To Our Investors and Friends,
The Philadelphia Semiconductor Index, which consists of leading semiconductor stocks such as Nvidia (NVDA represents 11.8% of the index), led the market higher -- up 29.9% this quarter. The rest of the S&P 500 followed suit, finishing the quarter ahead by 10.6%. The 10-Year Treasury bond advanced modestly by one basis point in the quarter to 4.23%. The 2-Year Treasury Note declined 17 bps to end at 3.72%. Despite a brief jolt driven by the Israeli-led attack on Iran, oil fell by 8.9% in the quarter to finish at just over $65 a barrel. This has been a very unusual market as professional investors remain cautious due to the unresolved tariff policy and the specter of stagflation, while traders quickly embraced the most speculative parts of the market. The result was a surge in the Russell 1000 Growth Index of 17.8% and an impressive 12.0% increase in the Russell 2000 Growth Index that was driven by the most speculative companies in the index. These include quantitative computer and space stocks which are trading at levels reminiscent of the internet bubble 25 years ago. The Russell 2000 Value Index rose a more modest 5.0% and the Russell 1000 Value Index increased 3.8%.
The rapid recovery in the market has been driven by the view that investments in Artificial Intelligence should continue unabated even as concerns over tariffs and the potential for a slowing economy remain. Under the surface, however, there are signs that the current spending on AI infrastructure is not producing great returns and may foretell a moderation in future investment. According to a recent research report by Goldman Sachs, the hyperscalers (cloud software and AI infrastructure providers) including META, Alphabet, Amazon, and Microsoft have spent almost $480 billion in capital expenditures over the last three years. The investment bank projects this spending to more than double over the next three years, supporting the view that Nvidia and others can continue to grow their businesses significantly over the same time frame.
We believe indications of poor returns on investment do not bode well for a doubling of spending from here. As can be seen in the chart below, these hyperscalers have been seeing decreasing returns on their investment, and even higher spending suggests returns may continue to fall. The most damning evidence of falling returns on investment comes from CoreWeave (CRWV) which went public at the end of March. CoreWeave spent $8.7 billion in cap ex in 2024 on AI semiconductors and hardware so that large hyperscaler customers could improve their returns by “renting” the higher processing power without having to put up the capital to own it. It turn, CoreWeave has been able to charge these customers significant prices giving them unusually high margins for a service provider. Still, they were only able to produce $1.9 billion in revenue last year, highlighting the low revenue yielded from such aggressive spending. The market figured this out – as Nvidia had to bail out the IPO by putting up $250 million to support the deal.
At Kingsland Investments, we invest in companies that are disciplined in their purchases of capital equipment, which leads to higher returns on investment. This fuels higher stock prices over long time frames. This is why we favor software companies that have more consistent revenue and profits over time than the hardware companies that the market favors now. We anticipate that if returns don’t improve for those investing in AI hardware, the market will force them to reallocate resources into more productive businesses in the coming years.
All the best to you,
Arthur K. Weise, CFA