Making Hay Monday - June 24th, 2024
High-level macro-market insights, actionable economic forecasts, and plenty of friendly candor to give you a fighting chance in the day's financial fray.
Charts of the Week
My wife has been adamant for well over a year that official government inflation statistics don’t come close to measuring the price explosion she’s seen in grocery stores. With many items, like berries and bread, she believes it’s been more like 100% vs the 26% we are told. Jefferies’ Chris Wood, the skillful author of the GREED & Fear report, published a note last week on exactly this point. Citing a source, Chapwood, that attempts to provide a better estimate of Americans’ actual cost of living increases in the post-Covid era, my wife, and all the other homemakers who agree with her, deserve some atta-girls. The Chapwood Index’s actual costs on the top 150 items Americans buy in the 50 largest cities rose by between 7.8% and 13.6% last year. In 2022, the range was 11.3% to 18.8%. Accordingly, while this index reflects the inflation cool-down reflected in official statistics, it continues to run at a painfully high level. Unfortunately, these increases are harder on lower income cohorts. This is likely a key reason such a large number of U.S. voters are much more concerned about stagflation than are those in the well-heeled economic forecasting community.
In his Thoughtful Money interview, the subject of today’s piece, Fred Hickey covers in vast detail the topics of valuation and market share within the Big Tech ecosystem. The chart above, created by Visual Capitalist, offers some quick-glance context for reference as you’re reading our interview summary or listening to the interview first-hand. In a word or two, Nvidia’s size relative to Apple, Microsoft, Alphabet, and Amazon might give the impression of a formidable giant slayer en route to industry dominance. As it happens, much of that market cap is at risk of erosion in the near term as hardware orders are brought back in line with actual demand. Nvidia has done phenomenally well on the “shovels and wheelbarrows” side of the AI gold rush, but it’s no longer 1849, and the best of the boom days might just about have run their course.
“Once a boom is well started, it cannot be arrested. It can only be collapsed.” -John Kenneth Galbraith
A Thoughtful Hickey Meets Thoughtful Money
Last week, my good friend and frequent host, Adam Taggart of Thoughtful Money, hosted Fred Hickey, author of the decades old newsletter, High-Tech Strategist. Their conversation ran just over an hour, with at least half that time dedicated to a close analysis of the technology industry, the Magnificent Four (or Five), and most importantly, the hype-frenzy surrounding GenAI. The latter, as a market phenomenon, is currently spinning itself into an unprofitable, overvalued cyclone of sunk costs and missed earnings goals.
We have linked to the interview (which you can also find on the Thoughtful Money YouTube page) and encourage every one of our subscribers to watch it all the way through. If you don’t have the time to take it in just yet, have a look at our summarized overview below to get a sense of where Fred Hickey is on the question of Generative AI’s role in this era’s bubble-inflating market.
Taggart/Hickey, Summarized
The major theme of the interview is overvaluation, which itself is brought on by the predictable hype that surrounds many or most new major tech developments. However, it is also being fueled by a misunderstanding of what AI is, how it can best be applied to real consumer demands, and where it presently is as a scalable and accessible collection of tools.
Much of the U.S. economy’s present state of extreme bifurcation is a result of bloated asset prices, which are contributing to a wealth gap that allows asset holders to continue living as though the economy is in fine shape. Hickey’s concern is that when those prices deflate, there could be a painful correction for all.
We can’t talk about bloated asset prices without covering Nvidia and the Magnificent Five, depending on which names you want to include.
Yet, as Fred is keen to point out, valuations for the remaining Magnificent Seven cohort are not based on business fundamentals; rather, they are a product of the myriad promises of efficiency-enhancing capacities of Generative AI (note the word “promises” – the realities are far from proven). For example, Apple’s earnings, as he wryly observes, are actually lackluster by its own standards and nowhere near vibrant enough to justify its recent stock boom. Like Fred, I vividly remember Apple trading at mid-teens P/Es when it was much smaller and its growth rate was strongly positive versus slightly contracting. Apple today trades at roughly 30 times this year’s estimated earnings, adjusting slightly for its fiscal year that ends September 30th.
Fred points out that the Generative AI-driven market frenzy has seen Nvidia, Microsoft, and Apple overtake the aggregate wealth of the Chinese stock market. What’s the problem? Well, per his argument, the wider the chasm grows between stock value and true business fundamentals, the greater the chance of a harsh correction. As we have all witnessed numerous times, if the starting point is elevated enough, those can quickly morph into crashes, even if they take months to play out. That’s exactly what happened in 2022 when many of what I referred to back then as The COPS – Crazy Over-Priced Stocks – were busted to the tune of 70% or 80%.
Another word of caution from Fred is his assertion that concentrated wealth in so few stock buckets has created a narrowing phenomenon which has resulted in more 52-week lows versus highs. A precedent for this can be found about a half-century ago in the so-called Nifty Fifty, about which we have ourselves written once or twice.
Driving home the market narrowness again this year, continuing 2023’s pattern only more so, the S&P is up a mere 3.6% in 2024, excluding the 10 largest AI stocks. Including them, it has jumped 12.3%. (NVDA’s recent swoon may have slightly altered these numbers.)
The real matter of precedent of great relevance here is that AI, contrary to how it’s been popularly discussed these past 18 months, has actually been with us for decades. All sorts of software tools have operated in line with intelligent programming to assist humans with tedious, complex, and data-heavy tasks since the mid-20th century. What’s relatively new is Language Learning Model software which, though Fred agrees it has several use cases, is still nevertheless not capable of thought, reasoning, or real problem solving. It’s a regurgitation feature, and an error-prone one at that – (he mentions “AI hallucinations”; look up some examples when you have the time). Personally, I’m relieved AI has these weaknesses and limitations. It makes me feel like it won’t eat the world – and humanity along with it – after all.
Still, per Fred, it was enough for Microsoft to feel as though it had a shot at overtaking Google in this arena by simply pasting ChatGPT functionality directly onto its second-fiddle search engine, Bing, and advertising it as a guaranteed value-add for consumers. To deliver what they hoped would be a knockdown blow, they loaded up their first punch with enough Nvidia hardware to weigh down an ocean liner. Those GPU purchases, which effectively blew a first blast of air into the Generative AI bubble, were also the start of NVDA’s ongoing flight to the stock market heavens.
But the challenge wouldn’t go unmet. Google, Amazon, Meta, and most prominently, Apple followed suit. The ensuing investment from these tech monoliths has amounted to $200 billion, despite Generative AI constituting something of a smoke-and-mirrors phase of existence these days. As Fred reminds us, the AI advent in its current incarnation will not give rise to the next Industrial Revolution, even if the valuations to which it is giving rise indicate otherwise.
One observation Hickey makes is that while much of the world recognizes the hollowness of many Generative AI products, services, and hardware add-ons, it’s Wall Street that can’t seem to jump off the train whose fires they’ve been stoking. Mutual funds, for a telling example, are brimming with tech, and all based on speculative growth rather than verifiable returns. That sort of mismatch is a precursor to correction, itself a precursor to wealth destruction. Now’s a good time for all to recognize that AI has been overly advertised, overly sold, and overly accepted at face value.
A precedent for all this, which Hickey elaborates on, was Intel, which enjoyed far more dominance but never exceeded even ⅓ of Nvidia’s inflation-adjusted valuation. Likewise, as Fred opines, the Internet actually was a world-changing phenomenon in a way that Nvidia and Generative AI will not match in the short term. Concurrently, we’re seeing asset inflation across a narrow market breadth because consumers, being cash-strapped, cannot invest elsewhere. The Fed’s QT policy is drying up the cash that might have dispersed throughout the market.
For context, Fred tells us that Microsoft is gaining revenue based more on acquisitions than on its AI ventures. In Apple’s case, it has seen virtually no real revenue growth since embracing the “Apple Intelligence” sales identity.
The operative theme in this is that it’s all unsustainable – eventually, the house of AI cards will collapse.
Fred also made a powerful point about accounting gimmickry in IT-land. It’s a trick I read about a few months back but, frankly, I’d forgotten about: tech companies are raising assumptions for computer server lifespans to cut depreciation figures. It’s hard not to view this as a ploy, a case of financial manipulation designed to inflate earnings figures. Nvidia is also funding their own customers – “round-tripping” – with CoreWeave being a case in point. This is a direct blast-from-the-past, harking back to what companies like Cisco were doing in the late 1990s, basically, vendor financing. That ended very badly, as this latest implementation of creative accounting is likely to.
As Hickey points out, a boom-to-bust sequence is highly probable. In his view, If left to natural forces, the dotcom drubbing – when the NASDAQ fell nearly 80% – would repeat with NVDA and its peers. As mentioned on Friday, like me, Fred is convinced there is pervasive over-ordering of AI chips presently and once that becomes obvious for all to see, NVDA will experience another of its signature 50%, or more, “corrections”. He feels that the mega-cap tech stocks in general could easily get cut in half. Thus, under the risk avoidance heading, he’d be cashing in gains. In his personal account, he is buying long date put options on some of the Magnificent Seven stocks.
When it comes to generating gains, his favorite long area is gold miners.