AI sobriety, new narratives and comebacks

The Weekender offers my perspective on market developments and their potential broader implications, written most Friday afternoons. If you'd like this delivered to your inbox on Saturday mornings via Northern Trust, please sign up here. 

Sobriety

I was asked in an interview earlier this month some weeks back to summarize what I expected for the AI trade after its seemingly never-ending party. My answer was “sobriety”. Not a hangover, more a period of abstinence. Like dry January perhaps? And into that reflective space, new habits, new narratives and new leadership might move (and arguably already have). Whether these habits sustain, or we fall back to the familiar, only time will tell, but we’ll discuss more of these potentially new narratives in a second.

First, we need to talk about that marvel of modern technology: not Nvidia - Nokia.

Finland’s antidote for teenage depression

 My eldest has been packed off to boarding school this week with his new footy boots, mouth guard, military grade tuck box and a Nokia 1104G basic ‘brick’ phone. I tell you this because for the first time I can proudly say I’m better at him at a video game; Tetris (and Snake). In truth, the real reason for buying the brick was his school. They’ve banned smart phones, seemingly adopting the recommendations set out in The Anxious Generation. Rules that I expect other schools may follow as it becomes untenable to allow an activity now shown to be bad for your (mental) health. (I seem to remember similar arguments re cigarettes and alcohol when I was at school, which seemed to do the trick). And the brick phone of choice, as per most mobile operators and mums is? A Nokia. There’s even a £99 Pink Barbie brick to help children digitally detox. And what’s good for Nokia should be good for Finland.

A country that may emerge as a symbol of the anti-social media movement, and potentially one of the greatest comebacks since…the UK, EMs or ESG?

If Oasis can, anyone can...

After 14 years of vitriol, bad-blood and some of the greatest insults of our time like, “Liam’s the angriest man you'll ever meet. He's like a man with a fork in a world of soup”, the rock band Oasis is getting back together. Huge news. One speculates as to the reason, but I’m thinking that money (think divorce) features highly. Another marriage which looks destined for a costly divorce, is that between China and the US. Could money (or lack-of) prove a unifying force in that squabble? Here’s hoping. But even if divorce (or further decoupling) is inevitable, might they still vow to get along ‘for the sake of the kids’.

For if siblings Noel and Liam Gallagher can make peace, anyone can. Even the US and China. Even William and Harry. Russia and Ukraine? If that were ever to happen, Finland would not only be the antidote for teenage depression, but also middle-aged aggression.

“If goods don't cross borders, soldiers will”

French Economist Frédéric Bastiat believed free trade between countries could reduce international conflict. While the theory seemed to fail during the French/Russian (Napoleonic wars), Britain/Germany (WW1) and Japan/Australia (WW2), if you accept the logic then who is more likely to drive trade – and peace – between China and the US? Harris or Trump? The Economist say it’s Trump. He displays a “business mentality” to Taiwan, for example, and so might find it easier ‘to negotiate…without appearing weak’. I’m assuming he’ll have Elon Musk by his side to help with the negotiations. Whereas some CEOs are persona non grata, he’s welcomed more like ‘one of their own’, at least Tesla is given its preferred supplier status in certain provinces.

Whatever the outcome in November, have a feeling we may hear more from Elon, and I’m marking Optimus and Space as just two things to watch out for.

Sobering news

My reasons for expecting AI to consolidate include: price action (‘down on good news’), technicals (‘triple tops’ and ‘bull traps’) and optically at least, a slowing rate of growth (albeit capacity, not demand led). Returns look anaemic relative to invested capex and a gold rush needs gold to continue. Signals of euphoria are emerging, like the $50T market cap forecast, a name change to .ai (TEM US) and according to this, Michael Mauboussin’s new book suggests past ratios are only relevant to the degree they capture today’s circumstances (those of you around in 2000 may appreciate the signal value of ‘new paradigm’ thinking).

Despite the euphoria, Jensen Huang’s been selling stock (see GPTR <go> on Bloomberg). Competition is beginning to emerge. Cerebras will soon IPO and Softbank’s opened its cheque book to Graphcore. Both might chip-away (sorry) at Nvidia’s moat. McKinsey’s can only find 3% of retailers to have successfully implemented AI. The Upwork Research Institute found nearly half those using AI have no idea how to achieve the productivity gains expected. David Solomon at Goldman’s believes they’ll make more money lending to AI than using it. Meta dropped a big AI project, Microsoft’s seeing firms drop co-pilot and their CFO talked about 15 year payoffs.

Few folks can party for that long. Some sobriety will be necessary. If only momentarily.

New narratives

But the AI bulls can counter many of these – and may even welcome a period of healthy consolidation. The CROIC arguments ignore the efficiencies gained at hyper-scalers through their own use of AI (i.e., they are finding plenty of gold). Growth constraints are not driven by demand so much as supply (namely TSMC) and folks like Musk, whose storytelling can help bring the future forward, remain highly animated. That and rate cuts could support valuations, which are above fair value, albeit below levels seen in previous bubbles. All true, but then rate cuts will support other things as well. Perhaps even more so. Indeed, since Nvidia peaked on June 18, tech has been a drag on the broader market, while rate / liquidity sensitives have done much better.

So, time to tell a few stories not being told. Where are the market comebacks likely to emerge? And what are the likely catalysts?

The nature of comebacks

Ruchir Sharma in the FT argues there’s a comeback under way as emerging economies are rebuilding their growth lead over developed economies — including the US – and corporate earnings are set to follow. Exclude China, and earnings are growing at an annual pace of 19 per cent, versus 10 per cent in the US. In Q2, for the first time since 2009, EM corporations (excluding China) beat earnings forecasts by a wider margin than their US counterparts did. Despite this, exposure remains so low and fears so high that emerging markets are off the radar of most global investors. “But that is the nature of comebacks. They emerge from obscurity, and the deeper the shadows from which they spring, the more drama surrounds the comeback — once it is recognised.”

So, might we expect similar now? A time when EM valuations vs the US are at an all-time low?

Here’s another way to picture it….

Source: Topdown Charts

And what might be the catalyst?

The FED. Lower US rates may lead to a lower USD – which is typically a harbinger for EM capital flows.

What about those dividend compounders?

If you believe in the need for a period of sobriety – the Mag7 consolidates and leadership shifts for a time – and if interest rates fall and ‘yield’ become scarce, then history suggests stocks with high earnings/cash yields should attract a premium. These typically display quality characteristics. Now, those who remember Aviate’s Quality Cash Compounders (QCC) basket, stocks with high and enduring CROICs, may be interested to know it’s up +15% YTD in USD. That’s decent considering it is ex USA (so no Nvidia etc.) Other quality, low volatility proxies are also performing well. Take my employer’s version for example (NTUQLVTR) it’s up +17% YTD. But that’s still not keeping up with my favourite factor: dividend. Not only is it outperforming (see NTUQDDFT, up 19% YTD) it’s doing so, largely unnoticed. In other words, there’s clearly a change underway in markets, although not yet in market narratives. But that should follow price. It usually does.

And soon you may be reminded that dividends are a major source of stock market return. And that the only thing with more predictability of future returns, is low starting valuation. And as you know, we've discussed countries including Japan and the UK in this regard previously.

ESG: the greatest comeback of all?

One emerging narrative we’ve discussed previously, with limited success, is the investment merit of extending beyond AI to its underlying supply chain in the material world. Our argument is: there is scarcity not only in IP and Chips but in the physical materials that go into making and sustaining them. While there is no shortage of coders, there is of construction workers and we’re yet to see AI swing a hammer.

But I’m wondering if now may be time for redemption. A comeback? A headline: ‘Google’s carbon emissions are up 48% in the past five years’ grabbed my attention. It’s a reminder that you can’t have progress without power. Energy in all its forms will continue to see demand growth, which should help renewables and regrettably perhaps, even oil. So good news for our copper thesis and while we’ve cautioned against the current framing of ESG, we are now wondering if after the rout, if ESG and particularly “E” are worth considering again? It’s not like the weather has suddenly improved. My Scottish friends say even Noah himself couldn’t have enjoyed his summer vacation, if taken in the west of Scotland (see record rainfall).

But what has changed is inflation. Lower prices may help with the cost-of-living crisis, in removing some oxygen from those fighting against climate policy (remember the riots in London, Paris and in rural Germany?) Add in lower rates, higher discounted cashflows and terminal values, and we could see the market narrative flip.

For price matters. To everything.

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