Animal spirits are driving asset prices to record levels
The S&P 500 hit an intraday all-time high yesterday of just over 6,100. It appears that investors and business owners are enthusiastic about the economic prospects despite all the unknowns. The rally in stocks and bonds, which lowered the 10-year U.S. Treasury yield to 4.6%, may have been helped by the fact that President Trump did not impose massive tariffs immediately after the inauguration.
The U.S. is transitioning to an administration that is much more business friendly. Lower regulatory burdens and a less litigious approach by the FTC may very well ease the reservations CEOs have placed on capital expenditures and other planned investments. Thus, it is unlikely that the economy will stumble during at least the next several months. However, optimistic expectations are already priced into the stock prices of companies. In fact, JP Morgan’s CEO Jamie Dimon recently said “asset prices are kind of inflated” when discussing the U.S. stock market.
We are now in earnings season. Based on the reports of the large banks, the economy and the consumer appear to be in decent shape. There are many more companies yet to report. Economic reports will also be critical to the Fed as it tries to balance its ongoing efforts to bring inflation down to its 2% target, while also paying careful attention to the new administration’s changes in trade and immigration policies.
Big AI infrastructure deal announced
President Trump announced a $500 billion joint venture called “The Stargate Project” with OpenAI, Softbank, MGX, and Oracle to construct new data centers and the power generation that is necessary to operate them. The initial round of investment is targeted to be $100 billion. The project is focused on building the necessary infrastructure for training new AI systems on American soil, ensuring U.S. control over the technology. In addition, the initiative allows OpenAI to expand its cloud computing partnerships beyond Microsoft, potentially addressing previous limitations in computing power.
The Stargate Project provides more evidence that investors are enthusiastically pouring billions into projects and stocks in anticipation of future profits. Combined with ongoing investments by many other tech giants, the massive investment in generative AI, estimated at $1 trillion announced so far, is generating considerable debate about its potential return on investment (ROI).
While some companies, particularly those already utilizing AI for tasks like recommendation engines, are seeing positive returns, the overall ROI remains uncertain. A key factor is the ongoing “arms race” among leading AI developers to build the most advanced foundational models. This competition requires continuous high investment, making short-term ROI potentially less attractive.
However, the long-term potential of these models, with anticipated improvements in efficiency and the development of new applications, supports the case for continued investment. For instance, ChatGPT produced $1.2 billion in revenues in 2023 and is expected to report almost $4 billion in 2024. Yet, ChatGPT remains unprofitable and is cash flow negative due to the massive need to continue its investments.
The industry is currently in a phase of infrastructure build-out and rapid model improvement. The emergence of “killer apps” beyond coding and customer service chatbots will be crucial in determining the ultimate success of these investments. There’s also a question of market concentration, with a few major players like Google, Meta, OpenAI, and Anthropic potentially dominating the field.
Whether the market will be winner-takes-all or support multiple successful models remains to be seen. However, there will be enormous opportunities for investors to identify the companies that develop “killer apps” and utilize AI to transform their cost structure. This is where we think the next decade’s winners will be found.
Don’t give up on the other 493 stocks just yet
While AI and technology stocks are certainly delivering wonderful innovations, there are many other types of businesses that will reap the rewards of new technology. Life sciences and the delivery of healthcare are two of the most promising opportunities. But this doesn’t mean the markets will deliver year after year of 20%+ returns like those we experienced in 2023 and 2024. We have to be prepared for lots of ups and downs as the opportunities unfold.
Macroeconomics is also very likely to be a big factor in the years ahead. Budget deficits are running at levels normally associated with recessionary conditions. Usually, governments run large fiscal deficits to counter high unemployment rates, but that is not the case today. If a recession were to hit the economy, there is not much room for government spending to maneuver. And, despite the aims of the DOGE to lower spending, neither party will touch entitlement programs which are the biggest source of our nation’s long-term fiscal challenges.
Interest costs are skyrocketing. Future bond issuance to fund government spending could cause interest rates to rise further. Rising interest rates are like kryptonite for high-growth stocks. Thus, while we are optimistic about the future of AI and the innovations that will follow, we are mindful of the growing risks.
And, after years of dramatic outperformance, the mega cap technology stock performance gap paused during the second half of 2024. In fact, the earnings growth of the Magnificent 7 is decelerating while published earnings expectations for non-tech sectors are accelerating. Thus, a transition in sector leadership may warrant a more balanced approach to stock selection going forward.
Today’s birthdays- actresses Mariska Hargitay (61) and Tiffani Thiessen (51), and Princess Caroline of Monaco (68).
Christopher Gildea
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