The 1990 cinematic classic Total Recall is set in the year 2084 and the writers had lofty expectations for the future. As the story goes, there are people living on Mars, medical technology has advanced to the point where implanting realistic memories of vacations directly in a person’s brain can be had at a cheaper price point than the cost of a flight and hotel, and cab drivers have been displaced by fully autonomous “JohnnyCabs” operated by genial robots powered by artificial intelligence (AI).

In one scene, Arnold Schwarzenegger’s character, Douglas Quaid, fleeing from the bad guys, hops in one such JohnnyCab and yells to the robot to “just drive”. After some back-and-forth where the robot exhibits strong natural language processing abilities, Quaid and the AI-powered vehicle ultimately suffer a communication breakdown. Quaid responds by ripping the robot off its moorings, throwing it in the backseat, and taking over the vehicle. The JohnnyCab takes this in stride, even making some humorous comments along the way. After evading the baddies, Quaid makes his way to an abandoned industrial park, where he leaves the vehicle but refuses to pay. Enraged, the AI-powered vehicle attempts to run him over, crashes into a wall, and explodes. A shocking – and inconsistent – series of events to be sure!

This scene conveys one of the key contradictions of human nature. Humans are generally blessed with the innate belief that the future, in general, offers great potential for progress, whether in the form of technological advancement or financial gains. At the same time, our nature is also to fear the specifics of an inherently uncertain future, perhaps worried the benefits of progress will accrue to someone else or that technological change will replace the need for our own labor or creativity or even try to kill us as the fare-jilted JohnnyCab did to Quaid.

Open Your Mind

Ironically, the reaction to the advent of autonomous vehicles in the present is another example. Sixty years ahead of the imagined future in Total Recall, there are fully autonomous vehicles operating in a handful of cities in the United States. These vehicles, with the assistance of occasional remote interventions, are already safer than human drivers as measured by incidents per mile. Waymo, the autonomous vehicle subsidiary of Google-parent Alphabet, reports a 48% reduction in police-reported crashes and a 73% reduction in injury-causing crashes compared to what would be expected from human drivers over the same number of miles driven. That’s particularly incredible when you consider that today is the worst this technology will ever be as better hardware and better algorithms continue to improve the performance of these vehicles.

Yet, there is still a significant amount of trepidation around the widespread introduction of these vehicles. This is mainly due to the fact that the mistakes these vehicles make are often inexplicable from a human driver's perspective. The internet is littered with videos of self-driving vehicles confused by traffic cones, honking incessantly, or seeming to unexpectedly gather in the middle of an intersection.

Get Ready for a Surprise

A similar mindset pervades financial markets, largely related to the predominance of artificial intelligence (AI) and related themes. There is a sense that we are in the midst of a technological step-change equivalent to the advent of the steam engine, electricity, the automobile, or the Internet. It is early days, but AI-powered chatbots are already handling an increasing load of customer service calls in consumer-facing businesses. AI-powered digital assistants are helping create images and videos, taking accurate notes that summarize business meetings, and using natural language processing to write computer code according to a prompt. And, of course, AI tools are proving quite useful in helping high school and college students cheat on research projects and essays. These use cases, and the many more that will surely come, may cause a tectonic shift in how people and businesses operate and supercharge economic growth. That may absolutely be the case.

Or it may not be.

Economist Paul Krugman is often ridiculed for a statement made in 1998 predicting the internet would have as much effect on the economy as the fax machine. Imagine how foolish those words sound now with the knowledge of how the internet has become central to how humans and businesses interact! Imagine the productivity gains the economy and humanity, more broadly, benefits from having the ability to instantaneously communicate and access information! Imagine how much more efficient businesses have become! Obviously, labor productivity growth has skyrocketed, right?

Well, it hasn’t worked out that way. Over the last 30 years, which roughly corresponds to the period starting with America Online flooding American’s mailboxes – the ones on the street – with physical CDs that allowed access to the internet, growth in labor productivity decelerated to 2% from a post-WWII average of 2.2%.[1]

Maybe this time will be different.

The push to invest in more powerful generative AI models, the chips to run them on, and the infrastructure and electricity needed to support them has been strong. Capital expenditures at the five major US cloud computing companies (Microsoft, Amazon, Alphabet (Google), Meta, and Oracle) have grown from $130B in 2021 (before ChatGPT was released) to what is looking like $215B in 2024, and this figure is expected to grow another 50% over the next five years based on the consensus forecast of Wall Street analysts.

However, these AI models are not perfect. Examples of “hallucinations” from large language models like ChatGPT and errors, such as the occasional bizarre actions of autonomous vehicles mentioned above, are pervasive. And unlike typical software, an engineer can’t simply find the error in the code and correct it. The only solution is to continue training the model with more data and more computing power until the hallucinations stop. But how do we know they’ve stopped for good or that the frequency has fallen low enough to make it difficult to detect?

Conversely, it is certainly possible that the enthusiasm for AI-related applications and the infrastructure to support them has “pulled forward” some amount of the future economic benefits into today’s stock market valuations. The market[2] is currently trading at 21.6x estimated earnings over the next twelve months, which is a meaningful premium to the prior 30-year average of 16.7x.[3] Plus, the ten largest companies in the market are overwhelmingly “Tech”-focused and now make up around 36% of the total market capitalization of the S&P 500. Great rewards are on offer if AI lives up to the potential of its most optimistic evangelists, yet great risks also lay in wait if the timeline on which AI applications are monetized is extended or if the benefits accrue to companies different from what is currently implied by market valuations.

What if This is A Dream?

If you are expecting a bold prediction on the future of AI and its impacts on businesses and financial markets, I would hope you have read enough of these communications by now to know that it is not a game we believe is beneficial to play. Whether AI turns out to be a revolution or simply an evolution, the fact of the matter is that the key to a successful long-term financial plan is to avoid both complacency and fear in all environments. Change is a constant, and the course of action most likely to harm your financial health is to overreact – in either direction – to the perception that change is a new variable previously unaccounted for. As always, the best course of action is to establish a realistic financial plan that incorporates an asset allocation that reflects your ability and willingness to accept volatility of returns, populate that asset allocation with a diverse set of cashflow-producing, competitively advantaged businesses and assets trading at reasonable valuations, and then, most importantly, keep one’s head.

Importantly, as things stand in the broader economy, we are in a pretty good place.

Unemployment, at 4.1%, continues to remain near historic lows. The prime age (25-54 years old) employment-to-population ratio is at 81%, higher than any point in history outside of the go-go late 1990s. Inflation, whether measured by CPI or the Federal Reserve’s preferred Core PCE, has fallen under 3% and is trending towards the Fed’s 2% target. The Fed cut interest rates by half a point in September and has indicated more easing to come. This expectation has already resulted in mortgage rates falling roughly 1.5% from their peak last year.

The stock market has returned 22.1% year-to-date, 36% over the past year, and now an average of 14.1% per year over the past fifteen years. This compares to a long-term average compound return of around 9.5%. Quite frankly, this has been an incredible period for compounding wealth and anyone currently or soon-to-be in their retirement phase should be incredibly grateful for the good fortune of their birth year.

Looking forward, it is possible that equity returns over the next fifteen years could substantially trail returns over the prior fifteen years. But that does not necessarily mean equity returns, or asset returns, in general, will be insufficient to meet your financial goals.

Just drive, JohhnyCab. Just drive.

[1] For a more complete discussion of this topic, see Robert J. Gordon’s The Rise and Fall of American Growth, Princeton University Press, 2016

[2] References to “the market”, “the stock market”, or its returns are represented by the S&P 500 Total Return Index.

[3] Per JPMorgan Asset Management Guide to the Markets

DISCLOSURES

Fees: Gross-of-fees returns shown incorporate the effects of all realized and unrealized gains and losses and the receipt, though not necessarily the direct investment of, all dividends and income. Net-of-fees returns shown are supplemental to the Core Equity Wrap Composite shown above. They are calculated by deducting the transaction cost of 0.10% and a portion of the total wrap fee designated as Kovitz’ management fee, which is 0.35% of assets per annum, from the gross return. The total wrap fee applicable to a particular client is dependent on the fees charged by the client’s financial advisor under the RBC wrap program. Composite Net-of-fees returns are calculated by deducting the highest, generally applicable wrap fee, which includes all charges for trading costs, investment management, administration, and custody, of 2.0% of assets per annum, less the portion previously designated for trading expenses, from the gross return. The total wrap fee applicable to a particular client is dependent on the fees charged by the client’s financial advisor and the applicable wrap sponsor. Such fees are negotiable and do not represent the experience of any Kovitz client. Gross-of-fees returns are presented before the deduction of management fees, but after the deduction of the portion of the wrap fee designated for trading expenses. Current wrap fees can theoretically range from 1.0% to 3.0% of assets per annum.

Prior to January 1, 2010, the Composite included the performance of assets that had been “carved out” of multiple asset class portfolios. When calculating performance, a hypothetical cash balance for each month was allocated to the carve-out on a pro-rata basis relative to the portion of each portfolio’s assets that comprised the carved out asset class. Beginning January 1, 2010, changes in the GIPS standards caused the Composite to be redefined and all carve-outs to be removed from the Composite. Carve-outs formerly included in the Composite continue to be managed in the same manner as they were before being removed from the Composite.

Definition of The Firm: Kovitz Investment Group Partners, LLC (Kovitz) is an investment adviser registered with the Securities Exchange Commission under the Investment Advisers Act of 1940 that provides investment management services to individual and institutional clients. From October 1, 2003 to December 31, 2015, the Firm was defined as Kovitz Investment Group, LLC. Effective January 1, 2016, Kovitz Investment Group, LLC underwent an organizational change and all persons responsible for portfolio management became employees of Kovitz. From January 1, 1997 to September 30, 2003, all persons responsible for portfolio management comprised the Kovitz Group, an independent division of Rothschild Investment Corp (Rothschild).

Composite Definition: The Core Equity Wrap Composite includes all fee-paying, discretionary portfolios, including portfolios managed under a relationship with a wrap sponsor, managed to the Kovitz Core Equity strategy. The Kovitz Core Equity strategy utilizes a private owner mentality to purchase equity securities issued by companies with durable competitive advantages and strong balance sheets that are trading at a significant discount to their intrinsic value. The goal of this strategy is to maximize long-term total return. The inception date for this composite is January 1, 1997, and the Composite was created on June 1, 2014. The minimum portfolio size to be included in the Composite is $250,000 until December 31, 2021. Thereafter, the strategy minimum was raised to $1 million. The benchmark is the S&P 500 index.

The benchmark for the Composite is the S&P 500 Index. The S&P 500 Index is composed of 500 leading companies in the United States, covers approximately 75% of the market capitalization of U.S. equities, and serves as a proxy for the total market. The S&P 500 Index returns do not include the effect of transaction costs or fees and assume reinvestment of dividends into the index.

GIPS: Kovitz Investment Group Partners, LLC (Kovitz) claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Kovitz has been independently verified for the periods January 1, 1997 through December 31, 2022. The verification report is available upon request. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. Verification does not provide assurance on the accuracy of any specific performance report. GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

Valuations are computed and performance is reported in U.S. dollars. The measure of internal dispersion presented above is an asset-weighted standard deviation. The three year standard deviation presented above is calculated using monthly net-of-fees returns. The three year standard deviation is not presented when less than 36 months of returns are available. The risk measures, unless otherwise noted, are calculated gross of fees. A complete listing of composite descriptions and policies for valuing portfolios, calculating performance, and preparing GIPS reports are available on request. The composite includes accounts that do not pay trading fees.

The description of products, services, and performance results of Kovitz contained herein is not an offering or a solicitation of any kind. Past performance is not an indication of future results. Securities investments are subject to risk and may lose value.