Expect the Unexpected, Probably When You Least Expect It...
February 1, 2025
On Monday this week, while out for my regular morning stroll with Olive, our beloved family ShihTzu, I was listening to a remastered Acquired episode about Taiwan Semiconductor Manufacturing Corporation, originally recorded in 2021. [A quick aside – if you are not familiar with Acquired podcasts, they are really worth checking out…couple of smart guys with incredible research and a very engaging manner.] The hosts were extolling the phenomenally successful development of TSMC. With 50% (and growing) market share, they suggested it was hard to imagine how things could not continue similarly. They did note the geopolitical risk to the company of a Chinese invasion of Taiwan or some other interference. Then, almost as an aside - I rewound it to make sure I heard correctly – there was a comment about a threat from something else, for instance a paradigm shift or the emergence of…wait for it...something much cheaper.
Whoa...the serendipitous simultaneity of this was stunning. Why? Because this was a randomly chosen podcast of several hours and that comment just happen to pop up that morning. And, as it happens, this was not just any Monday morning…this was the Monday when, even before the markets had opened in the US, there was sudden, and widespread, panic engendered by the appearance of a large language model from DeepSeek, a Chinese company focused on AI. The Chinese company had introduced an extremely well-functioning large language model that performed on a level with the leading US produced models and, here's the kicker, supposedly at a tiny fraction of the cost…i.e. much cheaper. That this was even possible without buying and employing billions of dollars of high-end Nvidia chips shook the markets - extended valuations and ever upward earnings predictions were quickly being called into question. A literal trillion dollars in market valuation disappeared, virtually overnight.
What’s the point here? Several actually. First, positive momentum in stock prices is very pleasant, hard to turn away from, and easing the worry about exaggerated valuations…until it isn’t. Usually, the shift in sentiment is sudden. We’ve been writing about this for some time – how should I make the point again? Trees don't grow to the sky? Bears make money, bulls make money, pigs get slaughtered? It helps to have a bit of discipline, be a little less greedy, take some profits.
Secondly, in a broader sense, nobody should really have been surprised. If you pay attention to markets because you are invested in them, you know this happens consistently, if not regularly. You might not have expected this particular piece of news or timing, and yet, when a market has moved as steadily higher as the equity markets have done for some time now, it is never a question of if, just when. With steady upward momentum, pressure builds. Eventually, something will, at least temporarily, shake things up. The markets are just looking for an excuse to reset a bit...and a variety of expected and/or unexpected factors can serve the purpose. When sentiment unexpectedly shifts, investors who have been nervous find a reason to sell, prices go down, often dramatically. Suddenly everything gets reviewed, and excesses – in valuation, in size of position, in financing – get called into question and start to come out of the system. Revised commentary and cogent explanations are only brilliant in hindsight.
Finally, a market reaction like we had on Monday also reveals something else – a different form of concentration risk. When one investment position has become a too large percentage of a portfolio, that is easy to spot. So yes, all the overextended owners of Nvidia could be heard howling on Monday as the need for untold amounts of their highest performing chips was suddenly not a given. However, if a portfolio is replete with many investment positions that all are related to the same theme, that is its own form of concentration risk. You owned just a reasonable amount of Nvidia, or you missed it so not at all? Fine…and yet you own AMD, Broadcom, Taiwan Semi, Marvell Technology, Lam Research...or a lot of AI-focused ETF's...and/or even some of the more distantly related companies in the power and data center worlds like Vertiv, Iron Mountain, Vistra. It doesn't matter how it is derived, with a large percentage of your portfolio invested in companies that were seen as AI beneficiaries, working the AI theme intensively based on the understandings everyone had before DeepSeek’s Monday revelations, you experienced the impact from a different kind of concentration risk.
Having concentrated portfolios can create great wealth if you are right…and significant losses if you aren’t. A concentrated portfolio will also likely be more exciting as the volatility will be more pronounced. Maybe that works for you...nothing wrong with that. Just understand what you are signing up for and be prepared for the sudden shocks. Alternatively, if you are looking to steadily grow your wealth, have less stress and sleep well at night, then being diversified with regard to the number of securities in your portfolio as well as the sectors where you are invested will give you that outcome. Hopefully, Monday will have proven to be a useful and valuable lesson in that regard.
One more comment on Monday’s market action. Monday was not the day to quickly correct any excesses, chasing stock prices and the market down. Sure you might want to let this sudden sentiment shift get you over the hump in unloading a stock that, for whatever reason, you have been uncomfortable with for a while. However, doing more than that in an emotional response to the market's dramatic drop is definitely not the right response. A reasoned, and reasonable, response would have you doing a portfolio review - what do you own, what adjustments might you want to make and, now that the markets have rebounded substantially (as they often do when there is a panic reaction to something unexpected), use this chance to do so thoughtfully instead of emotionally.
Several of you have wondered about the recent lack of suggested reading at the end of these columns…what can I say – my reading lately has not uncovered much that moved me to bring it to your attention. However, I do have something this week. I recently listened to a really interesting Ezra Klein podcast that I want to recommend. [Yes, the podcast is a property of NYTimes opinion so there may be a paywall…I found this YouTube link that may enable you to hear and see it https://www.youtube.com/watch?v=5qgcdl7pFNE]. It is an interview of Chris Hayes, an MSNBC anchor whose book The Siren’s Call discusses the importance, and unappreciated benefits, of attention. Don’t make any assumptions of the politics here – yes they are both left of center but that is not how this topic is treated. In fact, they praise Donald Trump’s understanding of the matter and excoriate the Democrats failure on same. This is insight and intelligence on a high level. Definitely worth a listen…revealed much that wasn’t obvious to me.
It will again be frigid cold where I am…and why not? It is the middle of winter, what did you expect? If you are in the northern part of the country and subject to these frigid conditions, I hope you can stay warm…literally and emotionally with friends and family. If not, enjoy that you do not have to suffer the brutally cold temps and winds.