To Our Investors and Friends,
The S&P 500 finished the third quarter up 7.8% as the economy began to show signs of slowing. As has been the case since the April lows, the rally was fueled by the Magnificent Seven (up almost 17%) and some of the most speculative parts of the market. The 10-Year Treasury bond dropped a modest 12 basis points in the quarter to 4.12%. The 2-Year Treasury note declined 17 bps to end at 3.55%. Oil fell 4.2% in the quarter to close at $62 a barrel. The Russell 2000 Value Index led with a 12.6% gain, the Russell 2000 Growth Index exhibited a 12.2% increase, the Russell 1000 Growth Index advanced 10.5%, and the Russell 1000 Value Index gained 5.3% in the quarter.
The stock market has staged one of the most dramatic rebounds in its history from the April lows driven by the hopes that artificial intelligence will change the US economy at its very core. In his latest book, Revenge of the Tipping Point, Malcolm Gladwell revisits tipping points to better understand how they occur. In his many examples, he explains that there is usually an overstory, a set of conditions that exist prior to the tipping point, that makes it far easier to drive the majority of people in that direction. Gladwell explains, “If change happened gradually, you could see that you were getting closer and closer to your goal and you wouldn’t be surprised when you reached it. But if nothing happens and then everything happens you are in this strange position of being discouraged during a long stretch in which nothing is happening and stunned at the point at which it all shifts.” Right now, the market is anticipating that AI will revolutionize our economy but the current lack of returns on investments in AI suggests we have yet to reach the tipping point. The risk to the market is simply that investors will lose patience for the benefits of AI to show up.
OpenAI, the creator of popular app ChatGPT, has provided a blueprint for how AI will change the world. The company anticipates that usage of their tools can generate considerable cost savings for users across a whole range of professions, making them much more efficient workers in the future. The blueprint is a traditional capital for labor substitution in which considerably more money is spent on capital to increase worker productivity, reducing the need for additional labor.
OpenAI estimates it is on track to produce approximately $13 to $20 billion in sales in 2025 yet has already committed to over $100 billion in expenses over the next few years. The company needs to increase the approximate 5% of paid users and make more per user to generate the amount of revenue needed to be a profitable entity. This may be a tall order for a company whose recent introduction of ChatGPT-5 in August is considered by many to be a disappointing upgrade. Without greater benefits, this gap will be hard to close.
Most of the capital costs for AI software comes in the form of semi-conductors, hardware, and electricity generation. OpenAI CEO Sam Altman believes that the amount of electricity required to fuel the artificial brains his company is building will be 1000x greater in 2033 when compared to what was required at the beginning of 2025. In fact, this year alone, demand for electricity for its software tools is expected to increase 9x to two gigawatts by year’s end. OpenAI’s projection of 250 GW electricity capacity by the end of 2033 compares to the US’s current 488 GW demand – about a 50% increase in total US electricity demand for this single AI company’s needs alone. As a country, we will need to find a faster way to generate considerable cheaper energy or live with prices that may go up materially from here.
At Kingsland Investments, we have always been focused on finding companies that benefit from tipping points during which young businesses are using new technologies to replace older, less efficient products and services. Central to this methodology is evidence of greater demand through significant revenue growth and profitability. AI will be very meaningful to the world economy, but the progress that we make in its utilization won’t be the linear path that Wall Street is assuming. Most certainly the rapid speculation occurring now will be met with many disappointments, and a handful of significant positive surprises. We will continue to spend our time searching for uniquely positioned businesses that the market will likely reward in the future.
All the best to you,
Arthur K. Weise, CFA