“Never in the field of human conflict was so much owed by so many to so few.”

This is a quote from a speech made by Prime Minister Winston Churchill on August 20, 1940, as he paid tribute to the efforts of the Royal Air Force during the Battle of Britain.

Churchill coined the phrase while visiting Fighter Command airfields in Southern England. He was acknowledging the debt that the world owed to the British airmen who were fighting against the odds to establish air combat superiority.

And while I am by no means equating heroic wartime efforts to investing, I think this principle has applied to the market over the last 20 years. A bulk of the returns in broad indices can be traced back to a select few companies.

So much owed by so many to so few.

But the winds are changing.

The stock market is undergoing a renaissance, and we are finally seeing a broadening beyond the MAG7 into year-end. Previously unloved areas of the market are showing signs of inflection while the crowded long trades are beginning to underperform.

In addition to navigating the fundamental tectonic shifts in the space, we now must navigate turbulent government policy, which could prove to be a strong tailwind – as long as you can hold on tight.

A red sweep will lead to less regulation, lower corporate taxes, and higher tariffs as the trade wars reignite. We need to square off a potentially higher for longer rate period where we may see moderation in the cutting cycle and a ballooning deficit that will lead to market substructures that create winners and losers.

We plan on continuing to pick the winners.

Megacap vs. The Rest

Megacap tech companies have enjoyed superior earnings growth by a wide margin for the better part of the last two decades. It just made sense that capital was crowding here. These companies were growing both top and bottom lines faster than the rest, while widening their moats. The relative gap is now beginning to narrow:

From a 39% gap to 4%!

Earning growth is the number one determinant of stock prices over the longer term. This is the quarterly weighing machine against the short-term voting machine that provides volatility. Just ask Nvidia. While many armchair experts declare Nvidia is the next Cisco, I believe they are heavily misguided due to one simple factor: earnings growth.

What we need to turn our attention to as we flip to the next calendar year is the rate of change. Bezos once famously said, “Your margin is my opportunity,” so we need to look at how potential competition (or regulation) can slow growth as we lap tougher year-over-year comps.

This doesn’t mean that megacap will suffer. As a result of decades of free cash flow and amassing treasure troves of data, megacap tech is still poised to see outsized benefits from the proliferation and productization of Artificial Intelligence.

We just believe there are better risk/reward opportunities in other areas of the stack.

Trump Trade

Watch what Trump does, not what he says. Policy over rhetoric. Trump 1.0 came out swinging against big tech while promoting a “drill baby drill” rhetoric. Over his first term, technology was the best-performing sector, while oil & gas was the worst. I think we’re set up to repeat here.

While many are trumpeting the lower regulation tune, it is not yet clear skies for megacap. Certain antitrust issues (e.g., Google v. DOJ) have now garnered significant bipartisan support. Additionally, we’re well aware that the Musk/Trump campaign trail attacked mainstream media as disdain mounted around censorship. This will affect social platforms known for censorship, like Meta. It looks like free speech is back on the menu, but you have to acknowledge that in doing so, there have been certain channels that have swung the pendulum too far the other way.

Regardless, I believe it’s time to build again.

Specifically, in certain areas of the market…

Crypto/Fintech

Small government has been an absolute disaster, much more than most people realize over the Biden administration. Anything that did not formally hold a banking license was hunted down and dissolved. There were gross over-reaches of bureaucracy that were incredibly un-American, and none more so in the fintech and crypto spaces. It is completely legal to make a meme coin; yet you will get sued by the SEC if you create a payment system with underlying utility because it was then deemed a security and regulated as such.

You can legally create a meme coin called “Sad Hamster,” yet if you create a payment platform that optimizes time-of-use energy curves when layering on solar/storage through a transactional grid… THAT is the thing that will get you into trouble.

If this sounds backwards, that’s because it is.

This is going away, and entirely new businesses will be created as a new era of innovation is unlocked. We have added exposure here and will continue to do so at the end of the year.

Semiconductors Moving to Haves & Have-Nots

One area that looks like a more cautious approach is warranted is Semiconductors. The nature of this supply chain is extremely global, and so is the diverse customer base. This has been an area of geopolitical interest because it is now seen as a national security issue for achieving advancements in artificial intelligence, and the White House is paying very close attention to this issue. The US has made moves to onshore manufacturing of key processes and components, and at the same time, they have encouraged companies to ban access to certain chips and machinery through restrictions that have hampered China’s access to cutting-edge tech.

When you think about powering AI, it affects everything in a global superpower – military defence, government intelligence, and economic growth through productivity enhancement. This is a new cold war era between China and the US, and it’s all focused on AI. Trump will again take a hardline when it comes to semiconductors and China’s access to them, so I think there will be a lot more volatile headlines there.

However, I think the market is sorting out the haves and have-nots. I think Nvidia will continue its impressive growth for the time being, while semiconductor equipment manufacturers like ASML and Lam may suffer because of their exposure of revenue in China. Networking companies like Arista, Broadcom, and Dell will continue to benefit because Nvidia’s new Blackwell GPU series requires much more complex infrastructure.

Even though geopolitical tensions and sanctions are going to ramp up, you have to look at the underlying secular growth trends that will continue to endure. A selective approach here is warranted.

Software is Dead? Long Live Software!

One of the areas left for dead in the market was software. The bear thesis went a little something like this: “AI is coming for everything; therefore, companies will get much more efficient and require less headcount. Since software is sold on a per-seat-per-year SaaS basis, lower seats mean lower revenue” – a pretty sound thesis in theory…

This worked in the first half of the year but has since reverted.

Software companies held an ace up their sleeve: the ability to shift their business models. More and more companies are shifting from SaaS-based models to consumption models that leverage AI agents. Since certain platform companies already serve as a system of record within large enterprises, their access to proprietary data, paired with low friction and high replacement costs, positioned them to be net beneficiaries of this.

This shift has several nuances:

• Point application software is very vulnerable to replacement, while platforms are more resilient.
• Business models must shift from SaaS to consumption models during the migration to focus on AI agents.
• Immediate and measurable ROI implementations will bring IT budget dollars back to software quicker.

However, startup companies that are AI-native are still a significant risk to incumbents. The incumbents must adapt to the new normal or risk getting replaced. In order to adapt, nearly every software company is layering on an AI agent to their application and seeing revenue double QoQ (albeit from a very small base). We may finally be seeing the next evolution in the product cycle, the move to the application layer (software & services in the chart below, using the corollary of the cloud revolution):

Wrapping Up…

There is no doubt that we are at the dawn of a new era in technology. I believe this will be the last year where AI remains a niche topic, primarily discussed in tech circles, rather than becoming a dominant conversation among the general public.

These applications will touch more and more aspects of everyday life through productivity applications, personalized “concierge” agents, small business enhancements, and robotics.

The companies of tomorrow will look nothing like they do today, as the only constant is change.

This new era is incredibly exciting, and those who hop on board are in for one helluva ride.

We are so back.

Nick Mersch, CFA – Strong convictions. Loosely held.

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