Why The World Is Spending More On War

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1:28Welcome to Prof G Markets. I'm Ed Elson. It is July 8th. Let's check in on yesterday's market vitals. The major indices declined as chip stocks tumbled once again. More on that in a minute. Oil rose after three ships were attacked in the Strait of Hormuz. The US rescinded its authorization of Iranian oil sales following those strikes. Microsoft stock rose on news that it is replacing OpenAI and Anthropic with its own models to bring down costs. And finally, SpaceX declined nearly 7 % on its first day in the Nasdaq 100. Okay, what else is happening? The NATO summit kicked off yesterday in Turkey.

2:12And the big takeaway so far is that a new global arms race is underway. Trump is pulling US military assets out of Europe and shifting focus to the Middle East and Indo-Pacific. That is forcing Europe to shoulder more of its own defense. NATO allies have agreed to at least$50 billion in defense industry deals and$40 billion in counter-drone capabilities. But America isn't slowing down either. Trump's 2027 budget proposes$1.5 trillion for defense, which is the largest request in history, and Silicon Valley wants in. Defense tech companies have raised more than$19 billion so far this year, already blowing past last year's record in 2025.

2:57In short, an enormous amount of capital is flowing into defense right now. The question is, what exactly are we gearing up for? Joining us to discuss this, we are speaking with Steve Feldstein, Senior Fellow at the Carnegie Endowment for International Peace. His new book, Bites and Bullets, Global Rivalry, Private Tech, and the New Shape of Modern Warfare, comes out in September. Steve, thank you so much for joining us on the show today. I'd love to get your initial reactions to what we saw at the NATO summit. It seems like a big conclusion or a big takeaway is that we're going to spend a lot more money on weapons, a lot more money on defense.

3:36Is that the right takeaway? I think it is. Thanks for having me on. And I really think that there's an overall context that's worth bearing in mind. And I think there are three factors that I've been looking at over the past couple of years that are really relevant. So I think the first one is that we are just seeing far more conflict occurring around the world today than even in the last five years. Last year, something like 250 ,000 people were killed alone on battlefields. So it means that war is prevalent and around and countries recognize that there is growing levels of insecurity. And so that matters.

4:07I think the second thing is that we're seeing a growing menace from Russia as it continues to get on a wartime footing because of the Ukraine war, as it continues to increase its drone capacity and manufacturing of other types of weapons. Countries in Europe, in NATO in particular, are concerned and they know they need to keep up and they need to they need to retool accordingly. And then finally, I think especially coming from the Iran war, we're seeing the use of new technologies, particularly AI targeting systems and so forth in play. And I think it's also giving a recognition to countries like Germany, France, and others that they also need to really think carefully about innovation and what types of weapon systems they need to incorporate so that they are able to fight wars effectively in the future.

4:51Yeah, I mean, one of the stats that blew me away that we just learned is that defense tech has raised more than$19 billion this year, and that's in six months. So we already beat last year's record. And it seems as though Silicon Valley and technology is playing more and more of a role on the battlefield. What do you make of that dynamic and that shift? How should we feel about the fact that tech companies are participating in warfare at this point? It's a trend that's really begun to ramp up. And I see it as not necessarily a substitute to traditional arms manufacturers, but more as a complement.

5:32So I'll give you a good case in point. A lot of people have focused on the Maven targeting system from Palantir that's paired with Claude and how it was used in the Iran war. And so a lot of people look at systems like that and they say, okay, we need something similar. We need a better way to have more efficient targeting and to match our missiles to potential places, military targets to strike. So it doesn't mean that you don't need traditional ballistic missiles. What it does mean is that you need that plus you need a more efficient way in which to generate the coordinates for how you would target and identify different military assets.

6:07And so to that end, a lot of it is sort of creating other types of weaponry in addition to what's already needed in terms of munitions, based on the fact that countries see that there's more war and more insecurity all around, whether it's from China, prospectively, Russia in the near region or other places. When you look at some of the tech companies that are participating, I mean, some of the companies you've written about, Google, Meta, Cloudflare, obviously Palantir. One thing that always strikes me is these are companies that are offering enterprise software services and solutions, and then also playing a role in the Ukraine war, in the war in Iran.

6:49I mean, that's quite a striking dynamic. And I wonder if that's something that we should, I don't know, maybe be worried or investigate in some capacity. The fact that, you know, the CEO of an enterprise company is also directing the outcomes of what happens on the battlefield. I'd be curious to get your views on what you make of that and if that is worth thinking about. I think you're right. It is a new role. And I think there's a few different conflicts of interest that arise from that. I mean, I think one of the great examples is, you know, if you have a company like Microsoft and it is both providing data infrastructure that is being used by militaries like Israel's military or other militaries, but it's also selling consumer goods to a wide variety of clients.

7:37Well, how do those two things work together? And I don't think there's an easy answer to that, but so far they've been able to skirt around the issue. At some point, these issues are going to become front and center where countries will say, look, either you're providing military equipment for the security objectives of a particular country, or you're selling to consumers across the board, neutral items meant for civilian applications and not for military use. And so these are, I think, questions that are coming to bear for a variety of companies, whether it's OpenAI, Anthropic, Microsoft, Google, AWS, or others, which are so far somewhat having it both ways.

8:14You mentioned earlier that what all of this spending tells us is how unstable things have become from a geopolitical perspective. I remember last year, Jamie Dimon saying that this was sort of the most unstable or maybe he said the most uncertain time since World War II. I mean, I think that was almost a year ago. That was certainly last year. Where are we now? Like when you compare July 8th, 2026 to July 8th, 2025, is this a more unstable time? And is it going to continue to get more unstable? It is. I mean, certainly last year we hadn't yet encountered the Iran war and all the spillover effects from that.

8:58So that's a really big thing that everyone is sort of grappling with. And it's not just about Iran and immediate adversaries in the Middle East. It's about a wider security architecture and questions there. We also see a continuing amount of fighting when it comes to the Ukraine war. And if anything, we're seeing even more escalation between the two sides with Ukraine striking Crimea, Russia coming back and striking Kiev and making bigger threats in terms of other potential adversaries. And so and then that's not to mention the kind of prospective questions related to China, which frankly, at this point has been quieter because of these other situations that taking place.

9:40So there are a lot of different geopolitical issues that are flaring up simultaneously. And we also are seeing, I think, a bit of an ebbing of power or at least the limitations to American power at this point, not to mention a volatile president who seems to change on a dime very quickly the geopolitical objectives of the United States. All these ingredients coming together make for lots of unpredictability when it comes to security and what things will look like in the coming months. I think the question for investors is, I mean, the main question is, will the spending keep going up? Clearly, it's gone up last year, coming into this year.

10:24Will defense tech companies keep on getting massive contracts? Will they get larger contracts? Will some of the larger, more traditional players get larger contracts? Will governments spend more and more? do you think that defense spending will go even higher than it is today? So one issue is that we have seen a ramp up in NATO spending, as you mentioned. And I think that will continue to increase. But what's interesting right now is that there's a gap between the amount of money that's there and the ability of current manufacturers to be able to produce according to the money that's been allocated.

11:02So I think the first thing we're going to need to see is greater capacity that's built up to match the money and the allocated contracts that are there for munitions. I think the second thing that we're going to see is a real ramp up when it comes to countering drones. So drones are proliferating. We're seeing that in Iran. We're seeing that in Ukraine and so forth. And we are also seeing a dire need by countries like UAE, Saudi, the United States, for that matter, countries in Europe when it comes to actually countering these drones and coming up with the right systems. That's a growth area. That's an area where you just are starting to see products at scale come to the market.

11:38And I think you will see continuing demand and investments for more of these types of systems, especially as we see drone use proliferate, which I'm certain will continue to be the case. Final question. Trump is now renewing his threats, thoughts about Greenland. He said the territory, quote, should be controlled by the United States. is the Greenland story not over? Is that something that we should be worth, that is worth us paying attention to like we did at the beginning of the year? Well, it's certainly not over in his head. And because he is president of the country, I don't think we can completely dismiss it.

12:19It's not something that I tend to focus on on a day-to-day basis. Trump says a lot of things. He has a lot of grievances. He has a lot of different issues that are top of mind for him. They tend to move from place to place depending on context and where he is. So it's not something that I think is due for an imminent action, but we can't just take it off the agenda completely either because he's the president of the United States and he says it, and so therefore it matters. Steve Felton is senior fellow at the Carnegie Endowment for International Peace. Steve, we appreciate your time. Thanks for having me.

12:53After the break, chip stocks take a tumble. And for even more markets insights, you can subscribe to my weekly newsletter, Simply Put, at simplyput.profgmedia.com.

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15:10We're back with Prof G Markets. After a meteoric rise, the semiconductor rally might finally be slowing down. Samsung, which is up nearly 400 % over the past year, posted blowout earnings yesterday. The company saw revenues more than double and profits increased by 1 ,800%. And still, that wasn't enough to satisfy investors. The stock fell 7%, sending nearly the entire market down with it. The Philadelphia Semiconductor Index closed the day down 6%. The Nasdaq closed over 1%, and the S &P 500 closed over 0.5%. So, for more on how Samsung's somehow spooked the market and what's going on with chip stocks, we are speaking with Zed Francis, CIO and co-founder at Convexitas.

16:02Zed, thanks for joining us. Chips have just gotten crushed over the course of the day. And if actually, if we look at the semiconductor index over the past five days, it's down 11%. This was supposed to be the leader. It has been the leader in the market throughout the year. And it seems like it's coming to an end. Your initial reactions to what we're seeing? Yeah, this quarter earnings is going to be very different than Q1 earnings. And it's as simple is valuations have changed dramatically. Back in Q1, so think back to, you know, April and early May when all these names were reporting, they basically all kind of did the beat and raise, and mostly the stocks had very favorable performance on the day after those earnings.

16:44But spot PEs were below three-year average back then. Today, they're about 10 handles above their three-year average. And forward PEs back then were below the S &P 500. Today, they're above the S &P 500. Now, the peg ratio for the space is still reasonably attractive. But all that means is the market is pricing in much differently this time, the amount of growth embedded into these companies. And so the hurdle is that much higher. So I would expect this entire earnings season to, if there's anything, any small item that feels like a miss to have these kind of nasty downward moves. And I expect it to just in general be a very volatile earnings season for the sector.

17:28Is there any reason why it's happening now? I mean, it just seems strange. Samsung reports this crazy earnings report. It's a beat on pretty much all fronts, unless I'm wrong about that. I'm pretty sure it was. And yet now's the time that investors say, we're out. This has gone too far. Again, I think you're going to need Micron level of blowout to really impress the market at this point with the current kind of valuation metrics in the space. Just looking at what Michael Burry has done, he's kind of made a name for himself in this semiconductor boom because he is shorting it. He shorted the semiconductor index.

18:09He shorted Micron. He also shorted NVIDIA. He's betting that Micron's going to fall 30%. What do you make of Michael Burry's moves? Do you think that he's ultimately making the right choice? IA expertise is in volatility. And when looking at volatility, he's not in a unique camp. Implied volatility, you know, the actual price embedded within the options you can actually trade is off the charts. You know, semiconductor, you know, using SMH, we can do the same thing with SOX. The spread of volatility in the semiconductor ETFs in comparison to QQQ, again, massive overlap of constituents, that spread is at its 100th percentile.

18:52You know, SMH volatility on its own is near its all-time hundredth percentile. This is a sector that's obviously performed very well. Yes, it's, you know, 10-ish percent off of those highs from, you know, a couple weeks back. But it's a common theme that folks are using options to bet against the space. And why I can say it with a little bit more conviction is when you look at the indices, again SOX, SMH, things along that basket of style of trading instruments, daily volumes are about four to one puts to calls. Open interest is similarly about four to one puts to calls. And during Q2, implied volatility just kept on climbing during all that trading activity that was heavily put slanted, suggesting that it's mostly people buying puts as volatility is expanding.

19:45Well, that's mostly trading. And additionally, as the semiconductor space has faded, as you said, over the last, you know, five-ish trading days, volatility in those ETS is actually fading a little bit with it. So we're seeing that stocks up, vol up, stocks down, vol down, which again suggests to me a significant amount of hedging and potentially over hedging in that space. why when it's profitable to be hedging the space, there's a little bit of that monetization actually pushing volatility lower. So I think it's, we'll call it not a unique view by a famous short participant. And frankly, the options are pricing it in.

20:27I mean, it's really expensive to have that view. Just when we look at the comparison between, I guess, the chips and so the companies that are making money off of the AI infrastructure build-out boom right now versus the hyperscalers, i.e. the companies that are paying to build out the AI infrastructure. So, you know, Microsoft, Oracle, Meta, etc. It's quite interesting because the hyperscalers have gotten punished so far this year. The infra players, the chip stocks, the memory stocks, those are crushing, which makes sense. Those are the companies that are really making all the money. But it seems like it's starting to reverse now.

21:11And it seems like the two are now starting to converge. I'd be curious to get your views on what this all means to what we're seeing for the hyperscalers, also for a lot of the software names, which are also bouncing back this week. Are those two dynamics related, do you think? Meta's announcement last week, I think definitely, we'll call it spook some folks in terms of the rotation now that they're going to lease out some of their excess capacity. Maybe it's not excess capacity, but I think that's how the market's currently reading it. But what I think is interesting for the long term where both might be successful is, again, it's an asset-heavy buildout.

21:50It's a capital-intensive buildout. And these hyperscalers are investment-grade, can borrow essentially as cheaply as anybody out there. So if you're somebody like Meta, borrowing at 30-year term at 6, 6.5 % to be able to facilitate leasing out this compute to other players that cannot essentially lock in any sort of term in terms of financing, especially not at those rates. They're just kind of doing a, we'll call it grown-up type of play where they're using their balance sheet to go ahead and build out capacity that other players cannot and hopefully capturing that spread of the long term. So, you know, I view it as this is the next phase for the hyperscalers.

22:34They're building things out for themselves. Now they're coming up with additional ways to increase free cash flow from the spend on infrastructure build. But it doesn't necessarily mean the semiconductor wave is over. In fact, it might elongate it depending on how successful they are essentially becoming that intermediary between the end client and building out that infrastructure. All right. Zed Francis, CIO and co-founder at Convexitas. Zed, thank you so much. Thanks for having me.

23:08Over the past couple of years, we've heard many projections about what AI may do to the labor market. According to Dario Amadei, AI could eliminate, quote, half of all entry-level white collar jobs. And according to Sam Altman, entire job categories would be, quote, totally, totally gone. But lately, business leaders have been changing their tune. Sam Altman recently told CNBC, quote, our industry underestimated how much we're going to be able to keep people at the center of everything. And Amadei said that companies, quote, can now do more with the same amount of resources. A recent paper from economists at Reveglio Labs and Ramp seemed to back that up.

23:49they found that the biggest AI spenders are hiring more than non-adopters, not less. So we wanted to speak to one of the authors of that study and ask the question, is AI coming for our jobs or not? Joining us is Ara Karazian, lead economist at RAP. Ara, thank you so much for joining us on the show. So the change of tune has been notable from these AI leaders, but you've been studying this. You wrote a paper on AI job loss. Your findings seem to be that AI is not killing jobs. What did you find? You know, this is a market where there's been a lot of mixed messages, both as far as what businesses are hearing about how they should be using AI and what people on the job market are hearing as far as how AI is going to affect them.

24:37So this was the first ever study to use firm level data on what happens at firms that adopt AI. So instead of using surveys or AI exposure scores, we could look at these firms bought AI, these firms didn't, what happened to their hiring going forward. So what we found is the firms using AI heavily grew their headcount 10 % over the two years following adoption. The firms that used AI lightly only grew at about the same rate as the control group. So we can talk exactly about what that means, high intensity versus low intensity. Beyond that, we also found outsized growth for entry level hires, so 12 % over two years.

25:12Yeah. Could you break down the the difference in those control groups there, what it means to sort of be adopting it heavily versus lightly? Well, what we found in our research is that the vast majority of firms that are using AI are using it in a fairly simple and basic way. You might have a chat GPT subscription across your entire employee base. But I think if you've used that technology, you will notice very quickly it's nice to have, but it's not particularly productivity enhancing. It's certainly not the technology that's going to vault the United States into the next generation of economic growth and development.

25:43However, the top third of firms in our data set are using AI a little bit differently. They're more likely to use multiple models. They're more likely to use the coding agents. They're more likely to use dedicated software for specific tasks like customer service operations. So those businesses tend to be assigned to our high-intensity group. And it's there that we see these concentrated gains. Now, there are caveats with that too. Those firms tend to be in high-growth sectors already. Now, their growth accelerates after AI adoption. and while we have not seen any declines in hiring outside of these high growth firms, we're also not necessarily seeing a lot of gains from AI adoption.

26:20So that's, I think, the open question for research going forward, whether or not the gains to AI adoption will be experienced by firms outside of tech. That seemed to be one of the interesting points is that we're seeing this specifically in the tech sector. We don't quite know how it works for the rest of these sectors and how generalizable it is. one critique uh that i'd be interested to get your views on is that i mean it doesn't seem that this is proving causality here meaning it could be that if you're a company that is heavily adopting ai maybe your headcount is growing for other reasons such as maybe you're a venture-backed company and you're you know forced to continue to grow i know a lot of ai startups that are growing significantly.