mattee2264

Fed have already said that a worsening unemployment situation could justify a cut even if inflation remains sticky. But it is hard to imagine unemployment rising significantly when the US government continues to run massive fiscal deficits at full employment. So I expect US GDP growth to remain strong and US inflation to remain sticky and with that being the case agree that it is difficult to imagine more than a few cuts this year and probably towards the end of the year rather than in the summer. Something that does concern me a little is whether there is a "boiling frog" scenario. So far high interest rates haven't been a massive issue because a lot of companies and consumers are still benefiting from low-cost debt raised during ZIRP. But refinancing cannot be delayed forever and there is a lot of leverage in the system as companies and consumers and governments took advantage of ZIRP to pile on debt.

Stagnation is the Japan scenario. It isn't going to happen to the USA which continues to have the most dynamic and innovative businesses. You need declining multiples AND earnings over a long period of time. So long as the medium to long term trend of USA corporate earnings is upwards (albeit with cyclicality) stagnation will be avoided. A sideways market is more benign and results from a combination of multiple compression and earnings failing to grow enough over the period of measurement to offset this. The Shiller CAPE is around 35. But for much of this century the CAPE has been in the 20-30 range. And since 2015 it has spent most of the time in the 25-35 range and that is even with two bear markets. So I think bears overestimate the potential for multiple compression. So multiple compression is a necessary but historically not a sufficient condition (unless you are comparing market levels at bull market peaks and bear market troughs). What you also usually need is for earnings to go on a long and interesting ride to nowhere over a long period of time. For that to happen you need major recessions that take years to recover from. And again the bear markets have been wrong in their prediction for a hard landing. Of course you do not need a major economic recession. 2000-2002 was a good example. The economic recession was mild. But the corporate profits recession was severe because it turned out that dot com earnings weren't sustainable because they reflected the peak of a boom and bust investment cycle and a fair degree of creative/fraudulent accounting which got cracked down on after all the scandals. But difficult to see that analogy playing out either. Difference this time is that the mature Big Tech companies (ignoring Nvidia/Tesla etc) have their earnings power backed by free cash flow and very strong moats. And even if AI doesn't provide much benefit to their earnings just from their core businesses they should do just fine. And if we avoid a major economic recession then the rest of the market should do just fine as well as their valuations are about average and their earnings will grow in line with nominal GDP growth over long periods.

Lower interest rates must also be a factor in higher margins. And we haven't really seen the full impact of reversion of interest rates to more normal (if still quite low) levels because most companies were smart enough to pile on low cost long term debt during the pandemic before the rate hiking cycle began. Financial engineering has also been a factor in stock returns exceeding earnings returns as companies were able to borrow cheaply to fund stock buybacks and a shrinking share count supports higher prices and provides a constant bid for the underlying shares. And something else that has been helping margins is that companies have been able to use inflation as an excuse to increase prices by 50% from pre-pandemic levels and even though their input costs have now come down and they've been able to make cost savings by cutting staff numbers and limiting wage increases to well below the rate of inflation these haven't been passed on to consumers. A reflection of how concentrated most markets are these days. And of course there are composition changes. You'd expect S&P margins to be higher when tech has gone from 10-15% to 30-35% of the index and in this cycle there has also been a shift in investor preferences away from low margin value stocks and cyclicals and towards high margin if low growth consumer defensives.

The main area in which competition authorities screwed up is by allowing a lot of acquisitions by Big Tech that essentially bought out potential or actual competition and greatly increased their market share. There has always been a soft touch to tech regulation on the basis that they don't want to discourage innovation and creative destruction will supposedly ensure that strong market positions are not permanent.

It is easy to see why Fed will cut rates at the first opportunity: -They want to get Biden re-elected -The government has huge amounts of debt to service and lower rates and a period of financial repression makes that a lot easier -There is a looming commercial real estate crisis as so many loans are underwater and they will want to avoid politically unpopular bailouts -Consumers are hooked on debt e.g. mortgages, credit cards and are suffering -Lots of companies will struggle to refinance cheap debt refinanced during the pandemic Disinflation stalling at around 3% is a minor inconvenience to them. And they can still claim that if they reduce by 75bps (the 3 cuts pencilled in) that policy is still restrictive and real interest rates are positive and they can explain away hot economic data by saying it is in the rear window and they see weaknesses in the economic outlook

Where a lot of these guys go wrong is they believe too much in mean reversion and the "lessons" of market/economic history which makes it difficult for them to accept that maybe this time it is different and they forget that economic laws are not like the laws of physics and are not immutable. These guys anchor on valuations being in the top 1% of the historical range with a CAPE of 35. But when over the long pull valuations trend upwards then it isn't as scary as it sounds. 100-150 years ago America was an emerging economy mostly engaged in the primary and secondary industries that were very competitive. So valuations were correspondingly low. These days America is a hyper advanced modern economy with globally dominant technology and service companies with fantastic market positions so it is not surprising valuations are a lot higher. Also the Fed's desire to maintain excess liquidity in the financial system and flood the system with liquidity at the first sign of trouble is very supportive to valuations because all that money usually ends up in stocks. Likewise financial repression seems inevitable given the size of the Federal debt which again supports higher valuations by keeping the cost of capital low and enabling financial engineering such as debt funded buybacks which create additional scarcity (reducing the sharecount) and give a constant bid to share prices. And ditto with all the pension contributions flowing into stocks as institutions increasingly favour higher equity allocations. Besides market valuations are distorted by Mag7 that constitute 30% of the index. Ex-Mag7, valuations look pretty reasonable if you believe that we are still in a low to moderate inflation and interest rate environment. And downright cheap if you think that AI can increase productivity for old economy companies. Mag7 stocks may be valued at PE ratios two to three times the median PE ratio. But their margins, returns, growth rates are way higher than the rest of the market. Of course they argue that their valuations, growth rates and returns and margins will eventually revert to the mean which will create large losses for investors. Hussman's latest missive is a well written description of this argument: "In the short run, there’s no question that strong demand for new, scarce products, such as AI chips, can enable a company to enjoy extremely high profit margins. Still, it’s dangerous for investors to treat these high profit margins as permanent, and to value stocks as if those profit margins will be sustained indefinitely. Put simply, the combination of a high growth rate and a high profit margin has never proved to be permanent. The current crop of “glamour stocks” increasingly relies on both here" But again there are some logical flaws. The profit margins and growth rates do not have to be permanent. You just need a long enough period of high earnings and earnings growth to justify the DCF valuation. And that is where Big Tech companies have excelled. They have achieved earning power and market caps that were previously unthinkable because as well as dominating their own large global markets they have disrupted multiple other markets and have navigated various technological changes to stay at the forefront and fend off competition. As a result they have managed to avoid the fate of most growth companies which see their growth slow down or even turn down as a result of encroaching competition, market saturation, maturity of their product and industry life cycles and mismanagement. Cloud and now AI have been godsends for them and if the pace of AI progress continues AI could be the gift that keeps giving as they will enjoy multiple product upgrade cycles and an adoption curve that gives an incredible growth runway so long as some start up doesn't come out of nowhere and steal their market share.

People conflate Mag7 with the market because Mag7 is 30% of the S&P 500 and the S&P 493 has basically gone nowhere over the last five years while Mag7 has increased about fivefold. And at this stage most investors are either indexing (or closet indexing) or buying call options on tech stocks. And it isn't difficult to understand why. John Authers in the article I referenced earlier discussed the concept of a "bubble" in fundamentals. Over the last 5 years or so Big Tech have grown earnings around 20% a year and their stock prices have increased by a similar amount. So not that bubbly from a valuation perspective and indeed valuations are far lower than those reached by Nifty Fifty and during the Dot Com bubble. Nvidia is a more extreme example but again a lot of its stock price increase is driven by earnings growth rather than multiple expansion. But the question is whether this earnings growth is sustainable going forward. Eventually the law of large numbers will catch up. And while AI is seen as extending the fast growth runway for Big Tech and delaying incipient maturity the reality is that aside from Nvidia no one has a moat in the AI space and eventually the hype will need to be supported by evidence of monetisation. And AI is bringing Big Tech companies into direct competition. And if AI does deliver productivity improvements and allow companies to reduce their headcounts then a lot of companies within the S&P 493 are going to get a double whammy from better earnings and a higher multiple.

https://www.bloomberg.com/opinion/articles/2024-03-12/nvda-vs-csco-a-bubble-by-any-other-metric-is-still-a-bubble?utm_source=website&utm_medium=share&utm_campaign=twitter Bit of a more balanced commentary from John Authers. Agree with the general point that a big question is whether the acceleration of earnings growth of Mag7 post-pandemic and in the case of Nvidia over the last year or so is sustainable and that probably matters a lot more than valuation which are rich but not to the same extent as Nifty Fifty or Dot Com levels.

Grantham bearish as usual on the US stock market but sees good opportunities in climate related investments https://www.gmo.com/europe/research-library/the-great-paradox-of-the-u.s.-market_viewpoints "Climate-related investments: With increasing climate damage and the increasing willingness of governments to take action, I believe climate investments will have top-line revenue growth that is guaranteed to be above average for the next many decades, although with no guarantees as to the smoothness of that growth. But, with all the cost of solar, wind, etc. being up front and little of the cost being operational, climate investments are exceptionally discount rate-sensitive, which has hammered them over the past two and a half years. And in its usual way, the market has overreacted to the trend of rising rates, making these investments real bargains today. Today, solar stocks are priced at over a 50% discount to the broad equity market, and some of the best clean energy companies in the world trade at levels that imply negative real growth" Anything climate related bubbled up in the aftermath of the pandemic and then got killed when interest rates rose. But therein perhaps lies the opportunity. Especially as market attention has switched to anything AI related and cryptos are back in favour. Of course renewables have always struggled to stand up on their own two feet without subsidies and other government grants and the energy transition isn't going to happen overnight which doesn't jive well with investors increasingly short time horizons. But over the long term we are going to have to get a much higher share of our energy from renewables. https://www.ishares.com/us/products/239738/ishares-global-clean-energy-etf seems a know-nothing investor way to play this theme. And the chart below shows that its price has returned to pre-pandemic levels irrespective of the fact that ESG reporting is becoming a way bigger deal and climate change is being taken increasingly serious. But interested if anyone on here has any specific names they favour.

Isn't it a little worrying for Mag7 investors that a start-up founded only a few years ago can release LLMs that compare favourably to the ones put out by OpenAI/Microsoft and Google? Reinforces the point that in AI no one really has a moat at this point. Mag7's ability to stockpile chips gives them an edge and they can outspend everyone on R&D. But in the internet age it was Google who ended up with the dominant search engine not AOL/Netscape/Microsoft. Any company with a good idea/product will have little problem attracting funding and users aren't locked in to a specific LLM at this point so will switch if something better comes along. And so far it is LLMs that are generating all the buzz and drawing in all the users and seeming to have the most practical use as a lot of people are using LLMs to write emails, assignments, research papers, marketing copy etc.

Does seem to be a bit of a race against time. Can the supply side benefits of Artificial Intelligence and immigration get inflation down quickly enough to allow the Fed to cut interest rates to a level where debt servicing costs are more manageable? And will GDP be able to grow at a 4-5% rate over the next decade or two which would greatly help reduce debt to GDP and reduce reliance on fiscal stimulus to keep the economy firing on all cylinders?

https://www.axios.com/2023/11/03/productivity-growth-us-economy https://www.reuters.com/markets/us/us-productivity-rises-fastest-pace-three-years-third-quarter-2023-11-02/ https://www.ft.com/content/61b8574d-724c-4486-b6b0-21191c22d476 https://www.brookings.edu/articles/machines-of-mind-the-case-for-an-ai-powered-productivity-boom/ https://www.bloomberg.com/opinion/articles/2024-02-23/us-productivity-is-on-upswing-again-ai-could-supercharge-it-for-good-or-ill?leadSource=uverify wall Quite a few hints that US productivity growth is on an upswing and that is even before widespread adoption of AI by businesses. If so it really would be a holy grail as it would result in faster economic growth and lower inflation (and therefore allow lower interest rates). Economic growth and productivity growth was anaemic for much of the post GFC period with most of the EPS growth of the S&P 500 driven by financial engineering, secular growth from Big Tech and tax cuts. So if this isn't a false dawn then this could indeed be the roaring 20s with the S&P 500 already up almost 150% from the pandemic lows and a long bull market can take markets up 300-500%. And that is a prospect that would keep even the most hardened perma-bear up at night.

Luca is also right. If AI results in a productivity miracle it is going to be the users who benefit. The technology really isn't that proprietary. Lots of companies are coming out with LLMs including start ups no one has ever heard of. For now Nvidia has a technological lead in GPUs but it may not last and you are already paying a high price on the assumption it will. And while Big Tech have deep pockets that doesn't guarantee success and in recent years they've become better at monetization than ground breaking developments and the woke bureaucracy in these organizations is undermining trust and getting in the way of product development.

I can't imagine the average low skill white collar worker has much money to buy Mag7 stocks especially with the cost of living squeeze ongoing and wage increases nowhere near sufficient to compensate for all the post pandemic inflation and even less likely now that companies are planning to automate work and reduce headcount. And if a lot of low skills do lose their jobs they will probably end up liquidating their portfolio of Mag7 stocks they bought with their stimmy checks. Same way most people aren't buying BTC because of considered concerns about the explosion of the money supply post GFC and unsustainable path of US government debt. When inflation was in the double digits everyone was dumping bitcoin. To the extent people are buying perceived AI beneficiaries and bitcoin it is because people like to chase what is hot and going up. And this is especially true of retail investors who do not have the patience to hold something like Berkshire that will get you rich slowly compounding 10% a year like clockwork. The main fear that drives investors in a bull market is FOMO. And that is helping to drive up multiples. Case in point there is apparently a huge increase in custodial accounts being set up with brokerages that allow teenagers to buy stocks because they don't want to miss out on the action. But yeah there is a broader point here that capitalism is a bit broken when it is difficult to get ahead doing honest work with wages barely increasing in real terms prior to COVID and post COVID probably falling in real terms (who's had 20-30% wage increases over the past few years?) while anyone with a stock portfolio has been making double digit real returns over the last 15 years and anyone owning real estate has been building huge amounts of equity given their interest payments were next to nothing for much of the GFC period. Putting whatever meagre savings low skill workers have into Mag7 stocks which they will probably have to sell to feed their families when their jobs get automated and they become redundant isn't the solution. What we really need is to find a better way of taxing corporations and HNW individuals who will milk it if AI fulfils its promise so some of the wealth created can get redistributed via a universal basic income or at least generous benefits until a way can be found to repurpose low skill workers. Of course tech optimists talk about agriculture and industrialisation and de-industrialisation and say that new jobs will be created. But that ignores the issue of structural unemployment. Think about all the mining towns and factory towns that decades after de-industrialisation still have high unemployment rates?

GRANOLAS is the buzzword driving European indices to all time highs. Their version of the Magnificent 7. GSK, Roche, ASML, Nestle, Novartis, Novo Nordisk, L’Oreal, LVMH, AstraZeneca, SAP and Sanofi Internationally exposed quality growth compounders. Now account for around a quarter of the Eurostoxx 600. And are up 60% over the last three years keeping pace with Mag7.

Something I have seen doing the rounds on Fin Twit is the idea that the release of Chat GPT is equivalent to the launch of the first web browser in the early 90s which means that we are only just getting started.

Yeah that is the bull case. That AI will lead to a productivity miracle. Much needed considering that for much of the post-GFC period US GDP growth has been sub-3%. And it will also dampen inflationary pressures as wage increases will be offset by headcount reductions and some of the efficiency improvements from AI can be passed along to consumers in the form of lower prices. So that will allow central banks to lower interest rates before the strain on the economy becomes too much. And if GDP can grow rapidly that will help to ease the debt burden over time. And of course if every IT department starts to allocate a sizeable chunk of its budget to AI then Big Tech can continue to grow earnings at a double digit rate and at 30% of the S&P 500 that is going to be a major kicker to S&P 500 EPS growth. So I am not surprised that bulls are talking about the Roaring 20s and setting targets for SPY 8000.

Couple of reasons. Firstly, Berkshire isn't promotional. Most big companies will get into bed with investment banking analysts and give them guidance in return for coverage and employ investor relation departments. Secondly, Berkshire is complex to understand being a conglomerate and an insurance company. Really you are just placing faith in Buffett's ability supported by his team to grow intrinsic value over time. Smart investors aren't usually capable of that leap of faith. They prefer something where they can come up with a complex investment thesis with extensive models and presentations running hundreds of pages. Thirdly, people hyperfocus on Berkshire's stock picking which has been a bit hit and miss over the last few decades (although Apple demonstrates he can still swing hard at a big pitch) when more of the value comes from the operating businesses and the well-run insurance operations. Also I think that markets generally have been buoyed over the last few decades by very interventionist monetary policy. Berkshire's business growth especially over a 20 year period has probably been in the top 5% but because it continues to trade around 1.5x book value you aren't getting the multiple expansion you get in other stocks.

I also find it ridiculous that people use Apple as evidence that Buffett is now a tech investor. Apple is a luxury consumer goods company and Buffett understands consumer goods well and easily grasps the idea of the Apple ecosystem and the associated switching costs. It doesn't mean we can expect him to go piling into AI stocks.

Buffett knows that bitcoin is a speculation. That doesn't mean it cannot go a lot higher especially if institutions decide they all want 5% of assets in bitcoin. But it is absolutely bizarre to call bitcoin a hedge for cash when it is so volatile and no actual real world transactions take place in bitcoin. It isn't even a good inflation hedge as 2022 showed. It is basically just another high beta play on the stock market and a sign that markets are still very speculative which Buffett alluded to in his recent letter.

Amusing that during the pandemic Green Energy was such a massive investment theme. Now speculators have moved on to cryptos and AI both of which are going to use a huge amount of energy and other resources.

Isn't this the worry really? The basic technology behind AI is out there and not proprietary. Mag7 companies have advantages because they are stockpiling chips, have the biggest R&D budgets by a huge distance, have existing capabilities in related technologies such as data analytics, machine-learning etc. It may be though that the practical real-life applications in the near term at least might be more niche and the niche markets just do not move the needle for Big Tech and they are instead going to waste a lot of money on overly ambitious projects such as AI co-pilots which don't add enough value to companies to allow them to be able to recoup their massive investments in AI. And the whole appeal of companies like Microsoft, Meta, Google etc is they were so capital light and gushed FCF. Now all that FCF is diminishing because AI is very capital intensive with all the chips and so on. And they are cutting staff and risk neglecting their core businesses because they are seduced by the holy grail of AGI.

Another dot com comparison point: The big tech PE multiples are far less crazy (even Nvidia if you project its growth out a few years) but Mag7 market cap compared to other sectors and even other countries is incredible and unprecedented. Deutsche Bank found the Mag7's combined market cap alone would make it the second-largest country stock exchange in the world, double that of Japan in 4th and Microsoft and Apple individually have similar market caps to all combined listed companies in each of France, Saudi Arabia and the UK. And already the Mag7 has had a pretty impressive run-up with a 5 year annualized return of 24% from 2018-2023. That is Granted the world is becoming very technocentric and the best tech companies are concentrated in the USA. But markets can carry even something basically true to extremes. Another dot com comparison point. During the dot com there was a lot of value in old economy stocks. https://www.ft.com/content/92fe31a2-35a6-4d4a-bb10-ffed4f1a017d FT article above suggests that S&P 500 has a forward PE ratio of around 25x if you exclude financials, stocks without earnings and Mag7. Mag7 has a forward PE ratio of around 29x and much better growth prospects. So hard to say that Mag7 are very overvalued without saying the rest of the market is also very overvalued.

I do not think that interest rates or what happens this year and next in the economy really matters that much anymore. So even if the bears are right and the US follows the eurozone and Japan into recession this year it won't make a jot of difference. Even a second wave of inflation probably will only result in a mild correction. Markets are looking through to anticipated productivity gains from AI to the Roaring 20s with the expectation that it will solve most of the problems in the economy as well as extending the growth runway for Big Tech. Productivity increases will increase GDP (reducing the debt to GDP ratio) and lower inflation (allowing lower interest rates). Old economy stocks will benefit as their fortunes are closely tied to GDP growth and GDP growth has been anaemic post-GFC and pre-pandemic stimulus. New economy stocks will benefit not only from AI related revenues but also from lower interest rates. And lower interest rates will also ease pressures on the financial and real estate sector. Of course the question is whether AI really will generate a near term productivity miracle. And worth remembering that even if there were near term productivity benefits from the IT spend during the dot com bubble (and growth was actually pretty amazing in the mid 90s and didn't require 7% full employment government deficits to achieve or massive increases in the money supply to achieve) it did not prevent the bubble bursting and taking the rest of the market down with it.

'Generative A.I. has kicked off a new investment cycle to build the next trillion dollars of infrastructure of A.I. Generation factories.' Nvidia CEO understands what it is all about. Big Tech are gonna invest and so are all the start-ups that will easily be able to attract funding to invest in AI. And even if the resulting product is rubbish after sinking so much money into it they are going to market the hell out of it. And the C-suite and IT department of every company is going to want to invest in AI as well and so it goes.