Scott DiMaggio: All investor eyes have been on this AI capex boom that almost continues unabated week after week. What’s your thoughts, Nelson?
Nelson Yu: Yeah, I agree with you. That AI capex story has been such a dominant story across equity markets. As a matter of fact, it’s almost masked everything else. You see memory makers, semiconductor makers up over triple digits this year.
SD: We’ve had 12 straight quarters of upward revisions to the AI capex numbers. That has been a huge impetus to US GDP. We couple that with the conflict in Iran and higher oil prices. The ghosts of 2022 are permeating throughout the markets and people are fearing that the Fed is behind the curve and will need to hike rates.
NY: Anything related to consumer, anything related to more cyclical types of segments of the market just hasn’t really performed. And I think that’s to your point about some of the overhang with the geopolitical risks.
SD: This AI capex boom—it can continue. It will continue, right, for many years. I guess it’s just a matter of, have the multiples gotten ahead of what we think the right valuation is for this boom.
NY: That’s right. We’re seeing this in the markets episodically. Every few weeks or so, we see a drawdown in terms of some of these AI capex companies, with some of these semiconductor makers and memory makers going through an air pocket, just really waiting for reinforcement about that growth story. But I think that’s a natural part of this build-out because as you said, the valuations have run up quite a lot, and the market’s just waiting for new recurring news to understand whether this can continue.
SD: In the bond market, as we look globally, the market is pricing in many more central bank interest-rate increases. We think there are too many rate increases that the market’s expecting. We do expect to see, despite this massive AI capex, a slowing growth environment in the second half of the year. And with these higher interest rates, with this steeper yield curve globally, we think there is opportunity in fixed income as well.
NY: That’s a really important dynamic that’s impacting the equity markets as well. Part of this AI capex boom has also been the need for capital investments. And so, if you think about the amount of capital that’s being demanded, we see it in terms of just this capex build-out. We see it in IPO activity. There is a lot of demand for capital to make these ongoing investments.
What this really calls into question is, can companies deliver returns that are in excess of that cost of capital? That’s the definition of quality. And there’s a broader set of companies that are achieving that quality definition.
Now, on the individual IPOs, I think it bears strict discipline in terms of how we go about thinking about whether we want to participate in those IPOs. We’re thinking about, again, that, are we able to generate returns above that cost of capital? And then we have to think about the valuation of those IPOs.
SD: And we continue to see a lot of these mega names borrowing multibillion dollar, multi-tranche, multicurrency deals in an effort to spend that AI capex. Similar to, Nelson, what you said, we then see a lot of dispersion in the investment-grade market. So, all this new issuance that has been coming—and a lot of it coming in just one sector in the investment-grade space—is really driving dispersion and we think driving opportunity for investors.
NY: We’ve seen enormous dispersion across the equity markets. The difference between the winners and losers is at historic levels. And I think right now it pays to be very active in terms of how we’re thinking through this. And again, I’m going to go back to that quality framework that you have to use. What are the most productive investments that companies can make in this boom? Just continue to chase after ever more capex, might not be the best thing to do.
But we do think that productivity enablers would be a great area to find opportunities. What are those? Industrial automation, specific manufacturing, even capital providers could be great areas to look for, for those productivity enablers.
SD: Yeah. And that active management, that dispersion, right, for me and how it plays out, number one in the rates market—we’re going to see a very different central bank experience and a very different economic experience. Whether you sit in a country that’s an oil exporter or an oil importer, a country that benefits from the AI boom or a country that maybe has to play catch-up, we think there are opportunities for clients to take advantage of that.
And just like you said, in corporates or in equity space, if we can use our quantitative, our systematic tools that really allow us to filter through the day-to-day noise and help us really identify, what are the names that are trading cheap, right, to their fair value? What are the names that are trading expensive? That quantitative, systematic way of capturing returns, we think will be very, very relevant in this environment.
NY: Yeah, that’s such an important point. Just the instinct to follow the narrative in terms of what we hear with headlines and react to every single up and down in the marketplace, it’s so overpowering. But if you have a systematic process that allows you to repeat that discipline over and over again, that’s so important in today’s markets.
With momentum being so strong, it’s so important to then be constantly looking at your portfolio and making sure that you don’t get too concentrated in any one theme across the portfolio. The market’s been very narrow, but it’s important to actually stay to your discipline and continue looking for names that help you to weather across many different regimes.
SD: The dispersion in the market really should lead investors to believe that active management is the right approach, especially in today’s environment.