted in a sector, any negative development affecting that sector will have a greater impact on the Fund than a fund that is not overweighted in that sector. An increase in interest rates typically causes a fall in the value of a debt security (Fixed-Income Securities Risk) with corresponding changes to the Fund's value.
Fund holdings and sector allocations are subject to change and should not be considered a recommendation to buy or sell any security.
