The Weekend Edition includes a market update plus Morningstar adds links to two additional articles.
When Steve Eisman speaks, investors listen. It helps that he’s a straight shooter, a refreshing trait in an increasingly PR-led world. His own wife described him as “not tactically rude – he’s sincerely rude” in the book that made Eisman famous, The Big Short, by Michael Lewis (Steve Carrell played his character under the name, Mark Baum, in the subsequent movie).
Eisman also has unique insights that few in the industry possess. It probably comes from his background as a bank analyst, and his deep knowledge of the finance industry and broader economy.
In the 1990s, he turned away from a corporate law career to become a ‘specialty finance’ research analyst at Oppenheimer and Co. It was there that he discovered the first subprime mortgage companies and wrote a scathing 1997 report on how they operate. Many of the same companies would reappear during the housing bubble that developed in the 2000s. Eisman eventually helped train analyst Meredith Whitney, who became a star with her string of critical reports on the banking industry in 2007.
Eisman is now Managing Director at Neuberger Berman, and recently appeared on the Meb Faber Show to discuss his current thoughts and market outlook.
On the US economy and consumers
Unlike before 2008 when he was uber-bearish on the US banks and economy, Eisman thinks the US economy is in decent shape. Consumers aren’t indebted, unemployment is low, and wages are going up. The banks have healthy balance sheets, with excess capital, if anything.
He does see consumers cutting their spending a little, though. Eisman says data from Visa and American Express shows volumes have slowed and delinquencies have started to tick up. However, it’s nothing to be too concerned about, he says.
If there is a recession at some point, it won’t lead to a financial crisis due to the health of the banks, Eisman believes.
The two great equities stories of our time
Eisman says that in bad times, people focus on the quality of balance sheets and credit quality, while in good times, they focus on stories. And he says there are currently two great equities stories: artificial intelligence (AI) and infrastructure.
Eisman’s interviewer comments that he doesn’t see Eisman as ‘an AI guy’ - understandable given his ‘Big Short’ background. But Eisman makes it clear that he just goes into areas where he can make money.
On AI, Eisman has some fascinating insights. He says that we’re at the early stages of the AI cycle. He cites listening to a recent earnings call from Accenture. Accenture has a consulting business and an outsourcing business. The former isn’t doing especially well, while the latter is thriving. One of the reasons why outsourcing is picking up is because America’s corporates aren’t ready for AI. Most companies don’t have their data in one place and cleaned up, both essential before they can start figuring out what to do with it. These companies are hiring Accenture to clean up the data. It’s why Eisman says that we’re not even close to a broad adoption of AI yet.
What are the best ways to play the AI theme? Eisman suggests that hardware companies are likely to outperform software companies in the long term. Over the past 15 years, software has trounced hardware, driven by the switch to the software-as-a-service model. This model provides recurring income, which markets love, and that’s led to an explosion in the multiples attached to software businesses.
Going forward, Eisman believes the cost to develop software will collapse because of AI. However, companies will still need hardware.
Eisman also points to cloud providers as beneficiaries of AI. For large companies, whatever they do with AI will be in the cloud.
He also says that there will be AI apps soon enough, and that will drive a major upgrade cycle in phones and iPads.
The other great equity story according to Eisman is infrastructure. He says it’s a combination of four mega-themes: onshoring, data centres, electrical grid improvements, and greenification. The industrial policy of the Biden administration, from the IRA to the CHIPS Act, has turbo-charged these mega-themes.
With onshoring, Eisman says the key beneficiaries are mostly industrial companies. He breaks them down into sub-sectors. For instance, companies in the construction and design sector, which can be broken down into three groups: electrification, automation, gas turbines, and materials. Other areas of interest include solar, hydrogen, utilities, and water.
Eisman suggests that at a broad level, the US is too dependent on chips being made in Taiwan. It’s a national security issue that’s resulting in more factories being built in the US. And that will continue, whichever party wins the US election.
Eisman seems especially bullish on electrical grid improvements. He says electrical consumption hardly grew in the US over 20 years. It’s now growing 2.5% a year. That’s due to demand from electrical vehicles and data centres. Currently, the US electrical grid produces about 4,000 terawatt hours of electricity. To meet increasing demand, that will need to increase to 5,000 terawatt hours over the next 10 years. It can’t be done with just renewables and will need a lot of gas. Hence why he’s optimistic on gas turbines, because turbines need to be built to make electricity from the gas.
Eisman suggests one stock as a potential beneficiary of the infrastructure boom: Quanta. It’s a company that gets hired by utilities to build renewable plants. He likes the story because it’s been a sleepy business for a long time and its price reflects that. Yet a secular change has happened that should catapult their earnings as well as what investors are willing to pay for them.
How the US election may impact the themes
Turning to the odds of a Trump victory in the November election, Eisman says they’re 100%. He explains that he watched the movie, Hillbilly Elegy, based on the book by Trump’s Vice-Presidential nominee, JD Vance. He says the movie shows areas of America like Kentucky and Ohio where people have been left behind. Half of the towns are boarded up. The stores are gone. The factories are gone. These parts of the US were ignored by politicians until Trump came along. It’s one of the main reasons that Trump was originally elected and will likely be elected again.
More broadly, Eisman says that the constituents of the two major parties have changed. The Republicans used to be the party of the rich, but they’re now the populist party. Meanwhile, the Democrats used to be the party of unions, yet they’ve moved from that towards the educated classes and Silicon Valley.
As to how politics may impact his two major equities stories, Eisman says it’s not black and white. He believes AI will be largely unaffected. For infrastructure, parts of it may be boosted, and other parts could be de-emphasised. For example, Trump would likely be positive for onshoring, though less so for greenification.
The great non-equities story
Eisman declares there’s a third great story of our time and it’s a non-equities one. Namely, Bitcoin. However, he doesn’t believe in Bitcoin and is staying on the sidelines.
Eisman suggests that there are problems with cryptocurrency. Is it a currency? Some people think it is, some think it isn’t. Yet, there is no data point that can prove it is a currency.
Eisman then says to pretend that it is a currency. Why should he own cryptocurrency? Proponents will argue that it’s a hedge against dollar debasement, to which Eisman replies:
“That sounds great. And then here’s my question to the crypto people … then on days where NVIDIA is up ridiculous amounts and interest rates are low and people are feeling great, crypto should go down. And on days where NVIDIA is down 5% and interest rates are up at the same time … crypto should be up. And that’s not how it acts. Crypto has like a 70% correlation to the Nasdaq. So, there’s theory and there’s practice.”
Consequently, Eisman says Bitcoin is a speculation, not an investment.
Coincidentally, we have two articles and a whitepaper this week exploring the two stories that Steve Eisman is bullish on. First, Fidelity's Tom Stevenson expresses his bemusement about how sentiment has turned on the AI story, from unquestioning fervour just months ago, to scepticism about whether gargantuan investments in the sector will pay off. He says if you don’t know how exposed your portfolio is to AI, now would be a good time to find out. Meanwhile, TD Epoch - a GSFM affiliate - has a whitepaper on how power constraints will impact the progress of AI.
And, Firstlinks' Joseph Taylor has a piece on infrastructure, highlighting lessons that the team at Magellan have learned from investing in the sector. They suggest that it's best to focus on quality and have the nerve to buy infrastructure stocks when markets take a dip or companies encounter short-term problems.
In my article this week, I look at Warren Buffett selling almost 50% of his shares in Apple. The move surprised investors given Buffett’s propensity to buy and hold companies for the long term, and his lavish praise for Apple as recently as in May this year. Why did he do it? What changed his mind on Apple? And what are the lessons for investors like you and me?
James Gruber
Also in this week's edition...
The great intergenerational wealth transfer continues to attract headlines. Accountant Danielle Hart and family lawyer Jane Koelmeyer have both seen how the transfer of wealth can work well, with inherited wealth helping families grow and thrive for generations, as well as how things can go horribly wrong. They offer their tips on how to get it right.
The biggest fear voiced by Australians prior to and during retirement is running out of money. Justine Marquet at Allianz Retire+ explores the key risks that should be considered when building a retirement income strategy.
Thank goodness for the ladies who led Australia to a record breaking Olympics gold medal haul. It helped that swimming events featured prominently, a traditional strength of Australia's. Vaughan Cruikshank, Brendon Hyndman, and Tom Hartley break down all the numbers from the Olympics and the reasons behind our success.
Two extra articles from Morningstar this weekend. Mark LaMonica reveals how to avoid basic errors that cost investors dearly, while Joseph Taylor highlights an ASX growth darling that looks grossly overvalued.
Higher interest rates help tame inflation, right? Not necessarily, says Chris Bedingfield. In fact, he says the evidence, both here and internationally, suggests that higher rates cause higher inflation. If right, it means that the RBA's efforts to lower inflation back to its 2-3% band may not be successful.
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Weekend market update
On Friday in the US, stocks edged higher, capping off their best week of the year in an amazing turnaround that defied recent concerns about rising recession risks. On the day, the S&P 500 and Dow rose 0.2% while the Nasdaq was flat. The yield on 10-year Treasuries declined three basis points to 3.88%. Crude oil fell 1.8% to US$76.74 a barrel, while gold increased 2.1% to US$2,507.76 an ounce.
The week's gains in equities followed a string of encouraging economic reports. The S&P 500 was up 3.9% this week, while the Dow Jones Industrial Average climbed 2.9%, and the Nasdaq Composite advanced 5.3%.
From AAP Netdesk:
The local share market on Friday finished a good week with a strong rally. The benchmark S&P/ASX200 index ended up 105.6 points, or 1.34%, to 7,971.1, while the broader All Ordinaries gained 106.1 points, or 1.31%, to 8,189.9.
The ASX200's 2.49% rise for the week was its best weekly performance since mid-December. The ASX200 has now risen for six straight days, clawing back all of its losses from its sharp 3.7% plunge a fortnight ago.
The rally came after the US Census Bureau reported that American retail sales increased 1% in July - far better than the 0.3% rise economists had expected.
The number of Americans making new unemployment claims last week also fell.
Every sector of the ASX finished in the green on Friday, with the energy sector the biggest gainer, rising 2.2% as Woodside climbed 2.4%.
The heavyweight mining sector - which has been a laggard in recent days as iron ore prices dropped to less than $US100 a tonne for the first time since mid-2023 - was close behind with a 2.1% gain. Fortescue climbed 3.1% to $17.34, BHP rose 2.0% to $40.01 and Rio Tinto grew 1.6% to $110.09.
All of the big four banks were higher, with CBA up 2.4% to $138.13, ANZ climbing 1.4% to $29.59, NAB rising 1.5% to $36.48 and Westpac finishing 1.2% higher at $29.66.
Buy now, pay later company Zip Co was the biggest gainer in the ASX200, climbing 13.5% to a two-year high of $2.19 after announcing a partnership with fintech Stripe in the US.
From Shane Oliver, AMP:
The Fed is on track to start cutting in September. Benign US CPI and producer price inflation data for July indicate ongoing progress in getting inflation back to target. And Fed officials are starting to focus more on the cooling jobs market. A 0.5% cut is possible but in the absence of much weaker jobs data ahead of the 18 September meeting a 0.25% cut is more likely. The US money market though has priced in a 75% chance of a 0.5% cut in September and four cuts by year end.
The Reserve Bank of New Zealand joined the global rate cutting cycle, cutting its cash rate by 0.25% to 5.25%. It now projects its cash rate falling to 4.92% by year end and 3.85% by end 2025. Don’t forget that back in May it considered a rate hike!
None of this means that the RBA will automatically follow. But just as Australia followed global inflation and rates up in 2022 – despite some saying we wouldn’t because we were different – it’s likely to follow on the way down in the next six months. Yes, disinflation stalled in the June quarter, but it did in the US in the March quarter too. And underlying economic variables are not that different to many countries that are now starting to cut rates – eg, unemployment is similar to that in the US and UK and wages growth has been lower than in the US, UK, Canada and New Zealand.
So, while Governor Bullock in Parliamentary testimony reiterated the message that the RBA “does not expect that it will be in a position to cut rates in the near term”, we continue to see it starting to cut in February on the back of slower growth, higher unemployment and lower inflation than its currently forecasting.
That said, the RBA’s return to time-based interest rate guidance after seemingly swearing off it after the 2021-22 “no rate hike before 2024” experience is surprising. Its current guidance is qualified by being based on “what the Board knows at present” and the Governor noted that “circumstances may change” giving the RBA an off ramp in the event of much weaker economic data or a financial shock – but then the 2021 guidance was qualified too, and the current guidance is getting reported as “ruling out rate cuts this year”. That said, there will be much less community annoyance with an earlier cut as opposed to the response to the start of hikes in 2022!
Curated by James Gruber and Leisa Bell
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