mattee2264

Yeah I meant the current market level can be easily justified if earnings stabilize and resume growing (i.e. soft landing) and interest rates moderate (i.e. disinflation continues). You'd then end up paying just over 20x growing earnings relative to 3-4% interest rates which would make equities look pretty attractive so long as earnings growth rather than multiple expansion can do the heavy lifting from hereon out. Most of the recovery so far has been driven by multiple expansion as sentiment has swung from pessimistic back to optimistic. Corporate earnings for the market as a whole are continuing to decline albeit more moderately than was initially expected. Outside Big Tech I agree things are pretty meh. I think a little too much optimism is being baked into the financial sector as it is interest rate sensitive and we still haven't seen all the fall out and especially in relation to commercial real estate which is under a lot of strain. Commodities I think are a bit undervalued as supply is still incredibly tight and Biden can't drain the SPR forever. And there is some economic sensitivity so if we do go into recession some further downside there. And consumer staples/utilities etc are still trading as bond proxies and perhaps haven't fully reflected the end of ZIRP. Big Tech is too hard for me. But if you are commenting about the overall market you do need to form an opinion. Main questions I am thinking about are: 1) Is there a potential for an investment slowdown similar to dot com bubble? During the pandemic a lot of technology investments in cloud etc were pulled forward and that provided a major boost to earnings. But what if this investment spending slows down or goes into reverse? 2) In a weakening economy where the cost of new debt is very expensive how much appetite will there be for non-technology companies to invest in AI? And until they are willing to make those investments how will the technology companies monetize their own AI investments? 3) How will Big Tech pass the test of a more garden variety recession? Google and Facebook are reliant on ad spending. Amazon is reliant on online retail spend. Apple is reliant on people upgrading their phones and renewing subscriptions to apps etc. Tesla is reliant on people buying cars and so on. COVID was unusual because Big Tech were major beneficiaries. But if there is a fall in consumer spending and investment spending then we might see that Big Tech is more cyclical than people are expecting.

Agree that so far the market as a whole has been able to grow earnings in line with inflation and have been relatively unaffected by the increase in interest rates. And if that continues to be the case and inflation remains low and interest rates can fall back to around 3-4% (above pre-COVID levels) but very manageable in a growing economy then there is nothing much to worry about. But there could be a false sense of security explaining some of the seeming complacency in markets. -Cutting the excess fat accumulated during the boom years before falling demand hits prices and margins can help maintain or even grow profits. And it is a nice story to sell when earnings disappoint slightly and buys companies a bit of time. -Similarly it is easier to keep pace with inflation when consumer demand is still resilient and you can put through cost increases without impacting volumes. Especially as there is some inertia in spending patterns and wage bargaining when there is unexpected inflation -As you mentioned companies still have low cost debt entered into during COVID and are benefiting from higher interest income giving a boost to earnings -And consumers still have some excess savings and so far job cuts have been quite limited -And energy prices have swooned which has taken a lot of the edge off. Although there are signs this trend may reverse -Also even the Dow still reflects the concentration in Big Tech and the AI story has helped investors overlook near term softness in revenues and earnings. But already some of the hype has died down and companies are trying to manage near term expectations. And during a bull market it is easy to have a longer term horizon and get excited over such things. But investors have a tendency to become very short term oriented when sentiment reverses. Case in point dot com bubble when some very good companies who would clearly benefit from the internet changing the world in much the same way AI eventually will still sold off massively. Anyway time will tell -

Is a soft landing, interest rate cuts and productivity led growth driven by AI wildly bullish for markets or has it been largely priced in at this point? It is the companion error of getting bearish at the point when things are obviously bad in the economy and stock prices have already fallen significantly.

US GDP 2.4% in Q2. CPI inflation latest reading 3.1%. Still at pretty much full employment. Fed supposedly near the end of their rate hiking cycle and saying they could decrease rates before inflation returns to target. AI promising improved productivity and an extended growth runway for Big Tech. No wonder sentiment is pretty bullish right now and we are not that far off all time highs.

Yeah you can still get rich and clearly you are better off holding real assets than cash. It will just probably take a lot longer and a higher savings rate and a longer working life (especially as with higher life expectancy you need to fund a longer retirement and need to self-fund rather than getting a nice final salary arrangement from your employer).

I think it is the case in a lot of Western countries that people with respectable middle class jobs are struggling to get on the property ladder, afford to raise a family and save enough for retirement. Especially hard for youngsters who missed out on the double digit real returns of the last 15 years. Pretty clear that ZIRP has massively increased wealth inequality and therefore intergenerational equity. But unfortunately even with the Fed pulling the rug away there hasn't really been any meaningful change in sentiment and people continue to chase Big Tech and maintain very high equity allocations. And markets know that if something looks like breaking the Fed will simply expand its balance sheet to mop things up. And it is a typical late bull market phenomenon that even as interest rates rise investors continue to see equities as far more attractive because the greater risk of equities isn't really showing up either in the underlying earnings or the quoted prices. It will take falling earnings and falling prices for investors to appreciate more the attractiveness of a fixed but certain return.

Microsoft to charge $30 a month for add-on generative AI features. Markets obviously reacting very positively. But I think if Big Tech try to be too quick to monetize generative AI before it actually adds any value it is a risky move. Obviously they might get a lot of people signing up because it is a fun fad. But if the reality doesn't live up the hype which seems to be inevitable then people will cancel pretty quickly. And unlike something like cloud which pretty much came as a freebie to Big Tech they will need to invest a lot of money into AI and if the returns on these new investments do not match their historical returns then any growth from AI will come at a considerable cost and not necessarily be value generative. Really it would have been a lot better I think to tease the future possibilities and talk up the investment and the wonderful returns they expect from it. And wait until they actually have a solid value-add offering before trying to monetize too aggressively.

12m of straight CPI declines from a peak of 9.1% to the current 3.1% and it is understandable that markets are being a bit complacent especially as we are still at full employment and not in recession despite 500bps of rate increases. Agree that there is a possibility of a stagflationary recession that could catch markets by surprise and tie the Fed's hands so they can't bail markets out the way they usually do. Market is very much positioned for disinflation and lower rates favouring growth companies.

The best correlation is actually between Big Tech and inflation. CPI inflation fell from a peak of 9.1% to the current level of 3.1% and over the same time duration Big Tech roughly doubled recovering the majority of its earlier losses from the inflation shock. And essentially Big Tech investors are frontrunning interest rate cuts they see coming. Also when sentiment is still bullish equities with their theoretically unlimited upside will always seem more attractive than bonds even if the latter offer a much better current income. While last summer/autumn should have been a reminder that stock prices can go down as well as up instead it reinforced the lesson that every dip is a buying opportunity and any losses are quickly recovered if you hold on which again gives equities seemingly attractive option value (heads you win big tails you don't lose much (or at least not for long). And unlike dot com bust earnings haven't fallen off a cliff and with AI in prospect investors can assume that the stalling of earnings growth or modest declines represents a lull and can look through to an economic recovery and an AI boom.. What might ruin this pretty story is a stagflationary recession that ties the Fed's hands and results in a meaningful decline in corporate earnings the market finds hard to ignore and brings into question their rosy future assumptions and brings into play a higher for longer narrativev that probably will require an adjustment to valuations

BoA did a more nuanced report which makes good reading. They suggest investors need to consider 5 questions 1 ) What caused the market concentration? (ultra-low rates and a lacklustre economy in 2010s combined with indexing and pandemic-driven tech adoption with AI the latest boost) 2) Has this happened before and how did it end? (bubbles fuelled by excessive leverage, democratization or markets and rampant speculation tend to end badly) 3) is today's Big Tech different from prior bubbles? (yes. bigger might be better today versus 2000. Big Tech has $200b net cash versus SMID Tech had net debt. For AI scale matters) 4) What are the important catalysts to watch for? -saturation in ownership (more overweight the stock the more acute the selling pressure around negative surprises) -changing competitve landscape (tech trends can shift quickly) -policy/politics (regulation) -rate risk (higher real interest rates may hurt growth stocks ) -demand (pull forward in tech capex during COVID similar to that ahead of Y2K which was followed by sequential years of negative top line growth) 5) How can equity investors navigate these risks? (seek opportunities outside Mag 7)

I bought Microsoft and Apple quite early last decade when they were selling for about 10x earnings because Microsoft was seen as ex-growth because of its exposure to the declining PC market and Apple was seen as a hardware company selling overpriced phones. After they doubled in price I sold! Lesson learned was that you can leave a lot of upside on the table if you ignore growth and long term prospects. Buffett made the same mistake early on with Disney when he was still very much influenced by Ben Graham. Other mistake I have made a few times is not doing enough work on financial position so got caught up in the Sears and Chesapeake bankruptcy. Lesson learned there was that in a turnaround situation and for cyclicals you don't want to be on borrowed time! And the other mistake is being a bit too influenced by market history and expecting that valuations and margins will revert to the mean. When probably there is a case for higher margins and higher valuations in a New Economy.

Bloomberg article isn't quite correct IMO as it understates the importance of inflation which was devastating to long duration assets such as bonds and technology stocks. Big Tech bottomed around the time that CPI inflation peaked at around 9.1% end of June. Since then there have been 12 straight months of CPI declines and that resulted in a V shaped recovery. And actually it is quite typical for there to be V shaped recoveries when bear markets are a result of shocks rather than structural factors such as recessions. Earnings were a secondary factor. But AI has helped investors overlook declining near-term earnings in Big Tech and partly because the recession was postponed we saw more of a stabilisation of earnings rather than a collapse in earnings (the way earnings collapsed during the dot com bust). The problems for the future outlook are that: 1) We aren't yet out of the woods. So what so far looks like an immaculate disinflation could still turn into a hard landing accompanied by a new surge of inflation which would put the Fed in a very difficult position. 2) The AI hype is already starting to die down a little. And more balanced and more informed experts are going to start to pour a bit of cold water over it. 3) Even if we avoid an economic recession there will be a continuing corporate earnings recession and while markets may look through the next few quarters of weak earnings we have still seen on a company by company basis that earnings disappointments especially for the market darlings can result in severe punishment.

Peak inflation was 9.1% CPI in June 2022 and closely coincided with the market bottom and devastating losses for Big Tech. Since then inflation has more or less fallen in a straight line to the current reading of 3.1% CPI. And aside from some jitters in the autumn there has been a V shaped recovery especially for Big Tech who bore the brunt of the market decline as a response to the inflation shock. So no surprise really that investors are very bullish. Inflation back to the 20 year pre-GFC average. Economy still at full employment and yet to fall into recession. No contagion from the regional banking crisis. Add AI to the mix and it is easy to look through any near term softness in corporate earnings. The question is what next? Will the economy overshoot and fall into recession? Will something break that the Fed is less equipped to fix? Has inflation bottomed (and it would be typical for peak inflation to mark the cyclical low and trough inflation to mark the cyclical high) and could it start to rise even as the economy continues to slow down? Will corporate earnings over the next few quarters disappoint more than expected?

I was wondering if anyone has considered the impact of a falling US dollar on the market. I assume some boost to EPS given that a good amount of S&P 500 revenues are earned in foreign currencies and also inflation will give a further boost to nominal earnings. So perhaps a combination of 5% inflation and a falling US dollar along with the continued AI hype and crowding into Big Tech could be an offset to the negative headwinds from a deteriorating economy and higher interest rates.

https://www.wsj.com/articles/it-isnt-just-boomers-lots-of-older-americans-are-stock-obsessed-ca069e1a?mod=hp_lead_pos8 1/5 of over 85s are fully invested in stocks!

I think certainly for the higher quality names within the Enormous Eight you are trading off valuation risk for the other types of risk which are far lower for them than the run-of-the-mill S&P 500 company. For example: -Inflation risk: well they have fantastic pricing power -Recession risk: they provide essential products and services people cannot live without -technology risk: they are innovators at the forefront of emerging developments -competitive risk: they completely dominate their markets and can simply buy up any emerging competitors -financial risk: they generate huge amounts of cash, have huge amounts of cash on their balance sheet and little need for debt and higher interest rates actually benefit them to the extent they can earn more money on their cash So little wonder they are seen as a safe haven in an increasingly uncertain and fast changing world. But of course the reason high valuations are dangerous is because they are largely psychological and reliant on investors willingness to pay a 50-100% premium to the market multiple (and a much higher premium if you take the market multiple ex Enormous Eight) because of their desirable qualities. I think a particular challenge to watch out for is how they'll do if we do go into recession. They are cyclical to some degree and investors have been used to their earnings going up every year at a rapid clip and while that hasn't been the case over the last few years they've at least managed to maintain their earnings. But if earnings start to decline then that could spook investors.

2023 First Half Returns... The Enormous Eight... $NVDA: +190% $META: +138% $TSLA: +113% $AMZN: +55% $AAPL: +50% $NFLX: +49% $MSFT: +43% $GOOGL: +36% Everyone Else... S&P 500 Equal Weight ETF $RSP: +7% S&P Small Cap ETF $IJR: +6% This is a pretty good summary of the first half of the year. Any predictions for what the corresponding second half numbers might be?

I think it is possible to identify mini-bubbles and bubble stocks. The stay-at-home stocks (e.g. Zoom, Peloton) obvious examples from the pandemic. And more recently Tesla and Nvidia valuations clearly defy logic and to make any sense require incredibly optimistic assumptions about market shares and market growth and future profits. And yes AI is likely to result in a mini-bubble as well that will burst at some point. But this is more helpful in staying away from such situations (or at least not overstaying your welcome). I am not convinced it is incredibly helpful in timing the market as often bubbles burst and overpriced stocks fall back to earth without much of a market impact. 2000 was a bit different because of the extent of the bubble (encompassing technology and communications) and also the fact that even for the more mature and higher quality companies their revenues and earnings simply weren't sustainable and once the internet and associated communications networks had been built out they'd made most of the money they could hope to make and became ordinary companies again. And of course the dot com start ups with no earnings and not much more than an exciting story mostly went bust. This time round within the S&P 500 the very high valuations are mostly limited to Big Tech. And ignoring Nvidia and Tesla for now they may well be justified. These are very profitable companies with very strong competitive advantages and their earnings look sustainable even if they may not grow as fast as they used to and they are also very innovative as their exploitation of cloud/data analytics etc. showed and are likely to enjoy a large share of whatever market opportunity there is in AI going forward. They also have defensive qualities as they are essential to the global economy and businesses and consumers cannot do without their products/services (recession hedge) and enjoy pricing power (inflation hedge). And valuation risk alone is generally a bad reason to avoid holding high quality companies or indeed the market as a whole (especially given it the S&P 500 is stacked with high quality companies). And as for the recession talk. Recessions are very difficult to predict. And it is even harder to predict the timing or the magnitude/duration. Or the impact of the recession on different sectors e.g. manufacturing, services etc. Let alone the impact on the overall stock market. The chances of a hard landing are probably a lot higher than is currently priced into the market. And if there is a hard landing then corporate earnings may fall by 20% or so which would have a market impact. But not necessarily a proportionate impact as markets may decide to look through a recession. And they may also cheer if a hard landing brings inflation down and raises the prospect of a Fed pivot. And while cyclicals may sell off even more investors may decide to continue to follow the COVID playbook of rotating into Big Tech rather than rotating into bonds.

Nasdaq best first half in four decades. Irrespective of what you think about the economy betting against the market means betting against Big Tech and that may have worked last year but this year it is a way to lose your shirt.

Agree that inflation is redistributive. But I think the real implication for markets is that we've left behind Alice in Wonderland macroeconomics whereby deficits don't matter and can be funded by money printing and ZIRP and QE can be deployed every time the stock market has a correction. What never gets mentioned is one of the biggest drivers of inflation is the US government running trillion dollar deficits. There is no inclination towards fiscal restraint in the USA and the so called debt deal basically just froze fiscal spending at pandemic "emergency" spending levels. And if you have over a trillion dollar deficit at full employment then automatic stabilisers mean that your deficit will get even bigger if unemployment rises because income tax receipts fall and unemployment benefit pay outs rise. So the Fed is fighting a losing battle and neutral rates won't cut it when they also need to offset the impact of irresponsible fiscal policy. And as I said this all makes for a situation where interest rates will probably have to remain above 5% for some time. This isn't the end of the world but it will have an impact on market valuations. Also Societe Generale in a recent report showed that all the YTD gains in the stock market can be explained by AI (i.e. fantastic 7 catching a bid with AI mania exploding). For the rest of the market macro does matter. And this is a bit of a repeat of summer of 2020 as Big Tech are viewed as the safe haven rather than US Treasuries or even traditional defensives (incidentally a lot of consumer staple stocks are selling off!) so a bad economy will only help Big Tech's momentum. So the market could well continue to head higher even if we do head into recession. Longer term though there probably will be a valuation reset especially when people realize that AI isn't really going to move the needle much for trillion dollar companies and we've seen the way that markets punish its darlings when they fail to meet impossibly high expectations. And it is difficult to imagine a dynamic fast growing economy emerging from the recession. The massive debt loads are going to weigh the economy down for the foreseeable future. AI will take a long time to have a major benefit to productivity. Climate change initiatives are going to inevitably mean sacrificing some economic growth to achieve climate change targets. Geopolitical tensions are going to continue to encourage de-globalisation. And without ZIRP it is no longer possible to disguise lacklustre growth through financial engineering and using leverage to try and juice returns. So short term who knows and the path of least resistance is probably higher. But it is difficult to imagine great returns over the next decade from today's starting point.

I think an interesting question is what happens to market valuations once market participants get used to the idea that interest rates may have to stay higher for longer to keep inflation in check over the next decade. Agree that a lot of the COVID inflation was transitory. But there are operative factors such as trillion dollar deficits, de-globalisation, natural resource shortages etc that mean we probably aren't going back to ZIRP which has been massively supportive of valuations.

I'd say the bears got the following elements of their thesis wrong. Big Tech: people were expecting a re-run of the 2000 tech bubble bursting. But Big Tech have recovered all the 2022 losses because earnings have held up better than expected and there is future optimism about the course of interest rates/inflation and of course the hype about AI means investors can now project a lot more future growth. Another factor is that Big Tech is seen as defensive by a lot of investors especially given their outperformance during the COVID recession so rotating out of cyclicals and into Big Tech as recession fears start to build has also been supportive of stock prices. US Gov: deficit spending of over $1TR a year at full employment is very supportive of the economy. And it goes a long way towards offsetting the impact of tightening monetary policy. Rate sensitivity: while we have seen stuff breaking e.g. pensions in the UK, regional banks in the USA etc. the damage has been contained and the Fed has been able to mop up by injecting liquidity into the system and liquidity is very supportive of stock markets. Unemployment: we are still at close to full employment. That is supportive of consumption which is the lifeblood of the economy. Excess savings: this has helped cushion the blow of a higher cost of living and higher interest payments Sentiment: there is still a buy the dip mentality especially in the younger generation of investors for whom the GFC and dot com bubble are distant memories and in this long long bull market any losses were recovered very quickly (e.g. 2015, 2018, 2020, 2022) and there is still a belief that if things get bad the Fed will bail them out. But really it comes down to earnings and multiples. Bulls are foreseeing a mild earnings recession and their 2024/2025 estimates are well above $200. So with a 20x multiple (on the assumption interest rates have peaked and will moderate to around 2-3%) you get close to 5000 SPY. Bears are seeing a modest/severe earnings recession and see 2021 earnings of $220 as peak earnings and typically bear markets bottom out at around 14x peak earnings which gets you to 3000 SPY

Contrarian indicator?

Fiscal stimulus is ongoing with the debt deal just normalizing emergency level trillion dollar deficits despite the fact we are at full employment and the pandemic is long over. So that is definitely providing ongoing support to the economy. I think we have seen something akin to tacit collusion whereby companies en masse have been able to put through hefty prices increases without much resistance. Perhaps if we do go into recession some of these price increases will have to be reversed to some degree. And already we are starting to see a bit of that. I am not expecting a lot of wage inflation especially if we go into recession but there will be some because generally pay reviews are annual usually at the start of the year and in 2022 companies were probably able to get away with the pre-pandemic 3% pay rises but will probably need to give a bit more this year. What has been a bit surprising is the degree to which Big Tech have been able to maintain pandemic earnings (well in nominal terms at least). My assumption was that to some extent pandemic earnings were unsustainable as they were achieved when everyone was on their phones/online 24/7 and their old economy competitors were severely handicapped by lockdowns etc. But I guess it goes to show how strong Big Tech are and how people continue to underestimate them. But they haven't been properly tested by a recession so I think earnings could show a bit more cyclicality than people are expecting if we go into recession later this year or early next year. And I think to some degree their explosion in prices YTD is a replay of the COVID period when people saw them as a safe haven. In other words, they are the new defensives (forget bonds, consumer staples, utilities etc!). And what could be more seductive than a select group of stocks which offer glamour, incredible past performance, apparent safety (largely based on their pandemic performance), familiarity (especially for the younger generation), and seeming invincibility as every time they get knocked down (e.g. 2018, 2022) they come back stronger and reach new highs. And now the added kicker of an incredibly fertile avenue for future growth in AI. So little wonder everyone wants to own them and pretty much does and is comfortable paying high double digit multiples even as interest rates head higher.

AI is used as a partial justification for the Fantastic 7 melting up. But aside from Nvidia (where the revenue benefits are clearly already more than priced in!) is it really going to move the needle that much over the next decade? Companies like Google, Microsoft, Apple are already making around $200-$400BN revenues a year. Even if revenues from generative AI grow at a rapid clip similar to Cloud from a low base it would probably take many years to account for more than a fraction of their revenues. As for traditional AI it is really nothing new and these companies already have sophisticated data analytics capabilities that are already contributing strongly to their huge revenues so while it might improve the value proposition for someone like Microsoft especially for upgrades etc and perhaps allow companies like Google and Facebook to target their advertising even more effectively will it generate tens of billions of new revenues for them? And generative AI feels a bit gimmicky at the moment e.g. Bing has a new AI co-pilot etc but it has made no difference to me and I still use Google and most of my friends are asking Chat GPT silly questions and laughing at the answers and more techy people are delighting in finding ways to trip it up. And you also have to wonder to what extent it will start to cannibalize their existing main revenue streams which are already starting to look very mature and will be difficult to maintain especially in a weak economy where the vast majority of their customers are struggling. Also there seems to be an assumption that mega-caps will be the main beneficiaries when history would generally suggest that while they clearly have a massive advantage in terms of making investments, buying up promising start-ups, hiring the best talent etc. so did IBM and Microsoft back in the day (before Microsoft rediscovered its mojo) and Google and Meta emerged AFTER the tech bust. So often with a new technology it favours more innovative entrepreneurial companies that don't have to worry about their existing businesses being cannibalized and have a fresh perspective. Even if there is an incredible long term opportunity in the near term non-AI revenues are clearly going to come under challenge especially if we are heading for a hard landing. Apple, Facebook, Google and Amazon all have cyclical revenues. Tesla is an automobile company and autos are famously cyclical. And even in a soft landing that the Fed are predicting whereby GDP growth is only 1% or so for the year that will translate into single digit growth figures which rarely goes down well when investors are paying 30-60x earnings expecting double digit revenue and earnings growth as far as the eye can see.