mattee2264

If Trump has little interest in climate change that will reduce some of the existential/obsolescence risk in relation to energy stocks so that might be moderately bullish. Shale has a pretty rapid depletion rate so if oil prices fall drilling will stop and that will push prices up. Already at $70 it is not economical for a lot of private energy companies to produce. There might be more consolidation in the energy space if low energy prices push down stock prices and private market values of smaller outfits. If the economy grows faster under Trump that is also bullish similarly if China do eventually give some kind of stimulus.

How do people think Big Tech will do under Trump? I can't imagine Republicans being as interested in anti-trust action as the Democrats were. I agree that Trump will probably throw Tesla quite a few bones. Might be some impact from protectionism on global profits especially if other countries retaliate. And if there is more confidence in economic growth under Trump you'd expect a bit of a rotation to cyclical/value stocks that would mean a rotation away from Big Tech.

Probably looking at 5 year performance (to include pre-pandemic) is a better guide as most stocks overshot in the COVID recovery because of the excessive policy response (ZIRP and fiscal handouts) and October 2021 was quite close to the peak of the last cycle. Agree with your point that they aren't as expensive as they were then because of build-up of retained earnings and the decrease in inflation-adjusted stock prices. But that isn't the same as saying they are bargains. And I think a lot of stocks are already pricing in quite a bit of optimism in relation to interest rate cuts and a soft landing and for this reason have recovered most if not all of their bear market losses. And there are also potential issues in the future to do with refinancing at higher interest rates and in the case of the banks commercial real estate problems. But yes if the economy can start improving and some of the AI productivity benefits start coming through then you'd expect from fairly average valuations that the rest of the market can produce healthy returns as a result of dividends + growth and there is room for valuations to go higher. The difference with Mag7 is the pandemic had lasting benefits as it accelerated the shift to cloud which has been a huge growth driver and the bear market also encouraged them to streamline their operations and improve their efficiency and they are also benefiting because the assumption is that Big Tech will also end up being Big AI.

Good article and Jeremy Grantham and colleagues have produced similar analysis in the past. Of course the main driver of stock returns second half of this cycle has been Mag7. They hardly pay any tax and even if interest rates stay around 4-5% cash and bonds aren't going to provide much competition so long as they can continue to grow at double digit rates and there is a lot more room for multiple expansion. Of course eventually their growth will slow down and that will hit their valuations and the rest of the market may struggle to pick up the slack with the headwinds of higher interest rates and tax rates the article mentioned. But in the short term that seems unlikely as public cloud spending is still growing at about 20% a year and AI will give another kicker to their returns and their market positions in the short term at least are unassailable and they have incredible pricing power.

Something I am trying to get my head around is the impact of all the AI spend on Mag7 profitability. For NVIDIA It is quite obvious. The AI capex of the other Mag7 members is NVIDIA's revenue and so long as they keep spending on NVIDIA chips at any price then NVIDIA will continue to enjoy insane margins and revenue growth. But I am wondering if there is also a benefit to the cloud divisions of Amazon Google and Microsoft. Presumably AI's insane computing and data requirements is increasing demand for cloud and therefore giving a boost to cloud growth? And cloud remains the biggest growth driver for Amazon Google and Microsoft who without it would be mature companies that would struggle to grow at double digit rates. If you look at the Q3 results of Mag7 members cloud growth is still incredibly strong and helping to justify multiples of around 40-50x earnings. And earning power is massive even without much in the way of contribution from nascent AI products. In the event that the AI investment boom turns to bust due to overcapacity and insufficient returns on all the associated capex then will the earning power of the other Mag7 members (as well as NVIDIA) take a hit? Or is this overwhelmed by the massive non-AI tailwind because over the world companies increasingly switch from on-premises software/hardware to cloud?

I think there are a few reasons why US deficits have yet to be inflationary: -There's been a very beneficial supply side impact from cheap immigrant labour which has helped to avoid a wage-price spiral -Despite that massive stimulus the US economy isn't running hot by any means -Commodity prices have dropped off significantly because of China weakness and sluggish global economy ex USA generally -A lot of the spending has been very unproductive e.g. adding to government payroll, paying interest, various vanity projects so hasn't really been filtering into the real economy in the same way the stimulus checks (which contributed to the first wave of inflation) did -Full employment is a bit of a misleading concept because it ignores individuals who have dropped out of the labour force

Economist has just done a front cover proclaiming the US economy to be the envy of the world. And such headlines often turn out to be contrarian indicators. BNP Parabis have noted that the Q3 2024 Atlanta Fed's nowcast estimate is up 3.4% annualized while their own nowcast for eurozone is 0.3% growth quarter on quarter. So annualizing that US is expected to triple eurozone growth in the third quarter. And the USA has had a far more robust recovery both from the GFC but also COVID while Eurozone and Japanese growth has been anaemic. Lots of strategists have produced charts showing how the US stock market has just beaten the pants of the other major stock markets over the last decade. And there have also been a lot of charts showing the increasing dominance of the US stock market of all country and global world stock market indices. US CAPE at 35x is a lot higher than other major markets especially emerging markets indicating much higher future growth expectations as well as lower risk. And anecdotally on the Bogleheads forum where the focus is more on asset allocation then 100% US equity allocation is increasingly fervently argued for with the need for international diworsification pooh-poohed. Buffett and Bogle were obviously both fans of a 100% US equity allocation for know-nothing index investors. Obviously it is easy to come up with reasons for all of this: -Big Tech and now Big AI are predominately American companies and they are global monopolies with incredible pricing power and seem to defy gravity in their ability to grow at fast growth rates and find new avenues of growth. -USD status as a reserve currency makes it easier for the US government to run huge deficits without the currency collapsing -US has benefited from an influx of cheap labour since the pandemic -US economy continues to be a favourable business environment with very lax competition law and business regulations which helps large firms to dominate markets while European markets are hampered by regulation and Japanese economy continues to keep having false dawns -Chip subsidies and the huge investment in AI have probably helped in recent years add to multiplier effects and prop up the tech complex -When growth is scarce it is rational to pay a high multiple for a stock market that has more than its fair share of blue chip growth companies -And probably quite a few more I haven't mentioned -Success begets success and therefore more and more inflows into the US stock market drive stock prices and valuations higher -Everyone is convinced that AI is the future with the expectation that the major beneficiaries of this are going to be Big US tech companies. But then again taking a longer view with the benefits of hindsight the US economy and stock market over the last century or so has been the clear winner. However it hasn't always been a smooth ride and the US stock market has suffered lost decades and much of the outperformance over shorter periods has been from starting points with much lower valuations both in absolute and relative terms. So perhaps some caution is still warranted and foreign diversification is perhaps more important now than ever. Thoughts?

I think the lesson is that no-one should underestimate the ability of fiscal and monetary policymakers to help the stock market defy gravity or their willingness to do so. Global central banks are all on course to ease aggressively even though their economies are doing just fine all things considering. Whoever gets elected is going to continue to run huge fiscal deficits to juice the economy. An over-easy policy stance in theory is inflationary but because its impact just seems to find its way into asset prices rather than the real economy the main inflationary impact is going to be on asset prices. And so long as there is a free lunch or the price lies far ahead in the future policy makers aren't going to care. Also the AI ecosystem is incredibly circular so incredibly self-reinforcing. Big Tech are minting money so can afford to spend huge amounts in AI capex regardless of the state of the economy or interest rates or tax rates or whatever else. This in turn boosts the earnings of chip companies and reinforces AI enthusiasm. No one seems to consider the possibility that it could be mal-investment or overinvestment and the future returns might not be sufficient to justify them. Instead markets are hyped up on the near term growth of the chip makers and the assumed future growth both of Big Tech and their AI products and the rest of the market and the economy based on the assumed productivity/efficiency improvements AI will deliver. And as long as the articles of faith are that: -Policy makers can manage the economy so that deep long recessions and financial crises are a thing of the past -AI is going to allow trillion dollar companies to continue to grow at fast rates and result in a productivity miracle for the rest of the economy Then I really think the S&P 500 could rise an awful lot more from now. GMO have a nice table comparing 2000 and now. They claim the media PE was 60 in 2000 for the top 10 companies compared to a median of 27x now. So on that basis we could see markets double over the next few years before we hit a bubble peak. Of course there is a bit of a difference because the mega-caps are a much higher percentage of GDP and are more mature and while the pitch with the internet was that the new economy would replace the old economy e.g. e-commerce, digital advertising, with AI the idea is that it will allow companies to expand margins and cut costs and the resulting cost-savings will presumably be the AI companies revenue.

Short term at least I think US outperformance seems pretty darn likely. US economy continues to show resilience (although I think a lot of it is due to the trillion plus dollar deficits and government hiring spree) but the Fed seems determined to aggressively cut interest rates. I imagine all the AI capex is also probably having some multiplier effects in the same way the US economy accelerated during the dot com bubble. And a bubble cannot fully form without the impetus of easy credit and that's been the missing ingredient so far in the AI bubble as rising interest rates have been a headwind. I'm an AI sceptic but it is the stuff that bubbles are made of: a revolutionary technology that promises to boost productivity, cut costs, increase margins and extend the growth runway of the tech mega-caps. Big Tech CEOs feel forced to invest huge amounts which is propelling NVIDIA to the stratosphere and corporate CEOs will also feel forced to invest in whatever products Big Tech put out because they know all their competitors will be doing so and everyone likes to try out a new technology and the idea of automating mundane tasks allowing companies to lay off lots of workers is an easy sell. The problems probably arise a few years down the line if expending more and more computing power fails to bring about further advances in the technology and the AI products fail to deliver the hoped for benefits or the costs outweigh the benefits which would make it difficult for Big Tech to achieve payback on their huge investments let alone a return and if they then cut back on their spending that will hurt the semiconductor companies who are minting money at the moment.

Agreed. Although if the Fed is hell bent on easing then it has a pretty big runway to offset any disappointments in relation to earnings (both corporate and GDP).

I find it a bit disturbing how much both Chinese and US not to mention Japanese stock markets are moving in response to actual and expected policy announcements. Doesn't look like a sign of healthy economies.

Interesting thing though is if you look at that chart selling when forward PE ratios rose above 20x you'd have been well served to lighten up on stocks and had an opportunity within a year or two to get back into the market at close to an average valuation. And worth noting that over the last 30 years we've been in a pretty low interest rate environment which will have had a benefit to average forward valuations. Question is whether this time is different. Market does seem to be anticipating fast growth of Big Tech earnings both over the next 12m but also for many years after that. And Big Tech forward PE ratios are clearly well above the average for the market.

It is pretty stupid really. China want us to take their low-skill manufacturing jobs so they can move up the value chain and take advantage of the scientific and technological capabilities they've been building as well as their strategic resource base. I can't help feeling that long term China may well be an absolutely fantastic investment bet to the point that it probably doesn't matter whether it may be currently overbought on the assumption that the stimulus package (and assumed future stimulus packages) prevent an economic depression. Short term things seem murky though. A consumer economy is easy to stimulate with stimulus checks and low interest rates. But investment has been a huge driver of the Chinese economy and there is a massive overhang of malinvestment and even low interest rates and easier credit conditions are unlikely to be enough to stimulate investment. And if the government tries to replace the investment spending by making its own investments a further misallocation of capital is even more likely.

Annoying that the major China indices have bounced 50% off the bottom. But there was a similar bounce after the COVID intervention and a lot of people were expecting another leg down but the stimulus kept flowing and it never happened. And you are still paying only about 12x earnings which is over half the valuation of the US stock market. And with the US stock market you're already pricing in a resilient US economy and Big Tech dominance and a favourable low tax and low interest rate environment and many other positives which may not be sustainable. And even after the bounce the index is still trading at levels that were seen over a decade ago. Short term outlook isn't great but there are reasons to be optimistic about the long term prospects of the Chinese economy as they've made significant technological and scientific advances and are moving into higher-margin businesses.

True. Then again when gold has a good decade it can increase many multiples in price and for most of the last 15 years or so it has been trading in a range of $1000-$2000 only breaking out over the last year or two.

Yeah that is the problem really. The insurance premium can vary depending on how scared market participants are. And also because there is no intrinsic value then there will be a lot of performance chasing. The gold price has basically doubled from pre-COVID levels. To some extent that reflects inflation as the price level and the money supply is around 30% higher. But offsetting that inflation has come down significantly which diminishes its value as an inflation hedge and interest rates are a lot higher so the absence of any income becomes more of a negative factor. Understandably there are concerns about the path of US government debt but difficult to know to what extent such concerns are already priced in and whether if governments finally decide to address the problem whether that will hurt the gold price. To me the gold miners look more interesting. You are essentially buying gold at a discount so there are two ways to win (the discount closes or gold price increases). The industry is consolidating and the gap between costs and prices allows for some mismanagement.

Lot of chatter about a nuclear renaissance.

Big China stimulus. Good for sentiment but I think without meaningful fiscal support won't do much for the economy.

I think I can guess one of the explanations for this. Mag7 are a much larger proportion of the index than they were at the 2021 peak and their earnings expectations are appreciably higher which has had a corresponding knock on effect on their multiples. Of course that is partly sentiment as there is clearly a lot of AI enthusiasm. But also grounded in fundamentals as growth stocks are valued on future earnings power. Also cyclicals haven't really sold off that much so markets aren't pricing in a recession or even much of a slowdown at this point. Well other than commodities which have taken a bit of a hit although probably more because of China's economic malaise.

The spin is that it is "benign 50". This is the Fed's view. That the economy is just fine and progress on disinflation means that it is appropriate to lower interest rates and we are still on track for a soft/no landing. The bear view is that the economy is heading into recession (or is already in recession) and the Fed is behind the curve and playing catch up. And JPOW mentioned that some other central banks have already started cutting. So to some extent it might be making up for not doing 25 bps last time round. The cynical view is that government debt is unsustainable and lower interest rates are required to allow the government to service debt etc. Who knows what the truth is because economic data has been all over the place. And I think that is something that people are not fully appreciating. How unpredictable the economy has become after COVID because of all the different shocks (policy shocks, supply side shocks, geopolitical shocks, immigration shocks, technology shocks etc). And probably to some extent economic data is subject to manipulation as it is an election year. But I think far too much importance is given to interest rates. Earnings are the main driver and the stock market pretty much shrugged off rising interest rates because they realized that inflation was good for earnings as the big firms have pricing power and obviously AI has been a huge driver of the market indices since the October 2022 lows. What happens next will be far more dependent on what happens to corporate earnings and in particular those of Big Tech who will be expected in coming quarters to show some kind of return on their massive AI investments.

I think that stock markets are still priced for low interest rates. And when markets are dominated by growth stocks low interest rates translate into very high multiples. The idea though is that we will have "benign" rate cuts i.e. rate cuts because disinflation means that interest rates do not need to be so high rather than rate cuts because the economy is heading into recession. If we do go into recession then even with lower rates you'd expect multiples (and earnings) to fall. And I do not think Big Tech will be spared from this double whammy. Clearly high multiples also reflect high confidence that market leaders (which are mostly tech) will continue to grow at fast rates. And given the massive investments they've made in AI, they also reflect confidence that AI will be a major source of that continued fast growth. I agree that over the long term PE multiples have structurally drifted higher. 100 years ago 20x earnings was a bull market mania valuation. This century it has been about the norm. Right now we are closer to 30x earnings. Perhaps that could be the new normal if tech dominance continues. And as we saw during the Roaring 20s and the Nifty Fifty Bubble investors are willing to pay very high multiples for blue chip growth companies. The problem is that once you are a blue chip growth company either you mature and your growth slows OR competition/creative destruction can send you into decline. Big Tech are trying to avoid this fate by being at the forefront of innovation and entering into new markets and basically buying or investing in any emerging competition and are also engaged in all kinds of anti-competitive practices. But it is not an easy feat and there are already signs of cracks.

"The debt-to-GDP ratio was approximately 97 percent at the end of FY 2023. Under current policy and based on this report’s assumptions, it is projected to reach 531 percent by 2098. The projected continuous rise of the debt-to-GDP ratio indicates that current policy is unsustainable" This is shocking really. Also begs the question as to how much of the increase in corporate profits compared to pre-pandemic levels is attributable to huge deficit spending (not to mention massive expansion of the Fed's balance sheet). And even before the pandemic from 2015 to 2019 the US annual deficit increased from approximately $500m to just under $1TR. Not to mention the cumulative expansion of the Fed's balance sheet over this cycle which is far in excess of the half hearted attempts at QT. And fiscal stimulus operates to some degree with a lag so there is a cumulative benefit from all the deficit spending over the last decade. Imagine what would happen then if at some point the US government was forced to either increase taxes or cut spending or if interest rates rose significantly to reflect the unsustainability of the fiscal trajectory? Really we do seem to be heading to the Japanification of the US economy and no doubt interest rates will have to stay low so that government debt (not to mention consumer and corporate debt) can continue to increase at a breath-neck pace and ultimately it will be the USD that takes the hit. The difference is that Japan has been able to keep inflation under control helped by a shrinking population and global disinflationary trend which only reversed post-COVID as well as a pretty stagnant economy. Inflation is now below 3% in the USA. But that reflects a slowing economy as well as a benefit from mass immigration which has kept wage inflation in check and strong dollar and the decline in energy prices has helped. But inflation probably remains the fly and the wall that will prevent another decade of the virtuous cycle of debt and money supply expansion.

What is clear is that neither party has any intention of fiscal restraint. And unlike in Europe the markets won't discipline the USA for that in any meaningful way. That probably does mean that we will have higher for long interest rates (although there may be some easing over the next year if the economy continues to weaken) unless the much anticipated AI productivity miracle materializes

No idea whether this is a correction or something more ominous. But what is apparent is: 1)Bad news is now bad news (and therefore rate cuts are unlikely to be bullish but rather will be seen as confirmatory of an incoming recession). It also means that a lot will depend on how much the economy weakens in the coming quarters. 2) Mag7 are starting to run into problems: Nvidia's latest chip is delayed 3 months, Google lost an antitrust case, Buffett is unloading Apple, Meta are hyping up a glorified AI chat-bot, we aren't really seeing the anticipated acceleration in growth from AI spend and investors are starting to get concerned about the huge capex spend. So the news flow and next earnings reports are going to matter a lot. 3) Because of 1) if investors rotate out of Mag7 they are going into defensives and cash/bonds and that isn't bullish 4) There are some systemic vulnerabilities that can result in a lot of forced selling and cause various things to break. 5) Even after the sell-off the equity risk premium is probably inadequate (especially for Mag7) so even repricing of risk is enough to create additional downside.

If the Japanese carry trade unwinding is the cause of a lot of forced selling then emergency interest rate cuts are just going to make everything a lot worse! And an emergency cut will just reinforce the feeling that something bad is on the horizon. So Fed would be better off waiting until September and if there is further evidence of the economy deteriorating only then think about a first rate cut.