Three Key Thoughts:

1. Iran and AI Dominate
2. No Labor Apocalypse Yet
3. Inflation and Rates Stay High

Iran and AI Dominate

For the last four months, two themes have dominated the financial markets: (1) the status of hostilities with Iran and, most importantly, the Strait of Hormuz and (2) the peril and promise of Artificial Intelligence (AI).

Since late February when the war with Iran started, it was expected that the intense military operation would last only a matter of weeks. While that turned out to be true, getting to an actual peace deal has been difficult. In retrospect, that should not have been a surprise, particularly once the Iran Revolutionary Guard figured out that it could effectively close the Strait of Hormuz. What is surprising is that the US military didn’t plan for this or have an effective solution to it.

Having acquired this capability, the IRG is loath to give it up. Indeed, it sees the Strait as a toll road which can provide financing to the IRG independent of the government of Iran. To compound the problem, the US (or Israel, as the case may be) has taken out much of the non-military Iranian leadership, including the Ayatollah, so it is not clear that anyone can speak authoritatively on behalf of the country in negotiations.

That leaves us with the IRG making shipping through the Strait dangerous, even while the Iranian government has supposedly agreed it should be open. Meanwhile, peace talks are supposed to be continuing on other difficult issues, like the Iranian nuclear program. Bottom line, we view the current situation as simply a pause in the conflict, not the prelude to a lasting peace agreement. This will keep oil prices volatile.

The AI boom has many facets, most good, some not so. On the positive side, the power of large language models to help us solve problems big and small will certainly enhance our productivity. Many businesses are rapidly incorporating AI capabilities into their business processes – this will go on for years to come as the capabilities become more advanced and companies become smarter about how to use AI.

Demand for the infrastructure needed to support AI is also driving greater growth in many industries. Semiconductor demand is off the charts, as are the stocks of the companies that produce them. Beyond that obvious need, data centers require not only specialized building materials but power and water supplies. Many businesses have found new markets for their products.

On the flip side, communities are beginning to push back against the environmental impacts of large data centers, even as a handful of large companies have made large financial commitments to provide the computing power. It will take some ingenuity on both sides to reconcile these conflicts.

No Labor Apocalypse Yet

There are sharp differences of opinion about whether AI will have a devastating impact on employment or will actually create more jobs as major technological changes have done historically. The answer is likely yes to both, i.e., certain industries and types of jobs may well be replaced by AI applications. Conversely, new industries and new jobs will likely be created in ways we have yet to envision. We believe that in the aggregate over time, many more new jobs will be created than destroyed by AI.

For now, the US employment picture remains pretty solid. Interestingly, one of the first areas to be negatively affected by AI – software development – has recently shown job growth. And we have yet to see major labor reductions in other industries, at least not big enough yet to influence the aggregate job market statistics. That doesn’t mean there won’t be a lot of change under the surface.

Inflation and Rates Stay High

With oil prices staying volatile for now and AI driving higher growth and productivity, we can expect inflation to stay elevated for a while. We don’t expect wildly higher inflation, but it is likely to be well above the Federal Reserve’s target of 2%. And, as inflation goes, so go interest rates. We don’t expect the Fed to move much in either direction, so we believe many fixed income investments are reasonably attractive. They provide a solid cushion against inflation and the possibility for capital appreciation if rates fall in the future.

Investment Implications

You don’t have to stretch on quality to find good yields on fixed income investments and many stocks outside the AI boom trade at quite reasonable values. We continue to favor a very broadly diversified portfolio with US and international stocks, fixed income and well-chosen alternative investments.