AI & Nasdaq Crash After US Midterms, Buy or Cry?

0:00Rich McDonald: On this week's Art of Investing, J.P. Smith, our expert in emerging markets, joins us. And when we asked him what his favourite equity to buy would be, he said, bonds. We've got spice with the stress ball in his hand as the Nasdaq's down 6%. What is the result going to be on today's portfolio? Because, let's face it, the chairman needs some support of the board.

0:31Rich McDonald: Welcome to The Art of Investing, brought to you by IG, the global investments platform. Well, what a time you are joining us because we're recording this on Thursday afternoon, mid-NASDAQ crash, down 6 % at the moment. So you're going to get our live reactions. And first reaction has got to be from That Man Spice. Well, thank you very much, Rich. I'm glad you leave it to a ball to sort of talk about this bear wave we're seeing. You in Rome have obviously set off a few explosions and let's see how things pan out. But as I talk, and I'd use that as a bit of a caveat because some of the movements I'm going to talk about might be quite different by tomorrow afternoon when you hear this podcast.

1:14Rich McDonald: And friend of the podcast, JP Smith, our emerging markets expert, joins us once again. Hi, JP. Hi, Rich. Hi, guys. Yeah, I'm delighted to be back. Thank you for inviting me again. So just before we get to the spice market update, gents, breaking news. We've been nominated again for the Good Money Guide Awards. Brilliant. Returning champions. Let's hope we can win this one again. We would absolutely love if you could go on and make your nominations there. You have to scroll down. Not too far. It's the art of investing. And you only have to vote for us. You might want to vote for other people as well.

1:51Rich McDonald: For example, there's somebody called Rich McDonald on there, Rich on Markets. If you scroll down towards the bottom, then that's an option as well. But Best Financial Podcast and Best YouTube Creator are there. Right, so with those market crashes happening, well, we go back to yesterday. Thankfully, the portfolio was snapped on last night's European close. So we're down 1.1 % for the week. That leaves us up 9.9 % year-to-date, up 22.4 % since inception. But the last few months starting to look a little bit tricky, down 3.6 % we are now. So how is that going to pave today's reactions and portfolio changes?

2:35Rich McDonald: Stick around to find out. First of all, it's the Spice Market Update. Thanks, Rich. I say I'm going to caveat this by saying I'm quoting numbers as of about an hour ago. So by the time you hear this podcast tomorrow afternoon, they might be quite significantly higher or lower. You never know. Anyway, the oil price, Brent is down about 13 % over the week. Came about really started because there was Trump saying that he was willing to have talks with Iran again. Iran's supreme leader said, yes, we're willing to have chats. And so that moved the oil price about 5 % down, which was great. And then the midterms happened.

3:11And we're going to have a lot of talk about what the midterm implications are later on. But that added another wave down in the oil price and to other sectors, you'll find out in a moment. But that took the oil price down another 8%. So we're down about 7 % week on week as we speak. In the past week, though, we have actually seen some all-time highs. And I throw out the FTSE 250 for CJ.

3:34Rich McDonald: Finally, when everything else goes down, the FTSE 250, that's the safe space. uh well also interestingly one of the areas we haven't been keen on europe the dax german dax that hit an all-time high as well and interestingly just for rich because i like to spread this the goodwill around the s &p equal weighted index hit another all-time high this morning oh wow sadly it's not all been good news though so as i speak the nasdaq is down about five percent it's it already hit a correction which remember a correction is down more than 10 percent on friday as of this morning first thing it was down about nine percent but is off another five since since then so we're off about 14 over the week now i guess that's been led by the chips and ai sector the semiconductor the philadelphia semiconductor index is down 19 percent that's seven percent down today core weave which remember started a bit of a wobble in some of these things about a couple of weeks ago is down 25 % over the week.

4:41But interestingly, a magnificent seven, showing their strength as cash generators, are actually flat on the week. That was before they only moved this afternoon. And that's because Apple's actually had quite a good week. They've had good results. And they hit a new all-time high. But NVIDIA is very weak, down about 10 % over the week. Bitcoin down five. And then here for CJ, the pound sterling against the dollar is up one percent and that's even despite the budget and the bank of england moves today perhaps the dollar index is up about 0.6 percent as we speak and that's despite trump and that's a bit of a risk off move we see the flight to quality or safe haven assets and the dollar is considered one of those so it's up about 0.6 percent over the last few days and that's interestingly that gold actually over the week's up two percent silver's flat um but copper which obviously you know is an integral part of the ai trade is down about five percent in the corporate results we're now about two-thirds of the way through the corporate reporting season i'm not going to dwell on these because we've got so much to talk about but broadly speaking we're ahead of expectations running at about 31 and a half percent growth in the s &p 500 earnings uh that was up from last week just being 30.5 and about 30 in the quarter too now we've had a whole host of results from the big tech names Palantir one of Rich's old shorts was down 12 percent Arm Holdings which are Cambridge-based UK company that fled to Japan and over to the US down 8 percent Qualcomm down 12 percent remember they make lots of memory chips for iPhones and other phones out there but the big one was Intel remember Trump's baby Intel which he bought a stake in the US government it's down 40 percent this week and that's because they had some very poor results but then they were hit by what's happening with the midterms.

6:32But it's not all been bad news. Apple had pretty robust results. They are the best performing magnificent seven share. They're up 25 % now from their 2026 low on very good results. And they've used that strength today to be going to the bond markets and they're raising, trying to raise$7 billion by different duration bonds across the US. That's probably all I want to say about the company results. But there's been some more big fundraisings, not just Apple. Last week, at the end of last week, we saw Microsoft raise$25 billion. And they issued an investment-grade bond, which is good news, because that's a high-quality one.

7:10That's the first raise they've done since 2017, so for nearly 10 years. Alphabet, who own Google, tapped the European bond markets for€7 billion. Oracle raised€10 billion of debt and another€10 billion by selling equity. Remember, they had their results last week and said they do no more than 20 billion per annum until 2030. And finally, Meta are on favour.

7:32Rich McDonald: So they've gone straight in and done 20 billion. Yeah, exactly. The next week. That's probably quite good corporate finance advice given the state of the market today. So they probably got that out of their way at a slightly better price than they would have done this morning. And finally, Meta, basically, on top of their 98.5 billion raise, they've raised another 15 billion in euro and bond sales. So quite interesting. The tapping of capital continues. From a UK standpoint, really the big news has been the Bank of England this afternoon, which is, remember, it's Thursday when we record this. As expected, they raised the interest rates by 25 basis points or 0.25%.

8:10There was an eight to one vote for that. Someone actually voted to increase it by half percent rather than a quarter percent. There's now meant to be a 35 % chance of another quarter percent rise in December when they next meet. and that was interesting they were saying that although they're seeing higher growth prospects and about by the way they're saying that about 20 percent of that growth is coming from ai now even in the uk is starting to benefit from that they also saw the possibility of five percent inflation in the first half of next year now i'm going to let chris have a bit of a ramp here because where rates are at the moment surely that doesn't reflect potential five percent inflation

8:46Rich McDonald: in the first half of next year well to be honest spice i i'm i'm glad you you didn't let on to everybody that it was me who voted for half a percent at the MPC. No, no, clearly I'm not a member of the MPC, but if I had have been, that's what I would have voted for. As everybody knows, I just think we're so far behind the curve in the UK. I was in the car today listening to a phone-in where they were talking about putting interest rates up and people complaining, mortgage holders complaining that interest rates going up would not be particularly helpful for the real economy. And, you know, one really has to say no shit Sherlock to that sort of thing.

9:24Rich McDonald: At the end of the day, the only thing the Bank of England can do is raise interest rates. That's their only weapon. They aren't the politicians. They can't fiscally tighten. All they can do is raise interest rates or cut interest rates. And inflation is a problem. Inflation is too high. And therefore, we need to raise rates. And the sooner we raise them, the quicker we realize that inflation will stay low, the better it will be for the economy as a whole and for everybody. CJ, a topic we're going to be discussing later with JP is Brazil. And I've been at the FX World Conference here in Rome, and there was a Brazilian economist here that I was speaking to.

10:03Rich McDonald: And do you know what their comment was? Go on. Go on. Yes, we have a problem in Brazil with inflation at the moment. I think the UK is having the same problem, isn't it? So it's known worldwide that we have a problem and we are in the same basket as Brazil. Well, I'm not sure we are in the same basket as Brazil, but we certainly are in a basket. Go on, JP. Well, I was going to say, Brazil has real interest rates, I think, of about 8 % at the moment. So if that's a template for the UK, then I guess we all need to be very afraid. But actually, the fiscal deficit, I think, is quite similar in Brazil.

10:39Rich McDonald: It's about 100%. What is it here, Chris? Just below, right? 100 % of GDP. So that's obviously the accumulated deficit, the stock, not the flow. It's speculated to get to above 100 and then to gradually reduce over time, but it's too much. It's too much. Well, the demographics are worse here than they are in Brazil. So I don't think it's a real realistic comparison, but it does just go to show. And also, I suppose we could find that if the wrong people lose the next election, then they could jet off to America as well. Yeah, I'm not sure who the right people are though, right? I mean... That's pretty much finished other than to say the Bank of Japan, as expected last week, did not raise interest rates.

11:19They're running with about 2.5 % inflation into 2027, but they said they're not raising them at the moment. The only other stuff I would talk about ordinarily here would be the elections, and I think we'll save that for later on because there's been some huge moves associated with Donald Trump's trouncing. And that finishes the market revamp.

11:38Rich McDonald: cg anything to add there um well i mean we've obviously got to talk about the um election but we're going to leave that for a little bit i i do think it's worth just pointing out i think we did last week as well but bond yields have done very well over the last few weeks contrary to my expectations and they've fallen by about 30 30 to 40 basis points um and that's been driven by uh you know worries about is the ai trade cracking we'll be talking a bit more about that in a moment and by then falling oil prices. But I think we always said that if oil prices fell, it wasn't clear why bond yields would fall too much.

12:17Rich McDonald: And you can actually see that the inflation expectations, as measured in the US, are still around about 2.1%, which is where they were when oil price was$110, which is exactly where they are today at 95. What's happening is that the real yields have come back and they come back as people have worried, is there a crisis in the world? Do we need to worry that the economies are slowing down and therefore the pressure on real yields higher will be a little bit relieved? And I still don't believe that, but I've been wrong for the last 30, 35 basis points. I still think that the equity market's buoyancy overall before today, clearly, but we'll be talking about those a little bit later.

13:03Rich McDonald: I still think they're telling you that liquidity is plentiful. The hyperscalers, as Spice has just said, are borrowing as much money as possible still in the bond markets. And the governments are doing the same. So I still think there's lots of pressure on bonds to go higher in yield. And I don't really want to get involved with them. Your capital is at risk. The value of your shares, ETFs and ETCs can fall as well as rise, which could mean getting back less than you originally put in. This content is for information purposes only and is not investment advice. Past performance is not an indication of future results.

13:32Rich McDonald: straight onto the portfolio and we'll rattle through those performances so the winners on the week and just look at this differentiation it is absolutely incredible so Europe best performer of all up 1.7 percent on the week then we've got the Russell 2000 you see the money flowing into Spice's favorite index there the small caps in the US up 1.4 percent on the week then FTSE 250 new all-time highs at 1.3 % on the week and the FTSE 100 was the fourth best performer up 1.1 but oh before that spice celebrates any further what have we got on the downside the chairman choosing to decide to buy the Nasdaq a few weeks ago down 5.2 % on the week copper down 5.1 % that's mine and spices japan nikai 225 down 3.8 % on the week we sold some of them we did sell some of them and we sold some msci emerging markets so if you're layering out the blame game we get some credibility for that we're one team one dream remember lads as we said that leaves us only down 1.1 % in the week so thanks be to goodness for europe there and the russell 2000 and the uk markets holding our head almost above water.

14:52Rich McDonald: Reminder yet again, that's not counting today's moves on Thursday. So why is the Nasdaq down 5.2 %? What happened in those midterms to give the data center trade such a rattling? I noticed CJ mentioned in his part there, whether the AI trade is losing faith, I think that's lost. That's long gone. We've got Micron down 15 % in one day here, nevermind down 40 % since the high. So a lot of those stocks, interestingly, moving from 24 times forward earnings to 16 times forward earnings. We'll discuss what that says about the belief in the trade as well. JP? I was just going to say, if you wanted a canary in the coal mine so to speak then korea would probably be the one right because the korean market has been the roller coaster to end all roller coasters and the two stocks in question are samsung and in particular sk hynix which is obviously a sort of fairly bulk commodity memory chip producer and that stock was up i think 65 percent earlier this year and is now, I think, almost flat on the year.

16:11Rich McDonald: And that peaked out, I think, in May. So I was puzzled, I must admit, by the market in the US last night where the hyperscalers did quite well. But obviously, the sort of spays and shovel stocks of the AI, the sort of chip stocks and so on, memory stocks, did relatively badly. And today seems to be sort of rebalanced. Well, it's not rebalancing, is it? Because they're both going down. But the hyperscalers are catching up in a way. I was going to say, one of the main theses behind why the hyperscalers have held up a bit better even today is because they've already made a lot of their spend and they're ahead of everyone in building data centers.

16:50So there's a lot of people out there, there's a long pipeline of planning permissions, waiting for consents, all that sort of stuff, getting loaded, getting connected up to the grids to get water and power. But the hyperscaler has been early out of the blocks. They've been doing this now for about 18 months, particularly people like Meta, which interestingly has performed very well in the last couple of days compared to all the others, because they went early. And so that's the one sort of bright light I'd put out there, that if the Democrats, and this is the thesis, if the Democrats come in and they make planning consent and permissioning for new data centers very difficult and very costly, probably, because they'll demand that local communities get paid sort of backhanders to help the schools, the roads, all the other stuff and hospitals that you will need, then, you know, it's going to slow up that build of data centers.

17:39But that's one of the things that hurts some of these more esoteric AI companies and the ones that are yet to provide the equipment to go into the big wave that's coming up.

17:50Rich McDonald: I mean, the way these stocks are trading, it's like the US is the only place that data centers are getting built. It's absolutely remarkable the way these stocks are getting marked down, just on the hypothesis that the Democrats will stop. spice do you think they could be built in different states instead i mean what you do know is they have to be built in the us or in space as elon would tell you if he has his way um but they need to be local uh to collect all the data and to to sort of then pass out the the compute power that's needed and being demanded by consumers and businesses um which makes it makes it very difficult and this is one of the reasons why we were quite cautious on india if you remember at the backlog we're saying india having built a huge outsourcing through yeah absolutely outsourcing and uh call centers um are struggling because they can they can't supply the rest of the world with data center power compute power from india they could do call centers from india as all of us know um and they're very good at that but that's left a big hole in their economy now because of the chatbots that are coming in through ai and hurting that side of it but no doubt we'll talk about that later when jp dives into more emerging market so could we see the data centers just be built in red states rather than the the ones that have gone blue then well i think there's already a there's already a interesting pipeline that's gone through i think the biggest area for data center build is virginia so you know it's just on right next to washington i don't think it's actually a red state i think it's actually quite a blue state but they've been they were early on on trying to grant permissions to get data centers to come to the state.

19:33And, you know, the state has benefited very much. And we also know that U.S. growth has benefited massively. Let's say most of the estimates out there from better qualified economists than I are saying that half the U.S. growth, so about, let's call it 3 % nominal growth, is coming from data center spend and AI spend. So, you know, if the Democrats come out and kill this trade, they're going to kill their own economy. And then guess what? They won't be voted in in two years time when it comes to the next presidential election, because you can bet your bottom dollar people like Trump will jump all over that and saying you're hurting the American people in the European economy.

20:10So it's a fine balance. They've got a fine balance here. It's not as bearish as I think some of the market moves are telling you and saying this is all over. It's not all over. There's going to be there's going to be considered sort of moves from both parties, but particularly the Democrats. I say they've got to be very careful. They don't kill the golden goose.

20:26Rich McDonald: CJ, that's what the market is telling you, isn't it? The growth story is over. The Democrats have just killed the data centers and that trade's over. What happens to economic growth then? One can put a lot of stories on things. We are only two days into the life after the midterms. And so, you know, people are hunting for the next theme and the next way it goes. I'm much more of the view that this is actually a complete waste of time, us worrying about this stuff. First of all, the market peeps in these things well before the midterms, right? So markets were already off 20 % in some of these stocks that you're talking about.

21:03Rich McDonald: and the just government got mullered at another 20 % or another 10 % or whatever it is. It strikes me that the issue really isn't about, are they going to build these data centres? Because I'm actually with Mark. If they don't, they won't get elected in two years' time. Because the one thing that the Republicans will say is, if you had built these things, we'd have had the growth you wanted. And if you don't, you're not going to get it. So I'm pretty convinced they're not going to stop the growth of data. Yeah, they might have to have more regulation around it. They might slow it down a little bit.

21:39Rich McDonald: Totally accept that. But I don't think it's going to stop it. The concern you have in a situation like this is always the same concern that you have. Isn't that the fundamental picture has got a lot worse? It's how much leverage was there around in those core stories, which has to get out of those positions. I'll give you two examples. I'm not worried about the fundamental story at all. I'm a buyer in the dips here. We've been raising cash. I'm a buyer in dips. The two things that worry me are the following. If you look at the momentum ETF, which is the thing that's basically been running the world for the last two years, it's been absolutely smoked.

22:17Rich McDonald: In October and November, it's been smoked. Some of these hedge funds have had an absolute disaster. Okay. And they will be leveraged. now the question is how good is their risk control if it was rich mcdonald we know it'd be really good but if it's some people sitting there over their skis how much more stuff have they got to sell and you'll remember that hedge fund guy back in august i can't remember his name rich you will remind me leopold leopold when he was caught out and he had to exit his position citadel stood behind him but not before a very messy time and so to me there's a question here about where are people in the momentum trade?

22:56Rich McDonald: Have they had to get stopped out yet? Or are they still holding on going, oh, it's okay, it's okay. That's my first worry. It's a major worry, but there's a second major worry as well. And that second major worry is around private debt. Now, there was a great story, people will have noticed it, I suspect, in the paper last week about a hedge fund called Arini Capital Management. Now, let me take you back a little bit. I'm a bond guy, right? So, I'm a pretty boring individual and when I was set my benchmarks a long time ago you realize pretty quickly as a bond guy that if you bought credit quality bonds that were worse than your benchmark i.e they were worse quality maybe your benchmark was triple a so you bought triple b bonds they would yield a lot more and therefore if you just held them and there were no problems you'd out perform your benchmark so the game that most bond players played over the last 20 years is buy poor quality bonds against your benchmark and most of the time you're going to be fine and the only time you're not fine is when people find there are liquidity events or when you get people going bust now this arena obviously from from what i read and and maybe i i'll say allegedly Irini had basically been buying triple C bonds and they've been leveraging those triple C bonds and they've done brilliantly they their funds have grown to 22 billion in assets their hedge fund is worth 7 billion now um they lost last week 7 percent 7 % and that adds to their 15.7 % loss already this year so they are down roughly 21 to 22 % in boring easy credit private credit strategies and you just wonder how many more of these people are there who've invested in CoreWeave or some of these other things and they're gonna have to get cleared out first before the market settles.

25:05Rich McDonald: So to me, the worry is not about the markets. I'm not worried about fundamental stories. These are just stories associated with Democrats winning some elections. They're not stupid. They know they're going to have to let most of these things go forward. The problem is how much leverage is there in the system. And until we see some price action that starts to make you feel that things are bottomed out, I think you've got to be a little more cautious than than wading in with both feet just one foot remember we have sold a reasonable amount of positions over the last two three four five weeks okay now to me we will look a little later when we've spoken to jp about what he thinks about the emerging markets because emerging markets have been they were tremendously good for most of this year and for the last three months they've an absolute crap so what we need to work out is we got seven and a half percent in them do we carry on with that and then if we've got new money are they somewhere that we might want to go or do we want to go into somewhere else so you know to me i was really happy on wednesday morning when i saw these election results i was really pleased the american people had um taken the messages that Voldemort had given them and told him to cease and desist in his ridiculous policies.

26:26Rich McDonald: And they were back. And I really liked that. So that was good. I heard one really funny comment, which I must repeat here, which is that people elected Trump thinking he knew about regime change. They didn't realize he meant in Texas. Very good. Well, I have to say, CJ, you and Spice might be surprised here, but I don't disagree. Whoa. I've come into this with cash on the sidelines in my pension. And you know, my exposure was dying. You know, it was in treasuries. And today I have been starting to put some money to work in the riskier side of things. So that will be a question when we come to the portfolio decision at the end.

27:14Rich McDonald: But why don't we see if JP can give us any interesting tidbits in emerging markets world first? JP, I'd like to start with China because last time we were chatting and that you were on the show, you mentioned that the problem with Chinese growth is it doesn't make its way to shareholders. So what is that growth story looking like now and what are the drivers of it? Well, funnily enough, Rich, myself and Ed Butchart have just published a note about Chinese equities saying that they're a policy tool rather than a profit machine. And that's exactly what they are. They don't function in the same way that markets function in, say, the US or the UK.

27:59Rich McDonald: It's a controlled market, essentially, which can either be a sort of strength or a weakness. I came on last time and I said the economy was really in the doldrums and that hasn't changed except in one perhaps slightly critical respect. Exports have picked up a lot and the type of exports that have picked up are in AI related products. And one reason that the Korean memory chip producers, especially SK Hynix, have been having such a hard time is that the Chinese have started to export quite aggressively. There was a Chinese company, CXMT, that came to the market recently. They're a big memory chip producer and they've been taking market share.

28:43Rich McDonald: So the Chinese economy was actually up four and a half percent or so over the year to date to the end of, I can't remember if it was August or September, wasn't it? And all of that, all of that was exports, all of it. And so China is in this curious position now where it's become almost a leverage play on AI. But at the same time, it should be a relatively defensive market because the Chinese authorities support it through state-owned institutions called the national team. So in terms of China's contribution to the world, to demand growth, it's just not happening. Now, whether that's a factor spies for copper anymore, I don't know.

29:19Rich McDonald: China used to be the big driver of copper when the property market was going gangbusters. It was also crucially the big driver for emerging markets. Again, we just published a very sceptical report on emerging markets. And we point out the only time you really wanted to own them as a whole was between 2002 and 2007, the end of 2007, October to be precise. And that is what we call the great emerging bull market. And China was the big driver behind that and the big driver behind the rise in commodity prices. So I would say to you, in terms of emerging markets, there are actually relatively few internal drivers there at the moment.

29:58Rich McDonald: And if you factor in the fact that China, Korea and Taiwan between them are probably now, just off the top of my head, I would think about 63 % of the emerging market index. Then even China is to some extent to play on the AI and export cycle. And certainly Korea and Taiwan most definitely are. But by the way, neither of them should be in the emerging market index at all. It's an absolute travesty that MSCI allow this or rather encourage it. And I think that is largely because they do consultations with their clients. The clients are for management shops and they don't, the clients realise that if those two were to leave the asset class.

30:40And by the way, FTSE Russell rate Korea as a developed market. And if you look at GDP and PPP terms, both Korea and Taiwan are now higher than the UK,

30:51Rich McDonald: although the way the UK is going, that's not necessarily saying a great deal. JP, I know that you're a keen listener to the podcast each week. Absolutely. You will have noted that we previously trimmed our exposure to emerging markets. So you brought up Korea and Taiwan there. Are they now starting to look like opportunities in themselves, or is it just another version of this AI trade? With Korea, there is a school of thought that actually there are a lot of value stocks in Korea. It's always been a very cheap market. Like Japan, the government has this sort of corporate governance program, and they're trying to encourage retail money in.

31:28Rich McDonald: But the problem is, for what you would buy, namely either a Korean ETF or an emerging market ETF, Samsung and SK Hynix are so dominant that really I would throw the question back to you. If you feel it's time for these sorts of stocks to perform, then Korea is basically the most geared play you could have on that. Taiwan's a little bit different because TSMC is dominant. It was about 45 % of the Taiwanese index when I last looked. It's about 16 % of EM. It's obviously got a much deeper moat because they're involved in a much higher added value business. Spice, I think you know the company quite well.

32:03Rich McDonald: It's come back now, well, with today, probably about 20 % from the highs. Some people would say, see that as an opportunity to buy a quality stock. But, you know, and this is a ridiculous thing to say, but it is quite over-owned. Every emerging market fund obviously has quite a big weighting in this. So, again, you're really looking at a slightly less geared play on the whole sort of AI technology cycle. But as a company, I mean, it's a fantastic company. and the rest of the market there is sort of you know there's again a very good technology sort of infrastructure there too so you could you could sort of think about that um either on its own or part of em but i personally wouldn't be a buyer here but then i have a very different view on the whole ai and what's happening in the markets to you guys so you know which is probably not why have been brought on so oh no we we must we must hear that jp you can't leave us you can't leave us dangling there and and our loyal listeners who who are who wants here what jp what jp says the whole time well i it's the same thing as i said about three or four months ago i mean i think you know we are approaching um a level of sort of capex certainly relative to previous capex cycles really big capex cycles like the internet some people would go much further back and they'd look at things like the railroads there's barely an instance of this type of transformative technology that hasn't created a bubble in the markets if you look at things and you mentioned earlier chris about private credit i completely agree with you about that and i think it is a real a real risk out there but there are other risks as well even for the listed companies in terms of off-balance sheet exposure in terms of the fact that I think Morgan Stanley are expecting certainly the big tech companies to be something like 500 billion negative cash flow next year.

34:01Rich McDonald: Now, that's definitely what they're going to spend on CapEx, isn't it? Yes. But their cash flow has gone from being quite positive now to being extremely negative or is in that process. Not all of them, but most of them. We had a commodity bubble in emerging markets in the 2002 to 2010 period. And the canary in the, again, the canary in the coal mine for me, when I looked at emerging markets and I went back to the sell side to cover emerging markets in 2010, what told me emerging markets was going to do really badly was the capex to depreciation ratios. And again, I talked about this last time I was on, they had blown out.

34:42Rich McDonald: So In other words, CapEx was relatively high relative to depreciation. With these tech stocks, you're going to see depreciation charges rising markedly over the next few years. Now, if they can't earn a decent return on that, and there are quite a few reasons to think that actually this AI may actually turn into more of a commodity. With the Internet, you had a first mover advantage. So you had big companies that essentially managed to create the big moats around them by going early and investing heavily. With AI, it could be quite different. You could end up with something that's more commoditized.

35:19Rich McDonald: The Chinese are in, you know, they're really into this in a big way. And I think for most of us, having an AI that isn't necessarily state of the art, but is good enough, will be something that maybe we're reluctant to pay up too much for. So I'm not convinced that these companies are going to garner a sufficient return to justify the sorts of valuations that they've been on. I think it's probably worth explaining why you worry that capex against depreciation is a problem, because you need to explain to most of our listeners why depreciation is important and therefore what it is against capex.

35:57Rich McDonald: Yeah, well, depreciation is obviously the rate at which you write off the capex. You put your capex in year one and then obviously you write it off against earnings over subsequent years at whatever rate. And as you know, there's a lot of controversy about what the right rate of depreciation is for things like memory chips. That's too technical a debate for me to get into. But at the moment, given that the capex profile has been rising quite dramatically and seems to be continuing to do so, although we may be coming near a sort of hiatus now, that depreciation charge is going to rise markedly over the next few years.

36:32Rich McDonald: So if the earnings, the return on equity is not sufficient, then the valuations will start to look even more stretched than they are now. Now it's really becoming a price to cash flow issue. As we look forward, it could become a price to earnings issue as well. I think actually, there's a strategist that I think is very highly, it's called Peter Oppenheimer at Goldman Sachs and many of you will have seen his stuff yeah I think he said it was quite interesting he said we think we're seeing a healthy scrutiny of earnings rather than fundamental weakness and I think that is probably what's going on because when you see a company like Intel being hit 40 percent in the space of a couple of days uh clearly the market is basically saying yes we're going to be going to become more discerning and that's why we're going to turn we're going to go to people like meta or apple um and yeah if they get their depreciation charges right one of the things that depreciation does is if you can meet your depreciation sort of charge that's cash and you generate cash so if you then bring your capex below that depreciation charge you're generating more net cash than otherwise at the moment as you say capital expenditure is exceeding that depreciation charge so they're actually consuming cash rather than generating it I think there's another issue as well.

37:52Rich McDonald: I mean, there's a sort of confluence, isn't there? The midterms is the proximate cause of what's happening, but there are underlying causes as well. And obviously, this concern around CapEx is one perhaps of the underlying causes. The other underlying cause, I'm sorry to go back to this again, because I think I was on the week that Trump and Israel attacked Iran, but that conflict is unresolved. And although the impact on the US is nothing like as great as it is elsewhere. It's kind of this nasty thing, isn't it, that's sort of overhanging. And although, obviously, in the midterms, the Republicans took a beating, J.D.

38:26Rich McDonald: Vance came out and he said this was due to the Iran war, and I think it's all about the cost of living, and the Iran war was a massive part of that. But that is something, again, which isn't, at the very least, it's not good for sentiment. At worst, it's more serious. Although, I have to say, I'm really surprised at how well the European markets have been able to perform, given what the natural gas price has been doing, which is actually quite impressive, actually. I always underestimate how, even having managed European portfolios for 10 years, quite how resilient sometimes these markets are in the face of really bad news.

39:02Rich McDonald: And JP, just talking about gas prices there, have you got any insight? Of course, you were the leading expert in Russia for a long time on Russian equities. Is there anything there now to give us hope of an end of conflict or is it as it continues? I wish there was, Rich. Look, sentiment towards this conflict fluctuates in terms of who's winning. Every six months, the sort of consensus shifts. So six months ago, the Ukrainians were doing really well. And in fact, they still are in operational terms. You know, the Russians have struggled to take territory. the ukrainians have obviously hit as we know from trump's pronouncements they've hit a lot particularly the downstream oil facilities in russia the russian economy is not in good shape but unfortunately we're coming up to winter and the russians are very ruthlessly destroyed a huge part of the power infrastructure in ukraine so it's going to be brutal people are leaving the country there they're having trouble recruiting and in a way they're sort of running out of troops.

40:09Rich McDonald: I think the average age of a Ukrainian soldier is in their 50s. And of course, Putin now is going for, I think, a sort of maximalist position. He's not really prepared to compromise. So I would love to say, I think there is some prospect. You've got the Americans, the Chinese and the Russians meeting, I think, in Abu Dhabi in a few days' time. But with the Europeans deliberately excluded, it's very difficult to see anything coming out of that. So with the best will in the world, it looks like more of the same, although it really is in everybody's interest to compromise in some way, even the Ukrainians.

40:47Rich McDonald: What they need more than anything is a coherent and credible security guarantee. And again, that will depend largely on the Americans because the Europeans aren't really in a position to completely provide that. So it's difficult. And then with the midterms, of course, as well, there may just be a little bit more assistance for Ukraine, because although Trump has taken an avowedly really pro-Russia position, if you go further down in the US military establishment and the State Department and also popular support, you know, Ukraine is definitely is definitely favoured. So we'd hope to see the Americans coming back a little bit more on side.

41:28Rich McDonald: To me, the question really is, and, you know, we clearly, none of us know the answers, but I think it's an important question is, what do we think the midterms mean for Trump behavior going forward? and he was pretty, pretty quiet, I thought, to be honest, from what I was expecting. He said, first of all, he accepted completely the vote. There was none of this, you know, let's march on Capitol building. They've rigged the vote that all the pessimists were saying. I mean, sorry, let's go back six months. All the pessimists were saying six months' time. Who knows if there will be any midterm elections because what he'll do is he'll say there's a war on so he doesn't need to have elections.

42:12Rich McDonald: that's all gone and now we've got a situation where yes he can veto anything that and that comes out of the congress but each time he you know he he does that um he's going against the will of people i'm just not sure he's got he's got the determination anymore he looked to me a little a bit of a beaten person and you know there is a chance in my view that he's a much more emollient than he has been what what what what are the chances of that do we think is that when he's at his most dangerous though when when he takes a couple of weeks and it sinks in you know does does that ego come to the surface and he and he lashes out but but that's my question so my question is where do you think what do we think he's going to be like do you think he's going to react badly as you say two weeks time he goes right that's enough I'm throwing the toys out the pram and off we go or have we got to the stage where he's saying do you know what I'm tired I'm 80 years old whatever he is and I've just you know I've had enough now and I'm ready to you know sort of give a few pardons to the family earn a few more billions for myself but not but not not cause too much fuss what do you think I don't know one of the really interesting things yesterday The worst performing sectors yesterday, so this is Wednesday of the results, were energy.

43:38Well, that was because everyone says, well, the Democrats are going to be more reluctant to sort of go to war on a prolonged basis with Iran. They'll be pushing for peace. And by the way, if you want to spend one and a half trillion dollars on defense spending next year, you're going to struggle to get any approval for it. And the second worst performing sector was industrials in the US, which include all the defense companies. So they were down actually more than energy yesterday. And the energy, you know, the oil price was down 8%. But the energy sector was down about 5%. And that was, I think, basically saying, right, Trump, yes, you might want to go and do something more mad in the Middle East, but you're not going to be able to sort of replenish our resources afterwards.

44:19And there is now a sort of rain on him. I still worry that he will do something if they don't have peace in these latest talks between Iran and the U.S., that he will still try and do boots on the ground and take Cargill in, which I've been consistent about for the last few months. And that's my probably biggest risk. So I keep watching the oil price. And it's very welcome that it's come down 13 % in the last week, but it's got to be watched very carefully.

44:45Rich McDonald: That's another thing, by the way. So, you know, I said there were three things I was worried about. And one was the, you know, the amount of private debt and the other one was the momentum trade. The other trade that was massively overdosed was that the Americans were going to go in to Carg Island the minute those opinion polls came out because everybody had that trade-off and so you don't I think I think most people have been liquidated in that now you know market falling 13 percent in a day tells you that people had a long position and I go back I come back to what I said said before we you know the important point the important thing to understand here is how many of these trades are still over-owned how many of them are people still got in bad positions um and how many people um are in pain and hurting and one thing we should say about our performance and now our performance is negative and it's not looking good for the chairman at the moment um is that you know at least we haven't had 70 in the us which is what most people have now and we've talked about this so many times on this on this show that people have got 70 world index have got 70 in the u.s and you know is that a sensible way of running your risk these days and that's the question we've asked before we'll ask again and is something that's very important could i just ask particularly rich i think on this one um how sticky do you think the retail money is in the u.s because obviously we've seen an unprecedented wave of retail investment.

46:20Rich McDonald: I think household assets in equity are obviously at a record level by quite a long way there. An emerging market, India, that did perform very well for two years, had an enormous retail bubble and then a hangover afterwards. The market only came back about 20%. At one point, India was doing 80 % apparently of global derivative trading or something, which sounds ridiculous, right? And obviously, in relative terms, we're nothing like that in the US, given the size of the market there. But, you know, are you worried or concerned at all that at some point retail might want to start taking some money out?

46:55Rich McDonald: As sticky as Superglue, JP. Okay. They are in. And I tell you, I was on a TikTok live last night, right, with 600 people watching the app-loving results come out after hours. Wow. And that's 600 people in the UK. Right. Right. These are kids, and I call them kids relative to you three, between the ages of 21 and 35. They were spending their evening at 10 p.m. at night watching people react to earnings. This is like a new culture that we've probably always dreamed of, getting people interested in investing. But as long as they've got jobs, then money from their salary seems to be going into either S &P 500, All World Tracker, and at the faster money end, then into all these retail favorite stocks.

48:04Rich McDonald: So they've had a hard month, but there's no talk of them selling. It's what's the next opportunity. It's quite incredible. Yeah, that makes me less bearish, I must admit, to hear that. If job losses start to rise, then that's it. All bets are off because then you have to see people take money out just to survive till they get a new job. Let's move the conversation on then to the portfolio. You know, Richard's given us a little bit of a heads up on the portfolio. that the chairman's done a terrible job and this year's performance of this year, our second year, it hasn't been anything to write home about.

48:47Rich McDonald: And I think what we've tried to do over the last month and a half is to show that we've had some worries and concern and raise a bit of cash. And so we're sitting here today with 25 % in cash in short gills, which I regard as cash, essentially um we've only got 20 in the us we've got 15 in nasdaq and s &p so let's call that the the ai trade stuff um and then we've got nikai seven and a half well let's say half of that's ai trade i mean that's another one that's been a very disappointing performance and em seven and a half let's say half of that maybe more than half of that is the EM trade, sorry, is the AI trade.

49:32Rich McDonald: But we've deliberately had a less than others, which has held us in good stead, but hasn't protected us from a poorer market. But we're sitting there with some cash, and the question really is, it's been right to take that cash out. Should we be starting to slip that money in? If we should, how much should we slip in? and which markets should we put it into if we are going to slip that money in. I'm not going to go first on this one. I want to hear what other people have to say. I won't let JP go first because he's going to say sell everything. He can have his view in a minute. I don't mind, but I'd rather it was indisbursed in the middle of the rest of us.

50:23Rich McDonald: Rich, let's go with you. You've had a good call. You've read the market down. that's good um now you're adding a little bit of risk where are you adding it and we're looking our portfolio would you add some how much would you add and where would you put it so of the let's say 25 we've we've got in cash or cash like um attributes i like to always go in threes. So I would put in something like 8 % today. I would put 8 % in when I become more confident or it drops. And then I always like to have one last amount of cash that hopefully you never use it. But if it comes down yet again, then you've got that.

51:12Rich McDonald: So 8%, how would I disperse that? Well, you seem convinced that this is not going to end up in the data centers not getting built you'd think that the democrats wouldn't do that to themselves if that's the case then some of these really affected trades in the memory world in the optics world in the power distribution that's going to power the AI trade in nuclear stocks, all that is down 40 to 50%, some of them more from the highs. So that's where I would maybe add 3 % of exposure or 2.5%. So to find a vehicle, because that's not the NASDAQ, right? That's probably more like the the Vanek blockchain ETF that we discussed, which I imagine must have been absolutely moored.

52:12Rich McDonald: It hasn't done well. I can tell you now, when we were looking to buy it and played in it, it was trading around the 850 levels and got up to 14 pounds. It's trading 682 today. So there's an example of how all that hot air has been taken out. Now, whether there's enough hot air being taken out, I don't know, but a lot of hot air is out of this trade. Go on. So yeah, so I would actually put 2.5 % in there as my really volatile Bossier. And then I would give 2.5 % to JP and I want to hear what his best long idea is and if we forced them to, then where would that go? And then I put another 2.5 % in gold because if this all goes wrong, then we know it's coming back to the central banks to save us and the treasury.

53:09Rich McDonald: And that means QE and that means gold will be up 20 % in my humble opinion. So a mixture there of aggressive and defensive, which is always good for a portfolio construction. So that's good. You've got things that work under different scenarios. JP, you've been put under pressure, two and a half. Where would it go? No, no swanning around. Where would it go? Okay, I'll buy 20 to 30 year US bonds. Yeah, right. Okay. So where in the EM? If I had to put it anywhere, I'd probably, given I don't believe that there's going to be probably an immediate snapback, then I'd probably put it in India, I'm afraid.

53:52Rich McDonald: India. Which I know you've already done. But if you think there's going to be an immediate snapback, then you put it in career. I mean, it's very straightforward. JP's told us already what he would do. He would sell everything and put it into 30-year treasuries. I'm asking for the riposte there, JP. Well, I just think that, you know, having a little bit of duration on the bond side now, especially if the oil price were to come back on a more sustainable basis and we were to see a bit more trouble in the equity markets, would be a decent hedge. But actually, you know, your portfolio looks good to me.

54:28Rich McDonald: I mean, it's diversified. You've sold things basically at the right time. I mean, I have to say, I think you've done a very good job. And as you said, you haven't really had very much in the US at all. So, you know, if you look at it from inception, you've done well. I'd just perhaps be a little bit more cautious about immediately, you know, wanting to wanting to go back there. Thank you, Jeff. That sounded like a vote of confidence, Chairman. Well, I need it, mate. I need it. It's a bit like your football team. when your players are all saying we've got we've got confidence in the chairman you know it's time to get out the cv well i mean i was looking at some of the fundamentals here and i think there's a lot of there's a big case of a lot of the babies are being chucked out with the bath water and as rich said there's there's been some absolutely enormous moves which in anyone's book is a crash and in those those sectors of the market you know remember anything more than 20 % fall is basically a crash knocking on for that.

55:21So plenty of corrections and a crash. But given we're still in the early phases of this, my instinct is actually to go to something that I feel most confident about. And I'm putting myself as I would have done if I was sitting in a big US asset allocation committee that Chris and I, we used to do on places like Manulife. You know, these guys will look at the rest of the world and go, well, what do we know best? and where do we feel most comfortable? If we are going to put our cash, if they've got any cash on the sideline, which I'm sure a lot of them do, where are they going to put that to work?

55:52And I think in the first instance, they will put it back to work in the US. I would personally go and buy the S &P 500 in the first instance, because I think that if they deliver on the sort of growth we're expecting, and as I say that earlier in the market report, actually the earnings are not the problem here. It's about expectations and whether you think you're at peak margins and whether it should be drated, etc. But the S &P 500, if they deliver, is now sitting on about 17.6 times P ratio next year. Historically, it's traded on 19 to 20 times. So let's say the earnings come through broadly as they are now.

56:29The economy doesn't go into recession because I don't think the Democrats will want that in any way, shape or form because that will absolutely kill their chances, as I said earlier on, of getting elected in two years' time at the presidential election. then i think that there's a good chance the s &p will deliver those earnings so we're looking at a 10 to 15 percent sort of re-rating as you get as those earnings come through the the market will then put it on a current rating of about 19 20 times uh and some of this may do a lot better still so i think you're looking at a sort of 15 return on just putting money in the s &p if we're taking a six to 12 month time horizon so i'm quite happy to go and buy the s &p here because it has been hugely derated compared to history.

57:11And I think they will deliver on their earnings because I don't think it's an earnings problem. I think it's a sentiment problem. Let's face this, if the bulls are back, they're going to be piling into places like Korea and Taiwan very quickly. I think that we'll see some of the best returns early on.

57:28Rich McDonald: Only one thing in the S &P 500 spice, of course, it hasn't come down in price. It's just that the earnings have gone up and we're rolling forward to look at 2027, right? So it hasn't derated and it's only 4 % off the highs? Yeah, but because the ratings have been so strong, the markets effectively derated it by this 10 % or so. And I think you'll get that back. But that's AI earnings, isn't it? Not just AI earnings. There's all the infrastructure stuff. There is the broader economy. The best performing sector yesterday was healthcare, I think, in the US, because guess what? The Democrats like spending a lot of money on healthcare that Trump doesn't want to.

58:07He wants to cut the prices of drugs and do all that sort of thing. So actually, the pharmaceutical companies did well globally yesterday. One of the reasons the FTSE 100 did well yesterday, because we've got two of the world's leading pharmaceutical companies in AstraZeneca and Glaxo. And that obviously helped the FTSE. So I think you're getting, you know, the great thing is the S &P, yes, it's got a much higher sort of exposure to AI than, say, the FTSE, which has virtually nothing. but compared to say nasdaq it's a lot lower and i think that the magnificent seven as i said earlier on in the market report i think one of the things if you elongate this investment cycle which is what i think the democrats are going to do they're not going to end it they're just going to elongate it i think two things happen the beneficiaries the in the first instance are those that have already spent or already raised the money so it is the magnificent seven they've been out there They've been building, building, building for 12, 18 months now.

59:00They are way ahead of some of the others. And there will be smaller companies and mid-sized companies that will also be there as well. That's great. But we're not in the job of trying to stop pick those companies. Together, you know, the Magnificent Seven is 30 % of the S &P 500. I think you get a very good exposure there to this invested capital, which should start to reap returns. And I only said it last week. I think that you're going to start to see the returns on some of this investment into the first quarter next year. And that's when I think the market will start to really aggressively re-rate perhaps some of these things like the S &P or the Magnificent SEM.

59:35So I think that if you elongate this capital cycle, you want to invest in the companies that have already spent the money and can reap the rewards because everyone else won't be able to invest as quick, won't be able to finish in time. and the other thing is i think it actually ultimately brings down the cost of capital because again not everyone's clamoring for that spare dollar right at this moment um and i think that will lead to a lower cost of capital overall um and you know that might that might well help

1:00:02Rich McDonald: bond bond yields as well there's something like an nvidia not collapse on that though because you don't have the same capex spending in the next year or two if it's elongated so nvidia's order but just disappears. Well, it's not going to disappear, is it? To be fair, it may not grow at anywhere that are at the same pace. But they've still already told you they've got orders out to 2029, as do most of the major memory providers and all the rest of it. And the market's heavily due rate. Yeah, from OpenAI and Anthropic because of the data centers. Yeah, I mean, look, you're not buying NVIDIA on 20 times.

1:00:38You're buying it today. It's down 11 times now. so i you know i i think that to me you've had a decent washout and i would start to be putting money into and i would go like i say the s &p is quite a defensive index relatively to some of the others out there like rather than buying nikai or emerging markets i would have that barbell put a bit into two and a half percent into emerging markets for the sex and violence potentially and five percent in the s &p just to say i've got a foot in in in a big market that the americans will buy first those that's where the americans will buy first and so much so my final question to you suppose is why not nasdaq i like nasdaq but i think that as i said that there's probably you know i want to see maybe a little bit more of this i don't know if i'm if i'm personally buying in my pension i'd be buying nasdaq but we're not trying to as you say we're never trying to shoot the lights out here we're trying to make 10 a year um and we've still got 25 we've got 25 cash and you know short-term gills which is effectively cash so by putting you know effectively about a third of it in just over a third of it in um i think that's a good way to do if this all calms down in the next week or so i'd be starting to say well buy nasdaq or nikai or more emerging markets to get that that extra bang for your buck as it were well there we go um okay so um

1:02:03Rich McDonald: i i'm i'm not sure i want to put i'm not sure i want to put seven and a half percent in i don't think things are as clear as that but i would be more about buying the things that have fallen really badly because the things that have fallen really badly have started to discount some of that bad news rather than things that haven't really moved at all so for example i wouldn't really want to buy any footsie here i wouldn't buy anything like that because actually they're sitting there and if the things bounce those aren't the things that are going to move upwards they're going to just stay as they are so to me it's really em japan nasdaq are the ones that i look at and i and i i'm i'm more tempted to put two and a half percent into nasdaq and buy some more nasdaq but not buy anything else just buy two and a half percent nasdaq and keep some powder dry for if times get a bit tougher but i you know i don't feel the need to put more money in than that at the moment because it's an uncertain environment i'd rather be buying another 10 % in higher up knowing that everything was feeling a lot better than where it is at the moment but i just feel that having taken money out we should put a little bit back in to show that we to to show willing i'm not i'm listening to jp i'm not confident about em um and you know i've i've got you know we've got em and it's it's not trading very well at all so i'm going to take the decision to buy two and a half percent nasdaq and just keep some powder dry but just put a little bit in i'm going to take out a cash because um jp doesn't want me to sell any bonds so i'll i'll i'll stick with those for the moment even though they're virtual cash anyways it doesn't really matter well you don't you don't have any duration do you no and i when i do i have plenty of duration is called tech stocks yeah no sure but in balance i have plenty of duration thank you um so to me i'm going to make a decision that we put two and a half percent into nasdaq out of cash and we watch to see what happens next week i just leave you one little fact which struck me um that is that since the war the s &p 500 has risen 21 times out of 21 times when they've had a midterm election afterwards in the next eight months and it's risen by an average of 16 % every single time so this is why I'm happy to buy this dip or correctional you want to call it well we we we're all in fairness apart from JP we're all saying that give or take around here the market is a level where we should be sticking some money to putting some money to work and so we should definitely do that and i and and i say that about jp maybe he would put a sore amount to work i'm not trying to do you down jp at all i'm just trying to say i think we're all of a more optimistic bent at these price levels but clear clearly it's still a very uncertain environment yeah no look as you should do because you know you've raised cash at the right time you know you've you act incrementally which i think for people watching and listening to the podcast is a really important lesson i mean i know a lot of people think that you know institutional investors you just sort of put it in take it out but but you guys you manage it in a very organic and incremental way and i think that's exactly the right way to proceed thanks jp and if you would leave the fiver on the door yeah it's the doorstep well or or when you leave that would be fine i'll settle for the party inflation yeah okay it's more than that not A bit of inflation.

1:05:33Rich McDonald: Okay, so decision for today, sell 2.5 % cash, buy 2.5 % Nasdaq. Over to you, Rich. Wonderful. Gentlemen, thank you very much, JP. Thanks for joining us yet again. It's been a pleasure as always. Thank you very much for having me. The link for the Good Money Guide is in the show notes there, along with JP's sub-stack as well, if you're interested in hearing more on his expertise for American markets. And, gents, I'll see if I can get back on the flight safe. because I'm off to New York. So this is the world tour at the moment. We'll see you live from New York next week. Cheers, Rich. Brave travels, Rich.