Animal Spirits Take Las Vegas

0:04Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:34Thank you to the FPA for having us. It is an honor to be part of this event, all the great work that they're doing to move the industry forward. And thank you to you all for sticking around. Heard it's been a long week. I heard you guys had some fun last night. Anybody had some fun last night? Yeah? All right. Who here is familiar with Animal Spirits? We have any listeners in there? Yeah? A few? Okay. All right. Well, for those of you who are not familiar with us, Ben and I have been doing this podcast for seven years now. I think we've got a pretty good groove going, so we're excited to bring it here.

1:12My name is Michael Batnick. I am managing partner, one of the four co-founders of Red Holtz Wealth Management, and Ben is the director of institutional asset management. So today, we know that you guys are financial planners, financial planning oriented, and And I think probably, I don't know when the line, eight years ago, index funds were fine, right? Like the investing side was, it was what it was. It was fairly easy and everybody understood what was going on. But now, both the demands of clients are a lot different than they were in the past. And the market looks a lot different today than it did a couple of years ago.

1:56So today we're going to talk about two of the biggest topics in markets, investing, portfolio management. We're going to talk about, of course, sorry we can't avoid it. It is what it is. It's the topic of the day, of the decade. We're going to talk about AI and we're going to talk about private investments. Sound good? Yeah? And we have a lot of charts. Lots of charts, yeah. So, all right, Ben, kick it off. All right, so we'll start talking about AI because we kind of have to. We're getting more and more questions from our clients about AI and how to think about it. And I think it kind of runs the gamut, but most clients are really asking, if this thing is a bubble, what do we do?

2:35What do you do as my financial advisor? How do you think about this? And then I think there's some other clients who say, if this is really going to change the world, are we under-invested in this space? And so I think it's two different worries that people are looking at. So we wanted to look at just how the S &P has done in the past three, five, ten years, just to see how this cycle kind of matches up. and you see things have been moving up lately. It's not out of the realm of possibilities. It's not super crazy yet, I would say. Maybe getting there for some, but it's not like this is completely off the charts, these returns that we've seen.

3:10The three-year number is getting there. So not coincidentally, ChatGPT came into the world three years ago, and so three years, last three years, has been 88%, not bad. I don't know, Ben, what's better? I guess, end of the dot-com bubble. I mean, there's not many periods. Now, if you zoom out, five years, it looks a little bit more reasonable, 108%. Like, I don't know what the average is, but it's not crazy outlandish. Yeah, because that includes the bear market of 2022. All right, so we spend a lot of time as market people just talking about the valuations, the market cap, the growth, the this, that, the concentration.

3:51And maybe we're not technologists, none of the people in this room are, not enough time talking about, well, why is all this happening? Where is all the spending coming from? Are the bets that are being placed today going to bear fruit in the future? So Mark Zuckerberg at Meta gave this presentation on one of the data centers that they're building in Louisiana. Now, I don't think it's a scale exactly, but whatever. It's almost the size of Manhattan. It's four million square feet? I think that sounds right. Yeah. It's massive. So for the first time in a long time, For most of the 2010s, the tech companies, everything was in the cloud or software, and now they're actually, it's physical now, which is, I guess, a risk and an opportunity because it's a risk because it's way more capital intensive.

4:42It's gonna be harder for them than it was in the past. Every hype cycle looks a little bit different. So the comparisons that are being made of the moment that we're in today versus the previous ones, it's the railroad, build out the transcontinental railroad in, I guess, the late 1800s, and then it is the fiber optic networks and the telecom bust and boom and bust. And there's, obviously, there are similarities, there's lots of differences. One of the differences is that, like, remember, you guys remember when, it was Jim Cramer, actually, that started the Fang thing. He coined the term in 2017, I believe, and at the time it was Facebook.

5:26That's crazy. It was only one A. Apple, Netflix, and Google, right? Amazon wasn't even there. We've had to change it every few years. Remember, it was the... But we've been talking about this concentration and like, ugh, diversification isn't working. That topic, we've been talking about this for years and years. And then, just the next leg higher. Well, I was thinking about this today. We had people who, We get emails from all of our listeners of our show all the time, and they ask us for advice. And someone in 2019, 2020 said, I'm thinking about going all in on tech stocks. Is this crazy? And it seemed late cycle then.

6:02Exactly. Think about how much further we are along. But a lot of the names in the previous episodes, not that they came out of nowhere. Like, Microsoft was obviously a company well before the dot-com bubble. But it was a lot of names that did come out of nowhere that had nothing but eyeballs and promise. In that respect, it's obviously so different. So this chart, we stole this from ourselves. Okay, I thought we stole it from somebody. Shows the - Credit to us on this one, that great chart. Yeah, great chart. This is the CapEx ramping up from Amazon, Google, Microsoft, and Meta. And on the most recent quarter, I mean, you see the numbers, they're outlandish.

6:45like even Meta, which is spending the least, spent$60 billion in the most recent quarter. I just, I'm big into audiobooks these days. Anybody else? Just me? One? One guy in the front, okay. I listened to American Prometheus, the book that the Oppenheimer movie was based on. And we spent$34 billion, adjusted for inflation, I think it was$3 billion at the time. We spent$34 billion over, I guess, a three-year period building the atom bomb. And these companies are spending, collectively,$250 billion a quarter and ramping up. And they've said, listen, we think the risk is underspending. So if we overspend by$200,$300,$400 billion, we think that is less risky than undershooting it.

7:40So obviously the worry for investors is, have we pulled too much forward? Are expectations way too high? Is it going to be hard to see a handoff from all this investment to ROI? And when will investors start requiring that? And that's the hard thing to wrap your head around is that you never really know how much of this is actually priced in. And in terms of where we are in the cycle, a lot of the, I'm going to use a B word, just the inflating of the bubble, of the enthusiasm, whatever you want to call it, a lot of the inflating has been done weirdly in like a risk-off or what would be a traditional risk-off environment.

8:14A pretty aggressive Fed hiking cycle, which is bizarre. So now we're on the other side of that. Gold hitting new all-time highs all the time. It's a very, if this is a bubble, it's one of the weirder ones that we've seen. But in terms of like what any we're in. I mean... Well, the Dodgers game went 18 a couple weeks ago, I think. So Ben is... We've got to be getting close. Ben on our show, he's a middle of the road sort of guy. He is on the one hand, on the other. Which is, listen, it's fair. I mean, especially in what we're talking about, nobody can see the future. There is a lot of nuance in this conversation.

8:50But I think - I'm from Grand Rapids, Michigan, so Michael calls it a Grand Rapids hedge. Because I believe most financial decisions don't exist in black or white. There's a shade of gray. I think everyone would agree with that. But from the listener's point of view, I don't think that they like the Grand Rapids hedge. and I'm a hedgerer myself because who knows, but they want somebody to say, guys, we get it, one hand, other than the other. Yeah, we know. Tell us. Because my point is, when you're in a crisis, everyone knows you're in a crisis. If there's a recession, everyone can feel it, right?

9:20People are losing their jobs, companies are cutting back, businesses are going under. When you're in a bubble, it's impossible to tell in the moment, right? Is this time really different? Is this something new? Wait, we've never had companies this big, these hyperscalers this big that have these types of profit margins that are creating this type of operating cash flow. And so in the back of your mind, you go, okay, it feels like a bubble. It feels like the railroad bubble. It feels like the dot-com bubble. But what if dot, dot, dot? And that's the hard part is that you can't go through a checklist and say, okay, this is definitely a bubble.

9:48We know for certain. There aren't certainties like that in these type of environments. All right, so maybe we're going to do a little bit of column A, a little bit of column B. Because I don't know how to handicap this. You're right. We're going to hedge it out. All right, next chart, Ben. Okay. Actually, I'm sorry, previous chart. Just before we get off chart six. Where are we? Do we not have the same deck? Do you not have this? Oh. No? Oh, okay. All right, it's okay, I'll talk you guys through it. All right, so the chart that's on the screen now, no, go back to that one.

10:23So,$434 billion in spend on these data centers this year, projected to be$591 billion in the following year, $700 billion, excuse me, in 27, and they're talking about a trillion dollars in spent by the end of the decade. Now, if this doesn't happen, yeah, this is a bust. I mean, obviously, this has to happen. So the chart that I'm looking at that I'm going to walk you guys through. But all these companies, they're burning the boats behind them, right? You invest in us, and we'll invest in you, and you invest in them. It's all circular. And so these companies have said, we're not going to just let someone take the lead and go with it.

10:56We're all in this together, which is either really scary or actually really intelligent. So column A, not bubble. If this spending comes to fruition, then it's early innings. Like, game on. Column B of, wait a minute, of course this is a bubble, is OpenAI doing, I think their recent numbers were$13 billion in revenue over the last 12 months. Obviously, it's rampant, like stipulated. But let's say it's understated. Let's say because Sam Altman took on the job. Let's say it's 20. Whatever. Who cares what it is? They're committed to spend$1.4 trillion over the next how many years? So if they can't do that, then all of these numbers are obviously nonsense, and then look out below.

11:37All right, I'm mixing up my columns, but another point for maybe this is a bubble is the Mag7. Oh, here, so this is the concentration one. You made another one that apparently didn't get in my list. But would I share your Google Doc? No, okay. We're looking at different docs? So it's a good thing we aren't powering AI, because it wouldn't work very well. So the chart that I'm looking at, can you guys see this chart? No, I'm just kidding.

12:06So the MAG-7, the market cap of the MAG-7 is$22 trillion. That is equal to stocks 52 through 500. So the bottom 449 stocks are equal to the top seven. But again, this is the type of thing that, well, all right, if you just had that context, you would say, time out. I want to get off the boat, right? Like, get me off this. It's like, this doesn't make sense. Until you think about it, you have to zoom in and understand what's going on with these companies. Ben and I made a chart for the show this week breaking down Apple's revenue by their big, by their different segments. The iPhone alone, the iPhone does more revenue or did more revenue in the last 12 months than Bank of America and Facebook, not combined.

12:55Just the iPhone. the iPad, which is like, it's a$28 billion revenue, like what? That's more than AMD. No, wearables, so the AirPod and the watch did more revenue than Schwab.

13:16Giggles, I agree, it's insane. And then the wearables, I'm sorry, okay, the Mac, the Mac did more revenue than Starbucks, or just about as much revenue,$36 billion as Starbucks, and as Salesforce. And then lastly, services did as much revenue as Target. So when you put it that way, okay, I mean, what should the market cap be? So I think the point is, we're in a new normal, for now, maybe for a while, of concentration in the stock market. And if you own any type of market cap weighted fund, you're going to have a lot of tech exposure, whether you like it or not. And the question is then, okay, what do we do about this?

14:01Right. So again, we know that people in the room, you're planners first, but this has to be part of the conversation because I don't need to tell you guys about sequence of return risk. I'm sure a lot of you have people that are entering retirement now, and it matters a lot. The next couple of years are critical for people that are in retirement. So it is kind of crazy, the handoff that we had. So 2022, we had a bear market. It was fairly run-of-the-mill if you look at a non-recessionary bear market. The average is about a 25 % decline. That's about what we had in 2022. But it seems like it was saved by AI spending.

14:33And this is the hard part to wrap your head around, is that the fundamentals for these companies have kind of matched the price growth. Better then. So this chart shows NVIDIA earnings growth versus price growth. And you can see that the fundamentals have actually outshot. And so that's the big difference between now and the dot-com bubble. in the dot-com bubble, it was all dreams. It was people were still, you know, hoping. For a lot of these companies, there wasn't even revenue yet. These companies today, a lot of the, most of the spending is coming right out of operating cash flow, and the growth is happening right along with the prices.

15:06So obviously the valuations are elevated. To your point about these being the biggest and best companies, those elevated valuations have actually made sense because the fundamentals have tracked them. And I think if those valuations weren't elevated at this point, then the market would be totally missing something. That would make less sense than where they are. That would be weird. These companies, there's no analog in history. There's no comp. Microsoft Cloud has done 20%. It's a$100 billion revenue business. They've done 20 % growth every quarter for the last decade. And it's not like people didn't know where this was going.

15:39And it's not like analysts don't raise their targets. But consistently, they've been able to deliver and exceed. I think the reason so many people have, maybe some people have some disbelief though, is the fact that we had a whole tech cycle and it ran almost perfectly into the AI cycle. Yeah. A lot of those tech stocks got dinged pretty bad in 2021 and 2022, but then AI took the handoff pretty quickly and then it's kind of back off to the races. And you can see this next chart we showed here, on the one side we have consumer staples and healthcare as a percentage of market cap. You can see even back in the mid 2010s it was a quarter of the market.

16:15Now it's down to less than 15%. Apple and NVIDIA alone are now worth as much almost as the consumer stables and healthcare segment of the market. But importantly, the market generally gets it right with the exception of when it doesn't obviously at tops. But we've seen charts floating around where it shows the market cap of tech or NVIDIA or whatever compared to whole sectors. And you say, my golly, again, I want to get off. I want to sell. This doesn't make sense. but you have to adjust for the business and the market cap of the staple sector matches the net income. Market's getting it right.

16:53And same thing on the other side of the aisle.

16:59All right, so I guess this is where the rubber meets the road is kind of the forecast. And this is the hardest question to answer, I think, in financial markets is always, like, what's priced in? Have expectations sort of caught up to reality or have they exceeded them? And this is looking at NVIDIA, and we're talking net income and revenue going forward from here. And the numbers just keep getting bigger and bigger and bigger to astronomical levels that we've literally never seen before. So some gray hair in the audience, some bald heads, which I love to see. Remember the late 90s, and you might be saying, like, Michael and Ben, you guys are young, you don't remember.

17:36I saw this with Cisco. The promise, it all came true. Cisco did grow 15 % a year for a 20-year period. The problem is that expectations in the stock were for 20 % growth, and you didn't get it. The stock fell 80 % and it took 20 years to recover. And so I will give my opinion on where this goes, which could obviously be very wrong. I do think that the S &P is going to 10 ,000. It's just a guess, who knows. Obviously it's not - Are you giving price targets now? Yeah, I'm giving price targets. There we go. I'm not going to make a time prediction on that, because then I can't be wrong. It could be 50 years from now.

18:17I mean, it's going there eventually. Listen, if you go on CNBC today, there's a way to never be wrong. You say, listen, the stock market is going to crash. This is a bubble. But first, go off top. You cannot be wrong in that instance. You're covered both directions. For sure. So I think that the way that this ends, and people are understandably paying a lot of attention. It's an interesting thought exercise, like when does this end, how does it look? It's not just going to end because people get bored or because people think that they're overpaying. It's going to end when their narrative changes and their narrative will change after an earnings call where the company says, uh-oh, we weren't expecting that.

19:00And until that happens, and yeah, good, I hope we get 15 % pullbacks. We need that. It's normal. It happens. But until we hear something different from the companies, and right now they're all saying the same thing. Not only are they not slowing down, they're accelerating. They all said they're going to spend more next year than they thought they were going to the beginning of the year. This is all feeling very toppy. All right, let's look at the S &P. Same thing with the S &P, and obviously so much of this is driven by the tech stocks. But this just shows that actually the market has been pretty decent at not front running forward earnings.

19:36And it's kind of following fundamentals, okay. The actual earnings versus the estimates. They haven't gotten too far off track and one of the reasons that the S &P has done so well this decade is because earnings growth. We're at nearly 10 % earnings growth per year in the 2020s. So one of the biggest questions for the market is, alright, well what about the other 493? Because to varying degrees people People have exposure to these stocks. I'm sure there are people in this room that are doing things outside of just the max step and outside of just the S &P, whether it's international or equal weighted or small or whatever.

20:15What about the rest of the market? And that's the question. So as we have belabored the point, margin expansion in tech is just off the charts, up and to the right. I think the hope would be, because I know a lot of advisors do have diversified portfolios. it's not all just in VTI or SPY or the Qs. I think the hope would be for this AI cycle that a lot of these smaller firms aren't forced to make the capital outlays that the big tech firms are making, and they're going to see the biggest efficiency gains, hopefully. But if you look at this chart of the profit margins of U.S. market ex-tech, it's really on trend.

20:55It's not great. It's moving up, at least. Barely. But the market is made up of what? 50 % technology stocks now almost. So that's the market, right? Let's talk about the CAPE ratio. When we first started Red Holtz Wealth Management in 2013, this was a big topic for financial pundits. I remember I was on my honeymoon and I read a blog post from Henry Blodgett about why the stock market is going to crash because any time the CAPE ratio has gotten this high, we know what happened next. And that turned out to be pretty wrong, huh, Ben? I think the problem with this as a, and I think it's great to have this big, Shiller took it back to the 1870s or whatever it is, right?

21:51It's great to be able to look across these different cycles. I think the problem is we've seen such, we've pulled forward and changed the way these companies are over the past 10 years, probably more than any time in history, in terms of their margins and their earnings growth, that it's kind of hard to compare today to the last 10 years of earnings. It almost isn't a fair comparison. Yeah, so what the CAPE ratio does, it stands for the cyclically adjusted price to earnings ratio. Because earnings are volatile, because prices are volatile, this takes an average of the last 10 years worth of earnings, it adjusts them for inflation, and it gives you a smoother picture of where we are.

22:26Now, I don't think anybody is saying, certainly I'm not saying that stocks are cheap, but does it make sense, to Ben's point, does it make sense to look at earnings from nine years ago, from four years ago at this point? Right, before ChetGPT existed, and yeah. I think this is one of my favorite charts to show how the stock market has changed over the years. This just shows the average margin by decade, going back to the 1990s. and I think it's one of the most impressive things that corporations have been able to do in the 2020s. If you think about everything that's been thrown at corporations this decade, the pandemic, obviously.

23:04We turned the economy off, turned it back on. People in white-collar jobs, remote work with no practice, just, hey, you're gonna work from home for the next few months, and a lot of people have been doing it for years now. We're gonna give you 9 % inflation, we're gonna give you supply chain shocks, all these different things that have been thrown at corporations, and yet they've still managed to increase margins this decade. It's kind of incredible when you think about, and the corporations are so much, obviously they still get things wrong, but they're so much better run today than they were in the past in terms of how efficient they are and how well they're able to handle shocks.

23:40The Fed took rates from 0 % to 5 % in the quickest time frame we've ever seen, and most of these corporations didn't really blink. It didn't really impact them that much. Not the small caps it did, right, but the biggest companies in the world So, barrel the weather that with little disruption at all. I can't remember who said it. It might have been an analyst from Bank of America who said, like, don't underestimate corporate America's ability to protect their margins. And if you look at this chart, the dip after the pandemic, that took you back to the previous all-time highs. Even after that, even after that perfect storm for corporate America, they were basically at an all-time high.

24:18And Ben, go back to the Capri Show chart one more time. So we've said this over the years a million times, but I don't want to take it for granted that everybody here has listened or read to everything that we've said, so I'll repeat it. In 2009, after hopefully the worst financial environment, stock market that any of us will ever see, hopefully, after a 55-plus percent crash in the market, the CAPE ratio was at its long-term average. I mean, that tells you all you need to know about this as an indicator. Who cares? After the worst market ever got back to the average for a second, said differently, it's been above its average like 99 % of the time for the last 25 years.