Almost every stock market in the world has seen their rally led by AI related stocks over the past few months with the bulls believing that AI will transform the world. Yet, there are enough naysayers who bring up the bubble word every so often. The rest of us are confused and concerned about how to position our portfolios amid this polarised view of the future. In comes the calm and composed Larry Swedroe with this rational and practical advice. Larry paints for us both the optimistic and pessimistic scenarios and gives us a portfolio construct that hedges known risks and diversifies against the unknown.
In the optimistic scenario, he talks about a virtuous cycle where AI drives significant productivity gains in turn driving economic activity, wages rise without stoking inflation, US and the west grow out of their fiscal deficits and innovation booms across industries solving humanity’s hardest problems.
In the pessimistic scenario, he talks about a vicious cycle where AI spends come to nought, government deficits crowd out private investments, growth stalls, interest rates rise only for governments to pressurise and keep them low, which in turn stokes stagflation and currencies lose purchasing power.
“These aren’t abstract academic scenarios—they represent fundamentally different futures for American prosperity. In the optimistic path, rising living standards, manageable debts, and American technological leadership create broadly shared prosperity. In the pessimistic path, fiscal crisis, inflation, and slow growth erode the American middle class and diminish U.S. global influence.
Which Path Will We Take?
The difference between these scenarios isn’t predetermined, and there are no crystal balls allowing us to foresee the future. Fortunately, the good news is that the key to long-term investment success isn’t forecasting the unknowable future—it’s building portfolios robust enough to thrive regardless of what that future brings.
Portfolio Construction: Hedging Known Risks, Diversifying Against the Unknown
Core Diversification: Include assets with low correlation to economic cycles [he gives a bunch of specific assets as examples]
Inflation Protection: Consider floating rate debt, TIPS, gold, commodities, and real assets like real estate and infrastructure.
Smart investors prepare for multiple scenarios rather than betting on single outcomes. Focus on building resilient, “antifragile” portfolios that can withstand unexpected shocks.
This last point is particularly important as we have the unusual situation of the Fed easing while inflation stubbornly remains above target, fiscal policy is easy, credit conditions are loose with bank lending expanding, and stocks are at elevated levels (they appear to be priced to “perfection”). The Fed’s move to easing in this environment could lead to a bubble-like environment with valuations rising in the short term, but creating the risk of a blow out (a repeat of 2000).”
Larry reminds us that uncertainties are a feature of investment decision making and it is pertinent on us to be humble enough to acknowledge them and build resilient, ‘anti-fragile’ portfolios rather than trying to predict the unknowable future.
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