How the changing AI storyline is impacting markets and investors.
Sometimes the hardest lesson to learn as investors is that many things move the daily share prices of a company. Company-specific factors such as guidance, earnings or operating developments are key influences for sure. Macro factors such as economic data, interest rates, geopolitical news and fiscal policy changes will also impact trading prices. Seasonal and timing factors come into play as well—remember the “Sell in May and Go Away” or “Santa Claus Rally” adages, or how trading can be impacted heading into any given weekend.
However, one of the most powerful forces in today’s market is often the least tangible: narratives.
A narrative is simply a story that investors use to explain a complex opportunity or risk. The allure of a narrative is that it explains a very complicated situation and boils it down to a short, easily understood story that sounds smart. As a people, we like stories—storytelling is how we’ve passed information along throughout human evolution.
Today’s market has become increasingly narrative-driven. Narratives can drive capital flows, influence valuations and shape market sentiment. In many cases, narratives can have a greater short-term impact on stock prices than underlying fundamentals. With the growth of quantitative strategies, passive investing and algorithmic trading, markets can react quickly to shifts in sentiment, often amplifying trends beyond what company-specific developments alone would justify.
After a long bull run, when markets are late cycle, stories tend to resonate more broadly and carry a greater weight. The Internet, housing, China, the Magnificent Seven, AI; these stories captivate, and counterarguments are dismissed with, “They just don’t get it.” As the cycle ages, strong performance and a fading memory of past bear markets cause investors to become more fearless. It is a more fertile environment for stories to resonate.
Importantly, narratives are not always wrong. Many prove to reflect genuine long-term structural changes. The challenge is determining which narratives represent lasting transformation and which reflect temporary enthusiasm. Markets frequently overshoot in both directions as investors attempt to answer that question.
A good example emerged late last year, when a narrative took hold that artificial intelligence would significantly disrupt the software industry. The argument was straightforward: AI would make software development faster and cheaper, enabling new competitors to enter the market with lower-cost solutions, placing pressure on existing software providers.
Whether that risk ultimately materializes remains to be seen. What mattered in the near term was that investors rapidly repriced the sector based on that narrative. Valuation multiples for many software companies compressed dramatically, and the S&P 500 Software Index declined sharply as investors discounted future earnings power before any widespread deterioration in fundamentals had occurred.
Interestingly, while that risk has not disappeared, the narrative has largely faded from investors’ focus. As sentiment improved, many software stocks recovered from their lows, though the valuation reset has not fully reversed. It serves as another reminder that markets often overreact in the short run and under-react in the long run.
Today, a different AI-related narrative is taking center stage. Rather than focusing on AI’s ability to disrupt existing businesses, investors are increasingly questioning whether the enormous amount of capital being invested in AI infrastructure will generate returns sufficient to justify the spending. This shift in focus has contributed to recent volatility among some of the market’s largest and most influential companies.
So how do you invest in a narrative-driven market? With a healthy dose of balanced thinking, which calls for diversification and intentionality around underlying exposures. As your advisor, we will call out the underlying exposures within your investments versus key benchmarks like the S&P 500 Index or MSCI All Country World Index in our discussions. We will review the concentrations that exist in those key market benchmarks and how we may differ or want to rebalance to optimize weightings.
We will carefully evaluate your tolerance for realized capital gains, develop plans for mitigation of those gains as we fully round the corner into year-end, and implement strategies on your behalf to help you have an investment plan that’s mindful of narratives but not overwhelmed by them. By doing so, we will strive to strike a balance between participating in more recent successful market narratives while seeking to ensure your gains do not slip away if or when the storyline changes.
Written by a human.