mattee2264

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.

I think it is getting the point where it no longer matters what the Fed does, or what the economy does, so long as AI beneficiaries continue to beat expectations the market will keep going higher. Especially as at some point AI optimism will be translated into optimism for general economic prospects over the rest of the decade aka Roaring 20s.

Other thing about Nvidia is the "gold rush" analogy. In the short term it doesn't matter how much gold there actually is in AI. So even if you are sceptical about the practical value of AI, so long as Big Tech, consumers and businesses are fascinated by it and paranoid that if they don't invest in it they will get left behind they will pay whatever it takes to stockpile as many of Nvidia's chips as they can. Over the medium term it seems quite likely that Nvidia will fall back to earth once they either lose their technological lead or good-enough products at lower prices force them to cut prices and margins and Big Tech have got through the initial investment phase and their annual demand for chip diminishes. But in the short term Nvidia is going to keep going higher until they disappoint investors.

265% revenue growth in one year! And revenue expected to double over the next year. The gold rush continues.

Markets aren't stupid. They are seeing evidence of a soft landing and expect that will deliver interest rate cuts and an eventual return to growth (it is better to have a landing so long as it is soft than keep having the landing postponed with the associated lingering uncertainty) The first leg of the bear market was multiples reacting to higher inflation and rate cuts and at the time things looked pretty grim with double digit inflation and uncertainty as to how high interest rates would go and for how long. That leg seems to be over now (barring an unexpected second wave of inflation) and therefore markets are pricing in lower interest rates with a major benefit to P/E multiples. And note that if earnings are $1 then even PE multiples going from 15 to 20 is enough to increase stock prices by over 30%. So it is a pretty powerful impact even if outside of AI there still isn't much evidence of improving earnings. The second leg of the bear market was supposed to be earnings falling as a result of higher interest rates and falling consumption in response to cost of living crisis etc. Not a huge amount of evidence of this. Earnings have been pretty resilient and held up better than most would have expected. And while Big Tech earnings growth has been a lot weaker over the past few years and increasingly relied on cost-cutting/restructuring with the AI hype investors are looking forwards to a return to fast earnings growth. The few bears left standing continue to argue that every landing looks soft until it turns into a hard landing and cite various factors that are delaying the recession (US fiscal deficit spending, pandemic era excess savings, benefits to corporations from locking in cheap long term debt during ZIRP, loosening of financial conditions due to much higher stock prices etc). But even if there does end up being a mild cyclical recession the negative impact on earnings will be offset by lower inflation and interest rates and as we saw during COVID the market are comfortable buying the dip and looking through mild recessions.

I don't think market cares that much about the timing of rate-cuts so long as economy stays resilient and inflation doesn't take off to the point that rate hikes are back on the table. Fed will look through any inflationary increases due to the Red Sea situation. They will also ignore any month to month fluctuations. And when it becomes apparent that inflation won't go much lower than 4% without a weakening of the economy (which won't happen so long as deficit spending is $2TR a year) then Fed will probably find a way to change its target or wait patiently for hoped for AI productivity improvements. Still it is a little bizarre to see UK, Germany and Japan surprising markets with negative GDP growth and seeing their stock markets shoot higher. Either market is prophetic and looking through to a robust recovery in 2024. Or more likely the market figures bad news = quicker rate cuts and the rate cuts will produce the desired economic improvements.

I'm British. The welfare state is very hard to roll back. The USA is trying to have its cake and eat it by expanding the welfare state while keeping taxes low. The numbers do not add up so you are getting these huge budgets at full employment. And now you are having millions of illegal migrants who will probably end up on the benefit system. And if AI fulfils its promise you are going to get a lot of structural unemployment.

What I always find scary is how correlated the S&P 500 is to the Fed balance sheet. Since 2009 the Fed balance sheet has increased fourfold. And the S&P 500 has as well. It does beg the question as to how much of this long long bull market is simply just the result of asset price inflation. And of course the Fed has no serious intention of decreasing its balance sheet especially as the banking system will continue to need bailouts and the market will taper tantrum if QT ever picked up any kind of speed.

But I do not see any real need to lower interest rates. We did just fine in the 1990s with interest rates averaging 5%. So if we are in for another decade of strong growth driven by illegal immigration (lol), AI productivity improvements, and never-ending fiscal deficits (MMT lol) then the neutral rate is going to be a lot higher than it was during the pre-GFC period when GDP growth and inflation were anaemic. The economy seems to do just fine with higher interest rates. The main people complaining are investors who need low interest rates to pump up their long duration assets such as Big Tech. And I agree it is a ridiculous situation when you have traders and investors hanging on to every word the Fed says and waiting with bated breath for every jobs report and CPI print knowing that they will determine whether the Fed cuts once, twice, three times this year and whether the cuts start in March, June, or September. It never used to be like this.

If the Fed were truly politically independent it would make it clear that the US government's full-employment fiscal deficits are hindering its battle against inflation and delaying the rate cutting cycle. It is not at all surprising that with the US economy running hot disinflation is starting to stall. If the Fed were truly politically independent it would not have teased rate cuts last year when inflation was still above target sparking a massive stock market rally and looser financial conditions. But I think this year we know the US government will keep spending big in a desperate attempt to keep the economy booming in the hope it will get Biden re-elected and the Fed will do what it can to help that goal without completely destroying their credibility.

"Inflation is always and everywhere a monetary phenomenon" is the quote I always remembered him for. Sadly it did not age so well. Asset price inflation definitely! Consumer price inflation not so much.

What makes me uncomfortable is that AI brings the Big Tech companies into competition with each other. Previously they'd all carved out niches: GOOGLE: search/Youtube META: facebook/instagram MSFT: enterprise software APPL: phones and related services AMZN: cloud but mostly storage and e-commerce Now you'd imagine they will all try to come out with some kind of AI pilot that organizes your life. They will probably all try to come out with some kind of ChatGPT equivalent which replaces search (but even with search the money is made through the adverts as in a typical search you'd click on multiple links and visit multiple websites whereas with ChatGPT equivalent you make a single prompt and it spits out results and most likely in the premium versions you pay not to have ads) The monetization seems a lot more immediate than the internet as any AI upgrades are going to result in a monthly subscription fee. But we aren't talking about new products for tiny start-ups we are talking about companies already making hundreds of billions a year in revenues and are so large that they are necessarily limited by consumer and corporate budgets of whom they have already captured considerable wallet share. And unlike cloud which was basically gravy to them because they already had all the real estate so easy to basically rent it out, these AI tools cost a lot to train (even before considering potential copyright issues) and massive amounts of R&D are required to increase the functionality and iron out the bugs and the worry will be that if they skimp on R&D another Mag7 firm will steal a technological lead and eventually establish the standard and with economies of scale you probably need a pretty big share of the market to make a lot of money and their existing core businesses are so good that there is a high bar set to ensure that additional revenue is not offset by lower average margins.

Valuations are probably less relevant than the past because a lot of buying of stocks is price insensitive e.g. corporate share buybacks. When times are good and stock prices are high companies buy back far more shares than when times are bad and stock prices are low. And with ZIRP companies have been able to use financial engineering to borrow at cheap rates to buy back shares. As interest rates come back down this practice will resume. e.g. pension contributions. there is a continual inflow of money into index funds from this. e.g. switch from active to passive strategies. In the past (in theory at least) active managers used to buy undervalued stocks and sell overvalued stocks or even short them. Now the main active investors are hedge funds and retail trades both of whom favour momentum strategies and flavour of the month investments with a good story. e.g. Fed has been doing successive rounds of QE while keeping interest rates low (until recently) so if you can only earn next to nothing in cash or bonds then you tend to be a lot less discriminate when it comes to buying stocks i.e TINA. Even with higher interest rates a 4-5% long bond yield seems unappealing when investors are using to doubling their money every year in bitcoin or Big Tech and even in index funds are making double digit returns and investors are well schooled that dips are buying opportunities and the stock market always recovers quickly and without any lasting pain. Even during COVID while the market panic was scary by the end of the summer the market had already recovered made new highs. And while the 2022 bear market was more protracted than investors were used to the index only fell about 20% as confidence in a pivot and Chat GPT turned the tide and 2023 instead of being a down year saw the market recover most of its losses with the rest made up this year. And now AI has given the perfect excuse for markets to send Big Tech stocks to the moon and price in much better prospects for the rest of the economy with the idea that there will be a productivity miracle that will shock that economy out of its post-GFC doldrums and increase trend growth rate in the same way as in the mid 90s before it all went sour. Also interesting is that markets have pretty much shrugged at the good economic data and Fed talk walking down rate cuts. I suppose they have realized that the economy is a lot more resilient to higher interest rates than previously thought and Big Tech's growth prospects are being revised upwards so that even using a higher discount rate they are still worth a lot more. So I think we are only getting started. And probably the only things that will ruin the party are: a) Big Tech results disappointing and the roll-out of new AI initiatives not living up to the hype resulting in much slower adoption b) Inflation rearing its ugly head again and forcing the Fed into rate hikes or at least convincing markets in higher for longer. The V-shaped recovery carries with it the implicit assumption that the Fed was right along and inflation was transitory and the inflation shock is over. c) A hard landing with inflation not falling enough to justify a Fed rescue and earnings across the board falling.

Oh I know how you feel. Q4 GDP growth for USA came in at 3.3%. 2023 GDP growth was therefore a very healthy looking 2.5%. CPI inflation for 2023 is 3.4%. USA economy is at full employment. It is picture perfect until you remember that government ran a deficit of $1.7TR in fiscal year 2023. And is on course to run a $2TR deficit in 2024. And most of the hiring in 2023 has been by government while left right and centre big companies are laying off workers. High GDP growth rates can be achieved if the government spends a lot of money. But if it was that simple then socialism and communism would have succeeded and the richest countries in the world would be Russia and China. And it is not just government. Consumer debt has reached all time highs when you would think that with higher interest rates consumers would be trying to pay down debt. Consumer spending has contributed to the strength of the US economy but they also seem to be spending beyond their means. And both the government and the consumer are desperately hoping for lower interest rates to make their debt more affordable and easier to roll-over/refinance and although that is probably what they will get it does not feel like a healthy situation. Perhaps the AI productivity miracle will save the day and result in high growth and low inflation which will allow interest rates to stay low and for the US to ease its debt burden through economic growth the same way it did post WW2. But that seems a lot to ask for when the current AI offerings just seem to be glorified chat-bots and search engines that spout a fair amount of nonsense. Or maybe the wave of immigration will achieve a similar effect. Although there does seem to be a paradox in welcoming mass immigration at a time when a lot of jobs are supposedly about to be displaced by AI and if we are running $2TR a year deficits at full employment how big are deficits going to get when AI results in mass layoffs and the economy eventually succumbs to recession? So I am also very cynical about the health and strength of the post-COVID economy. But the stock market is not the economy and so long as America's strongest companies can continue to grow earnings and investors are still enthusiastic about their prospects then stocks will continue to go up. At some point there probably will be some kind of reckoning and the good times will end. But who knows when that will be and if the market can double again before that happens then even a severe 30-40% bear market isn't going to allow you to buy at lower prices.

I think the bottom line is that: -Mag7 are distorting market valuations. So to say the S&P 500 is overvalued you need to be able to say with confidence that Mag7 are overvalued -Mag7 are what Benjamin Graham would call speculative growth stocks. Speculative not because of their quality as most of them are incredibly high quality and have very strong financial positions. But speculative because they are selling at double the market multiple which implies a lot of confidence in future growth. If that confidence is warranted then is hard to say that they are overvalued. -Outside Mag7 valuations are fairly average by historical standards. Perhaps slightly above because if you took out 7 of the top 10 companies out of historical indices it would have lowered the resulting average valuation. And the winner takes all dynamic makes many old economy stocks less valuable and there is a greater obsolescence risk which is a negative valuation factor. Also over the last decade economic growth has been anaemic and companies have relied on financial engineering taking advantage of ZIRP to grow EPS faster than earnings. Economic growth should be better over the next decade especially if AI fulfils its promise but markets seem too ready to assume that interest rates will return to very low levels. They may do in the short run if the economy slows down but over the economic cycle I would expect interest rates to be around neutral which is usually proxied at nominal GDP growth or around 4-6% and I don't think the rest of the market (or Mag7)are priced for that). -The outlook for economic growth and interest rates is very uncertain especially over the next decade but I suspect they will have a big influence as to whether the next decade is good or bad for stocks. Probably you are counting on a fairly benign outlook of low-to-moderate inflation and healthy economic growth but so far betting against the US economy has been a mistake. In other words we are probably in what Buffett called "a zone of reasonableness". Perhaps at the upper end of that zone. There is an interesting asset allocation debate over whether the high concentration of the top 10 firms in the S&P 500 and of the USA in global indices warrants some attempt to rebalance either by shifting some funds to an equal weighted S&P 500 index or to small caps and shifting some funds to say an EAFE or EM index. There would be a diversification benefit but the risk is that in doing so you are reducing expected returns. Also a top heavy S&P 500 is nothing new and part of its design and with a S&P 500 you are getting a lot of global exposure anyway as well as owning most of the world's best companies. There is a continuity between the past and the future and over the long past a market-cap weighted S&P 500 index has been the winning strategy. That has been true in spite of its greater propensity for bubbles and painful 50% market declines or maybe because of it because those things are inevitable features of a capitalist economy and capitalism is still the best of the many imperfect economic systems out there.