Transcript:
Welcome to Beyond Consensus: Thoughts from the Dismal Roundtable. I’m Rick Brink, Market Strategist for AllianceBernstein. I’m joined by the usual crew: first out of London, Inigo Fraser Jenkins and Alla Harmsworth, Co-Heads of Institutional Solutions for AllianceBernstein, and from New York, Eric Winograd, Director-Developed Market Economic Research and Chief US Economist. Welcome everybody. We have a lot to talk about. We’re going to jump right in. We’re going to talk about the economy. We’re going to talk about a lot of things, but it seems like we are stuck at the spiritual center of AI being in every conversation that we have. I feel like we have cut this every way that we possibly can. Inigo and I were just doing his paper; another series I was talking about supply chains and what it’s going to take to develop it; now we have the economic and the market side of it that we’re going to jump into.
Eric let’s jump in right away. State of the economy, summertime, time of no data, lots of issues going on. Question marks around rate cuts. Now, we have some tariffs removed. We have a Fed meeting coming up. We have questions everywhere, and now it seems like the Fed might be backing off, but maybe they’re not. And it seems like the economy might be okay, but maybe it’s not. We have some data canceled, so we’re waiting to see. With all of that exceptional information you have, what’s your take?
Eric Winograd: Yeah, it’s been a very strange time. I think that the absence of data, particularly as you approach what could be turning points in the economy, makes it very difficult to really be focused on the sorts of granular data releases that we normally would be. I have to say though that in some respects that’s probably a good thing. There’s always a danger when you’re looking too much at the trees that you miss the forest. And we are not flying completely blind here. We do have other data that we’ve been able to rely on and in a lot of cases I think it’s better to take sort of a medium- and a longer-term view of the economy rather than getting too bound up in the short term. When we do that, when we look at the data that has been available—the limited government data of course—but we do get private sector data. There’s alternative data. The advent of technology; the improvement of technology allows us to look at things in ways we wouldn’t have before. What we see is an economy that frankly hasn’t changed all that much from where we were in the summer. Growth seems like it’s doing okay and it’s not exciting, it’s not gangbusters, but it’s doing all right in the US. It’s doing all right outside of the US, supported largely by rate cuts in the rest of the developed world and by policy stimulus in China. Inflation in the US is sticky as it has been for most of this year. It has come down, but it isn’t back to the Fed’s 2% target. It isn’t making real rapid progress toward that. So at a very top level, the economy still looks okay. As the statistical agencies dig themselves out of the papers that accumulated during the shutdown, we will get more information, but by and large, I think that’s what we’re going to see.
When you do look a little bit closer, the one part of this that stands out that’s really interesting I think is the weakening of the labor market. It’s unusual to see growth be as robust as it has—or maybe robust is the wrong word—but let’s say as stable as it has been and yet the labor market is weakening. The unemployment rate has gone up three straight months and is at a cycle high. The run rate of hiring has slowed really dramatically compared to where it was in the first quarter of the year. So, you see this sort of duality where growth looks okay and the labor market doesn’t, and that’s really the big puzzle as we move into next year.
Rick Brink: I feel like we should title this “The Buzzword Session” because I’m going to throw a buzzword out. As you mentioned, the labor weakening and at the same time, market’s moving really well. The economy’s hanging around. So, let me throw my first buzzword out: K-shaped economy.
Eric Winograd: Yeah, so a lot of people are describing the economy as K-shaped, and I think that that makes sense. You draw sort of a dividing line a couple of years ago, at which point, if you look at the S&P 500 or other stock indices, they’ve gone pretty much straight up and done very well. If you look at consumer sentiment just as one example, it’s gone the other direction. I think that does reflect a duality in the economy. And again, I know we’re going to come to this, so I’ll sort of foreshadow it, AI is something that pushes you in this direction as well. But if you envision the letter K, the upward sloping part of that is the wealthy part of our society. If you are wealthy, if you are a high-income earner, if you are invested in financial markets, if you have financial assets, the odds are good that you’re doing very well.
Financial market performance has been strong, corporate profitability has been strong. If you’re a high-income earner, you’re more likely to be indexed to corporate profits. Things look great from up at the top part of the K. By contrast, down at the bottom part of the K, things look a lot more difficult. The slowdown in hiring has made a big difference for low-income earners. We’re starting to see signs of stress there. Many in the low-income cohort do not have financial assets, or don’t have significant financial assets, so they aren’t benefiting from the run-up in market prices. Consumer sentiment—when we ask people about their confidence in their ability to find a job if they needed to—that has gone down quite significantly. So, if you’re on the bottom part of the K, things are tough and we see that, right? The inflation, the stickiness of prices, if inflation’s running around 3%, but the S&P 500 is up 15%, it probably doesn’t matter that much to upper-income households, but it matters a lot to lower-income households. So we are seeing rising delinquencies in auto loans and things like that that are reflective of stresses there. So, the bottom part of the K is struggling, and frankly, AI pushes you in the same direction. It’s the kind of technology that should boost the return to capital at the expense of the return to labor.
Rick Brink: I feel like we could do an entire podcast just on the story inside the story on labor, people that are unemployed, how long they’ve been unemployed, new college graduates, their time to find positions, all of that stuff. But I wanted to just stay on the consumption side as you’re talking about GDP because obviously there’s a wealth effect that’s always talked about by monetary policy folks, and so we are able to consume. I’ve got two things, then. If I’ve got questions around AI— and I feel where we’re going next with the next buzzword—then does that affect the upper end’s ability to consume? And at the same time, if GDP is an expenditure method, you’ve seen some of the charts, we’ve all seen some of the charts that a lot of what constitutes our GDP is actually the AI spending. So it’s the financial markets that might be affecting wealth effect that allow us to consume, but at the same time are showing in the GDP data. So it feels like, here we go again, we’re coalescing around AI.
Eric Winograd: It’s a really good way to transition into thinking about what AI means going forward. You’re correct. If you look at the GDP metrics, a large part of the growth that we’ve seen this year has been fixed investment in things that look a lot like artificial intelligence. There isn’t an official statistical category for investment in AI, but the things that smell like AI if you will, have gone from 4% of GDP a couple of years ago to more than 7% now. That is a very significant increase in what had otherwise been a very sort of slow and steady growth rate. It certainly looks like the economy has become more levered to AI and that does create some vulnerabilities. Inigo and I have talked about this in other places, but when you look at the share of GDP that is now AI capex, you can tell two alarming stories if you want to.
One is that those investments won’t pay off; that a lot of this is unproductive, that businesses have overinvested to some degree, and it isn’t going to generate the sort of revenue that investors are hoping for, or at least not on the timeframe that investors are hoping for. And if that disappointment happens, to your point Rick, you could see the market react poorly. Given that consumption in the economy is driven by upper-income households—more than 50% of consumption at this point from households is driven by the top 10%—if the market were to fall, the wealth effect could go into reverse and that could weigh on the economy. But you could also play it out the other way. Let’s say that this investment is productive and that it does pay off, well then, the demand for labor probably goes down even more and the bottom half of that case struggles. So, there are risks in both directions with this. There are also benign cases where it works perfectly and we’ll talk about those too. But we have to be aware that AI, like other technological advances before it, isn’t a panacea. It doesn’t cure all that ails any economy.
Rick Brink: It is fits and starts. Thank you, Eric. By the way, I also appreciate the indirect unintended, but still a wonderful plug—shameless plug—for our last Disruptors that was talking about Inigo’s paper on the effect of AI on productivity and labor. So, thank you for that.
By way of segue, Inigo, let’s jump in here. Sometime ago I came up with the idea of S&P 493 and now I’m seeing it showing up in articles. Of course my ego wants me to believe that I am the progenitor of all of that, but then I realized that people could probably figure out how to subtract seven from 500 all by themselves. I probably can’t take much credit for that, but it is worth framing it that way. I’m just going to turn it over to you. We always go with the cyclical, let’s start cyclical Inigo and then let’s think about this breakup between the seven and the 493.
Inigo Fraser Jenkins: Absolutely. We’re coming off a month where obviously it’s been this kind of shock to market returns, spike in vol, but then back to where we were in terms of vol and market levels. We zoom out a little bit just seeing the last six months or so, we’re looking at global stock market returns, it really is an AI kind of story because the S&P, ex the Mag Seven, or however you want to define it, has turned out a performance that is pretty similar to the performance of the world, ex US, altogether. What’s really moved has been a set of names linked to AI and the mega caps associated with that. So, you’re right in characterizing that the performance of stock market is very much linked to this.
We can think about a few different moving parts behind this big move up in the market that we’ve seen. Before we get on to AI specifically, just thinking purely cyclically and echoing some of Eric’s comments but just from a more equity-market perspective, first of all, we’ve seen an outlook that implies lower but positive EPS growth for US corporates 12 months ahead. That by itself is supportive of a generally benign environment, not super high growth, but benign enough to lead to a positive earnings growth. Secondly, you’ve seen this highly persistent flow into global equities. We now have seen basically 18 months of continuous inflow into equities from global investors but particularly flows into US equities from global and from US investors. What’s interesting about that is normally if you see a huge amount of flow in that perspective, it might raise alarm bells about whether people’s expectations have got too far ahead of themselves. But actually the way that we look at it, it doesn’t seem to be showing that; it’s showing a steady inflow rather than the kind of sudden rush that leads to alarm bells going off in terms of exuberance.
From an EPS growth perspective, echoing some of Eric’s thoughts on the broader growth rate to the economy and from a sentiment perspective, it looks like the outlook is fine and you’d expect our returns to be broadly positive, albeit not super bullish, 12 months forward. Of course we know a lot of that misses the big driver of market returns, which has been expectations of AI, and what that can do to the market overall, particularly to the mega-cap names. And as we’ve referenced in previous research and in previous podcasts, there are a few of these AI topics that are interlinked, right? One is the huge strategic question of, what can the productivity gain of AI be? The second is one we’ve already alluded to, which is, if you are very positive on the productivity gain of AI, have you got to be negative on labor? But then the third one that relates to the movement of the market is, is AI a bubble? Is the flow into capex gone too far?
Obviously, people are weighing in all kinds of ways thinking about this. The scary chart is if you normalize the size of the capex by the short depreciation time of this capex wave versus previous capex waves going back to the 19th century, it looks like the intensity of this capex wave is above levels that we’ve seen before. And that by itself should give one reason to pause. Having said that, I think there are paths that do justify what has happened to the market overall and to the Mag Seven or however you want to describe the benefit of the hyperscalers. Certainly some of the work that we’ve done, we are looking at the range of possible productivity growth rates that could occur the next few years, wanting to stress that we want to be super humble about any ability to forecast productivity growth in the first place.
But let’s look at a range of these and make some big assumptions around if there is a productivity gain, how much of that can be captured by AI companies, what’s the margin on that? And you get to a range of P/E multiples on the hyperscalers, by the time we get to 2030, that range from about 20x in a not very high productivity case to 30x in a high productivity case. Well, that looks fine. If those paths come to fruition, then I think we can justify valuations. The problem is that they do depend on: A. Some form of productivity gain that is a clear shift from what we’ve seen before; and B. Perhaps even harder, an ability to monetize that and have some kind of ability to earn a margin on that that’s comparable to previous margins.
The final thing I’d say is when we think about risks going forward from here, that’s the kind of question that comes up at the core of lots of client meetings. Thinking about risks from here, it’s not so much, can we justify the valuation? Because there are roots to justify that. It’s when do we know that this is working or not, and what kind of timeframe does the information come along? Because I think there’s a risk here that we are dealing with a capex cycle where depreciation cycles are short, and we can argue about whether they’re five-year depreciation cycles, maybe down to three-year depreciation cycles I’ve seen argued. That means you have to know what revenue path you’re on on a timescale that’s’ a lot shorter than that depreciation cycle. That sets up a risk that you get this sort of— I guess I’d describe it—it’s kind of like an air pocket where you simply don’t know enough information fast enough. The market wouldn’t like that. That doesn’t lead on to be bearish, but it does imply there is a certain degree of volatility, complacency if you like. I think we saw a taste of that last month and that I think will happen again.
Rick Brink: That’s a great point. I mean I can’t help, I don’t think anybody can help, thinking about the tech bubble and trying to draw some parallels and how that kind of played out on a couple of fronts. One of which is, if we’re going to look at the 30 side on the multiples, a lot of that’s going to be broad adoption, right? It’s that point where it goes from the people that create the tech that are driving things to everybody to cruise the gains from the efficiencies that comes from the tech. That’s where we see […]. There was an article I read, which referenced the S&P 493 for which I will still take credit, and it said that from January 2019, the S&P, if you broke it apart, the 493 is up a 100 and change and the Mag Seven’s up over 1000.
You can look at that “glass is half full, glass is half empty.” The “glass is half full” side is there are fits and starts with tech. It does take time for it to come online. Everybody adopts at different speeds, finds the way that they maximize it and get the most from it as they adopt it. Then is it a question where the S&P 493 slowly makes its way up because the gains accrue to them too? So, there’s also that story. I want to go back to the vol complacency because at the same time, while we’re waiting for everything to sort itself out— and the tech bubble did have a little bit of a pop that wasn’t good for a lot of folks—then the question is, how do you manage vol complacency and how does that flow through to portfolio design?
With that Alla, I will turn to you, of course. We are going to get to the strategic and tactical portfolio construction and all of that stuff, but I’m just going to ask you about, how does one manage vol complacency? We all talk about the idea of defensive betas—I’m figuring that that figures into this.
Alla Harmsworth: Yeah, it’s definitely a great question and a conundrum because we actually want to remain constructive on the equity market. We want to continue to have positive exposure to equity beta, but we do see the downside risks as having risen and we need to manage that vol complacency. It’s kind of a question for how do you position for this? We do need to identify some possible hedges to these risks. I.e., we need some defensive trades, but we don’t want to be defensive. That’s kind of tricky. The nuance here is that the timing of any such drawdown, of course, is highly uncertain. We just don’t know when things can go wrong, and we want to retain exposure to the upside while we’re waiting for that whilst being protected to the downside. What can we do? What could the safe havens be that we would be happy to own now?
One trade that we would recommend there is the global healthcare sector. It has done very well in the second half of this year, sort of catching up on the previous horrible performance that it had. We’ve long seen a strategic case for the sector based on the mega trend of demographics and aging population and also as a key AI beneficiary with AI able to help with the quality of care, product development and so on. It can also be an effective inflation hedge because we expect care costs to rise considerably faster than the overall CPI. There’s the ability to pass through inflation. Strategically we’ve seen a case for some time in the shorter to medium term or more tactically. Of course, the sector is still very cheap. Earlier this year it touched a 30-year low, which is similar to what happened in the previous attempts of the US government to reform the sector. The flows, which had been very, very negative, have only really just started to come in. There’s huge upside from a sentiment and valuation perspective. And, of course, there’s overarching fundamental case for the sector, we think, and a role in the portfolio of being a source of uncorrelated return. The risks the sector faces are very different. They are, sort of, very industrial-sector specific. It’s all to do with policy as distinct from the risk of a market correction or of the general market beta risk. We think that’s a good trade to have at the moment, both tactically and strategically.
Other possible trades are low vol. We’ve discussed it a bit. It is a defensive factor, hasn’t been doing very well obviously in a positive market, but it is a trade to position for vol complacency and it should perform well if we do have a spike in vol. It’s also a trade that performs well in a range of market scenarios, if you like. It does well if the market goes down. It also does well in our performance if the market is only modestly up. It fits well with our view of a positive but somewhat muted market return for the next six to 12 months. Low-volatility investing we still think looks interesting and attractive.
One more thing I’ll mention, another defensive trade, is international income or an international, for example, an EFA high- dividend exposure in equities. This is a factor that would be diversifying to our US growth tech exposure. It is basically a value factor, so a diversify in that sense but is more of a defensive value factor. It’s a bit more stable and less cyclical than other, say, deeper value measures such as price to books. We don’t need to see a massive cyclical rally for the trade to work. We think as a counterbalance, again, to a market rotation perhaps away from tech or downside, it’s a great trade to have on as well.
I know the gang here will have views on this, but I just want to say that regarding fixed income, we still want to be underweight as a whole because we still expect equities to outperform. That said, some selective exposure to shorter duration, high- quality investment grade for example, we think is prudent and a good thing to have despite the very tight spreads as another way to offset equity risk.
Rick Brink: Thank you. While we’re talking shamelessly about credit, I will also throw in my continued love for high yield and the same idea. And by the way, while we’re on bonds, Eric, I want to come back to you quickly because we do have a December Fed meeting that’s in about a nanosecond or so. I want to ask you, because you obviously get asked about this all of the time—what do we think the Fed’s going to do? But I think your answer is going to be it doesn’t necessarily matter what they do right now. Let’s talk about the path.
Eric Winograd: So again, think about the forest and the trees analogy here. From an economic perspective, it doesn’t really matter if the Fed eases in December or in January or in March. The matter of a few weeks isn’t that significant economically when we’re talking about Fed action. What is significant, though, is that they remain on a trajectory that leads to lower rates over time. It would be a big paradigm shift for markets if the Fed were to say, “No, we think we’re done cutting rates not just for now, but for the foreseeable future.” That would be more disruptive. Our view is that they should continue cutting rates. The current policy stance is restrictive, meaning that the rate structure is slowing economic growth at this stage in an effort to bring inflation down. But as inflation moves lower over the course of this year, we think the Fed will match that with rate cuts. That will be supportive. Our view, actually, is that they will cut somewhat more than the market anticipates, because I think we’re a little bit more optimistic about the inflation side of things and a little more pessimistic about the labor market side of things, both of which argue for additional rate cuts. But I don’t think anyone should get too hung up on what they do at any specific meeting. It is this idea of a medium- term trajectory that’s more meaningful.
Rick Brink: Could I ask you—because I know you and I have talked about it—but the optimism, let’s say around the inflation side, can you give a little bit more meat on the bone to that?
Eric Winograd: Yeah, so remember that inflation doesn’t measure the level of prices, it measures the rate of change of prices. So as tariffs go into effect, they pass through into inflation relatively quickly. But after a year, that initial pass through falls out of the year-on-year calculation. The price level doesn’t come back down, but the rate of change goes back to what it was before. With the first tariffs having been announced in April in a big way and then sort of steadily negotiated away over the course of this year, we think that some of that pass through is already in the system. There’s some more that is likely to come in the next few months, but by the end of the year, we expect that the regime will be largely in place and that the pass through will be mostly completed and that the tariffs will cease to have an impact on inflation going forward. Again, that doesn’t mean prices are going to come back down. That doesn’t mean the tariffs don’t have an impact. It just means that the way we measure inflation suggests that a year from now, we won’t be talking about inflation related to tariffs the way that we need to talk about it now.
Rick Brink: For some of you, you look at this all the time, maybe you’re masters of the inflation calculation. Maybe some, this isn’t something you stare at every day. Eric’s point is an incredibly important one because think in terms of US CPI—it’s a connected series of 12 monthly prints. So, every time a new CPI comes out, you’re dropping that “13-month-ago off” and you’re replacing it with one. So, we’re really just making a comparison between two months, with 11 of those months staying exactly the same. This is kind of a slow-moving boat, but the way the math works out is if there were some pretty heavy months of inflation because of tariffs early on and 13 months, 14 months, 15 months from now, there isn’t another boost or burst, it’s a step function, which is what tariffs tend to be, then that starts to fall out of the inflation, right? The mechanics of it is that you have to continue to get a sustained increase in prices to see that go up. If not—as it did in the first administration, by the way—it will drop out of the system after about 13 months. And that’s, of course, what one would hope that your central bankers are looking at all the time.
Eric Winograd: I should add though, Rick, also, that you’ve explained that very well. It’s also one of the reasons that I think that the Fed often appears to be disconnected from the economic reality that people experience, right? The Fed is talking about this very specific measurement of inflation over a 12-month period and so on. People are experiencing the price level, right? They’re experiencing the affordability crisis as it has come to be called. And so, when the Fed says, “Oh, inflation is well behaved,” and people say, “What are you talking about, prices are still really high?” That disconnect is part of the reason that the Fed makes a convenient punching bag politically because they do appear to be disconnected from reality. The problem is that the only tool that the Fed has to bring prices down is to tighten policy so much that it throws the economy into a recession. That isn’t a great outcome either. The Fed is left trying to balance the idea that they want to slow the rate of price appreciation, but not too much because if they slow it too much, then that means they’ve tightened us into a recession. It’s a hard job.
Rick Brink: That’s what I’m told. You would know, actually, you would know. Your whole family would know, actually. I want to get to just a quick around the horn. This idea of next year—I know we’re not even thinking about it here in the US. We just finished our Thanksgiving dinners, we’ve got the holiday season upon us all around the world. But, let me throw in there that the second the clock ticks into January, we’re going to start talking about midterms here in the United States, and that’s going to be another conversation that starts to show up, and as you saw during the presidential election cycle, it does have implications for markets. You can see some knock-on effect from polls, from some of the betting systems that are also going to be part of this. So, let’s not forget that we’re about to move into a midterm cycle and that’s also going to impact markets. You have a lot to think about—Happy New Year, by the way. All right, so around the horn, I just want to ask what everybody’s going to be thinking about or looking at? I mean, we’ve covered the questions, but Eric, I’ll come back to you first. What are you going to be looking at here as we move through the end of the year into the new year?
Eric Winograd: I said that the Fed has a hard job. Being the Fed chair is a hard job, and we’re going to be watching to see who has that hard job. Chair Powell’s term expires in May. President Trump has indicated that he expects to appoint a successor to him early in the new year. That person will have to go through a Senate confirmation process, but as that transition process ensues, it could be a little bit bumpy. Fed chairs—new Fed chairs—historically get tested by the market and particularly in an environment where the administration has tried very hard to reduce the Fed’s independence and where the Supreme Court has before it a decision that could eliminate the Fed’s independence. There’s a lot of potential for friction between the Fed and financial markets. If markets perceive that the Fed is cutting rates too aggressively and inappropriately, that could result in a significant increase in risk premium in the bond market. We’ll be watching the Fed very closely as we move through the next several months.
There are good outcomes here too, where the next Fed chair is someone who the market perceives to be credible, where the Supreme Court rules that the Fed’s independence remains and we sort of go back to business as usual, except presumably with a slightly more dovish Fed, which would be a very good thing from a market perspective. I don’t want to get too hung up on the risks, but however it plays out, that transition is going to be a big focus for markets for the next few months.
Rick Brink: Thank you, sir. And obviously as we get into the new year, you and I and everybody else are going to be talking a lot more about it, so stay tuned as we come back to these topics. Inigo, I’m going to go to you next; I’ll actually pair up the co-heads together. You can jump in together. What are you both going to be looking at? From a portfolio design perspective, but just in general, and obviously Inigo, you and Alla have a lot of research going on. So, what’s in the hopper?
Inigo Fraser Jenkins: Lots of things, but I think it’s probably impossible to escape from AI and the topic without taking up a bunch of our time on this podcast. But those different aspects of it, both the strategic aspects in terms of productivity gains and the tactical aspects in terms of market valuation. I think that will inevitably be something that people will keep asking questions about. A linked tactical question is just a structure of the market and the idea that there has obviously been an increase in market concentration, which is a very high level compared to the last 150- year history—not totally unprecedented, but certainly very high. And that link between concentration, emergent mega caps and just the scale of the flow into passive cap-weighted indices and what does the interaction of these forces really mean in terms of the riskiness of the market and the exposure of that. That’s something that certainly will come up in our research and be coming up in client conversations.
Alla Harmsworth: Obviously, it’s been interesting to see that the steady flow into equities and certainly into the US equities doesn’t seem to have made our sentiment indicators flash red so far. Although the market has been very strong, notwithstanding the recent correction, we still don’t have huge concerns tactically from a sentiment perspective. But that may change, and we will have to watch for that changing. If the flow starts to signal excessive positioning, excessive exuberance, then we’ll perhaps need to think more about how to position for it even more defensively than we’re doing right now over the short term.
Rick Brink: We’ve just about run up against our time. All of these topics that, as we turn into the new year, we’re going to be coming back around to them as you’ve heard all of us speak to. Especially as we get into the first months of the year, there are going to be a lot of things going on that are going to be impacting markets. We’ve got changings of seats from Washington to, well, actually down the street in Washington, with the refurbished Fed space. But all of that is something we’re going to speak to—market concentration, passive indices is obviously near and dear to my heart as well, Inigo, so that’s probably another topic we have to explore, but that’s for another time.
For now, the last thing I have to say is thank you as always for joining, for being part of this series with us. Thanks to Eric and Inigo and Alla for joining in as well. But most importantly, happy holidays to everyone. Have a safe one. Happy New Year, and here’s to a great 2026 when we will see you next time. Thanks, everyone.
