A return of less than 1pc above inflation on term deposits is not acceptable

Investors may have been relieved when cash deposit rates returned to a more normal level, but many are missing out on superior market returns.

Deutsche Bank says if the “Magnificent Seven” stocks were joined together, they would form the second-largest stock exchange in the world.

I have noticed comfort among clients in receiving a 5 per cent return in term deposits. Perhaps this is because these clients were receiving between 1 per cent and 2 per cent for the past decade, if not less, as rates went to historic lows.

This modest return appears to many a good outcome, but with inflation for the December quarter running at 4.1 per cent I would argue it has been very costly after a strong performance with the MSCI All Country World Index ex Australia (MSCI ACWI) having appreciated about 20 per cent since November last year.

MSCI estimates that, as a share of the global total, the US market cap hit a record high of about 62 per cent in 2021. At the end of last year, it was still at a historic high of 60 per cent.

A lot of that US market domination is linked to the major tech stocks.

David Einhorn of US-based Greenlight Capital puts forward the argument that the rise of passive or index investing is about the focus on price as opposed to value. He argues that “passive investors have no opinion about value. They’re going to assume everybody else has done the work.” So the more a stock goes up and its weighting increases, the larger the position therefore becomes.

Einhorn, in particular, is focusing on the so-called Magnificent Seven: the big market cap tech stocks Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia and – ­arguably – Tesla.

These companies alone are so large today that, according to Deutsche Bank, if they were joined together, they would form the second-largest stock exchange in the world.

On February 21, when Nvidia released its quarterly results in the US it also provided bullish commentary from its CEO, who stated that a “tipping point” had arrived in the artificial intelligence boom.

What is even more staggering is that on February 22, Nvidia rallied 16.4 per cent alone to $US785 a share, creating a tail wind for all AI-based companies and equity markets in general and one I believe will continue.

The rally, as Nvidia soared above $US700 a share, added $US277bn ($418bn) to its market capitalisation in one day (the largest increase in market capitalisation by a company in a single day in history). In the first two months of the year, Nvidia has increased its market capitalisation by more than $US720bn to $US1.97 trillion. To put this in perspective, the entire ASX was capitalised at $1.75 trillion as at January 31.

In February, the chairman and CEO of JPMorgan, Jamie Dimon, also weighed in on AI, arguing: “When we had the internet bubble the first time around … that was hype. This is not hype. It’s real.”

Back in September, Capital Economics said AI appeared to have all the “characteristics of a general purpose technology that will revolutionise economies and has the potential to deliver a substantial boost to productivity growth”.

It went on to forecast that the economies that adopted AI successfully would see a boost to productivity of as much as 1.5 per cent a year over the next decade. This will be led by the US, Korea and Singapore, with Germany, France and Italy being the three laggards due to EU regulation.

My view of AI is that it is creating a tail wind for markets. There is a valuation differential between the US and other developed market equity markets and it is wide – and many are arguing that US valuations are inflated. However, AI has created momentum.

This may raise eyebrows, but the facts are that these AI-related companies are increasing earnings. It is not just about revenue, as we experienced in the dotcom boom of the early 2000s.

That means it is important to concentrate on those companies with growing earnings, ones that are providers of AI or direct beneficiaries, such as consultancy firms.

I’d also say that there are emerging signs that opportunities in US stocks could broaden out beyond the Magnificent Seven this year for two reasons.

The first is the resilience of the US economy. The second reason is interest rate cuts.

Looking globally, as inflation has fallen, real interest rates have risen. It could be argued that monetary policy is now restrictive as a result. That suggests interest rates must decrease from current levels.

The exception is Australia, where real interest rates are not yet restrictive. In our domestic market, we did not increase the nominal cash rate by as much as other developed economies, and so inflation is not decreasing at the same rate as in those economies. We will have to catch up.

It’s a fact that interest rates have a major effect on equity markets. Looking ahead, I believe the US will start lowering rates in the second quarter and will cut rates another three to four times this year. This will underpin equity market performance and justify my optimism towards risk-based assets in 2024.

That’s why I say 5 per cent in term deposits is not good enough.

Will Hamilton is the managing partner of Hamilton Wealth Partners