It is estimated that there are 20 quadrillion ants spread amongst 12,000 species currently scurrying around the planet. These varied insects possess many superpowers, imbuing some with the ability to lift up to 50 times their body weight, some with lightning-fast jaws, and many others equipped with toxic venoms that can incapacitate much larger foes. There is even a species that can self-destruct on demand should the ant deem it necessary to defend the colony. Yet ants are perhaps best known for their tireless work ethic. Observe any collection of ants in your garden, on the sidewalk, or, for those more adventurous, in the jungle, and you are bound to see frenetic activity with seemingly every ant moving with glorious purpose as if directed by a single mind to meet the needs of the colony. Forget fears of artificial intelligence posing a threat to humanity; perhaps we should be worried about these ants that have us outnumbered 2.5 million to 1!

Take heart, though, a 2017 University of Arizona study[1] turned the common perception of the hyper-industrious ant on its head. After painstakingly marking individual ants and monitoring their movements over a period of time, it turns out the glorious purpose of the majority of ants is to simply lounge around and do nothing all day.

These “lazy” ants aren’t completely useless though. This same study noted that they serve as a sort of reserve work force, ready to step up at a moment’s notice should some catastrophe befall the active population of the colony. Being ants, these catastrophes can occur relatively frequently.

While our six-legged friends apparently lack the ambition to become the dominant species on the planet, there is some financial wisdom to be gained from emulating this approach to managing the colony’s energy and focus. Complacency borne of ignorance or sloth can certainly be detrimental to one’s financial health. However, even more harmful can be action purely for the sake of action.

As we close the book on 2024 and look forward to 2025, there is no shortage of impulses prodding us to act. This will always be the case in a media environment – whether it be TV, print, or social media and YouTube influencers – where economic incentives are driven by the attraction of eyeballs or clicks rather than providing prudent advice. The best media narrative is the one that creates the strongest reaction and the most engagement. This usually involves promising a surefire – and short-term – path to riches and rarely charts a realistic path towards long-term compounding of wealth.

Consider the typical analysis of the current state of global stock markets. U.S. stocks[2] had a second consecutive stellar year in 2024, posting a 25% return on top of 2023’s 26% return. Returns on stocks outside the U.S. were more muted with international[3] markets returning only 6% after also trailing U.S. stocks in 2023. At year-end, U.S. stocks were trading at 21.6x estimated earnings for the next year (it’s forward P/E) relative to a 30-year average of about 17x. In contrast, international stocks were being valued at 13.4x.

In light of these facts, two opposing narratives have arisen. One urges investors to pile into what has worked recently – namely, the eight mega-cap U.S. growth stocks that have driven the broader market’s returns over the past year and now account for ~35% of the market’s total capitalization. Recent performance and future enthusiasm are predicated on the prospects for generative AI (GenAI) applications to create immense value that will accrue to the entrenched tech giants able to invest in the infrastructure needed to bring them into reality. This approach is further championed given the backdrop of a persistently strong U.S. economy where GDP growth continues to outpace the rest of the world, unemployment remains low at 4.1%, and inflation[4] has moderated to 2.7%. With the Federal Reserve reacting to this strong macroeconomic backdrop by softening its language on further reductions in the overnight fed funds rate and the yield on the benchmark 10-year Treasury rising 0.95% since September to close the year at 4.58%, some say mega-cap Tech is the only game in town.

On the contrary, a second cohort staunchly argues that the valuation of the U.S. market – and, by implication, expectations for value creation from GenAI applications – has gotten ahead of itself and is primed for a period of painful multiple compression. The forward P/E of the U.S. market relative to international stocks – or even U.S. value – is larger than at any point in the last 25 years, and tis 25% higher than its own 30-year average. Historical data clearly shows that returns following periods of extended valuations tend to be subpar.

Unfortunately, the problem with determining which of these two opposing narratives to follow is that they’re both right. And they’re both wrong – or at least wrong in the conclusiveness of their conclusions. Further muddying the waters is that each side is represented by commentators or investors that have been saying the same thing for their entire careers while appealing to audiences predisposed to be receptive to their arguments.

Our unpopular, but we believe prudent, view is to acknowledge the merits and drawbacks of both sides of this debate and position our clients for success regardless of the outcome.

While valuations of U.S. stocks are high by historical standards, it is true that U.S. mega-cap Tech stocks are perhaps uniquely positioned to leverage their scale, access to customer data, currently entrenched products in customer workflows, and existing distribution to capitalize on the benefits of GenAI applications. While these benefits are still in the future and need to be measured against the massive capital investments, which are expected to approach $200B in 2025 among mega-cap Tech alone, it’s also highly likely that GAI will continue to improve into perpetuity. A stock market composed of businesses that more efficiently utilize their capital, generating higher returns on that capital, should trade at a premium to historical valuation measures . . . if reality matches expectations.

If reality fails to meet expectations, those pointing to stretched valuations will carry the day, yet above-average valuations are not, in and of themselves, a catalyst for stock market declines. One need look no further than the past five years to wonder how certain the naysayers can be that the market is overvalued and primed for a period of poor performance.

At the close of 2019, these same arguments could have been made. In fact, they were made. U.S. stocks were trading at 18.4x while international stocks were at 14.2x. U.S. stocks were at a premium compared to historical averages and international stocks were significantly “cheaper”. Many at the time called for reversion to the mean and for the more expensive market to underperform. Yet, the reverse happened. In spite of separate drawdowns of 34% and 25% during ensuing five years, U.S. stocks nearly doubled . International stocks returned only 26%. Even if one were to exclude the multiple expansion that buoyed the returns of the U.S. market during this period, earnings growth and capital return alone would have produced a return of 68%, which would have still been an above-average return on an absolute basis and also well in excess of international stocks over this time period.

As is always the case, past performance is no guarantee of future results, and the future is inherently unknowable despite the best efforts and collective wisdom of market participants. For our client’s investment portfolios, now does not seem like the moment for drastic action, but, rather, for carefully curated exposure to both the dominant theme of the day and, guided by value, exposure to other sectors that are potentially overlooked due to the enthusiasm for all things related to AI.

As your financial advisor, our primary goal at Kovitz is to help our clients avoid “the big mistake”. That’s the one that results in the permanent impairment of capital. This mistake could be something unique to your own circumstances, but it often takes the form of an emotional decision in response to a stressful market environment.

As opposed to the normal stressor of a sharp market sell-off, the stressor today is elevated valuations based on expectations for a new economic paradigm fostered by GAI, yet it is stressing nonetheless. Stress can lead to emotions, emotions can lead to irrational decision making, and irrational decision making can lead to “the big mistake”. While the role of an advisor is certainly to protect our clients from external threats, the main role – a role we are proud to play – is to serve as a barrier between our clients’ emotions and their capital.

Sometimes the best financial plan to avoid “the big mistake” is to simply lounge around like the reserve ants, waiting to act until it is necessary and not just for the sake of action.

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[1]Charbonneau D, Sasaki T, Dornhaus A (2017) Who needs ‘lazy’ workers? Inactive workers act as a ‘reserve’ labor force replacing active workers, but inactive workers are not replaced when they are removed. PLoS ONE 12(9): e0184074. https://doi.org/10.1371/journal.pone.0184074.

[2]References to U.S. stocks, the stock market, or their returns are represented by the S&P 500 Index.

[3]References to international markets and their returns are represented by the MSCI All-Country World ex-US Index.

[4]Inflation represented by CPI-U year-over-year change through November 30, 2024. Inflation measured by Core Personal Consumption Expenditures is a similar 2.8% vs. a year ago.

DISCLOSURES

Fees: Gross-of-fees composite returns incorporate the effects of all realized and unrealized gains and losses and the receipt, though not necessarily the direct reinvestment, of all dividends and income.  Gross-of-fees returns are presented before management fees, but after all trading expenses.  From inception through December 31, 2020 and after July 1, 2024, the Beginning Value Method (BVM) method was used to calculate returns. From January 1, 2021 through June 30, 2023, the Average Capital Base (ACB) method is used. Beginning on October 1, 2020, the net-of-fees returns are calculated by deducting model investment management fees, which are defined as the highest, generally applicable fees for the strategy of 1.00% of all composite assets. Prior to that, generally applicable fees were 1.25% for equity assets and 0.50% for cash assets. The firm's current management fee schedule is as follows: 1.25% on assets below $1 million, 1.0% per annum for assets from $1 million to $5 million, 0.85% per annum on assets from $5 million to $10 million, 0.75% per annum for assets from $10 million to $20 million, 0.65% per annum for assets from $20 million to $35 million, 0.55% per annum for assets from $35 million to $50 million, and 0.50% per annum for assets over $50 million. Such fees are negotiable. Where applicable, the total bundled or wrap fee charged to each portfolio is dependent on the end client’s financial advisor and wrap sponsor. The composite includes accounts that do not pay trading fees.

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).

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.