Can AI Keep Driving the Stock Market Higher? Callie Cox Explains (EP.220)

0:28We all need to make smart decisions with our money. artificial intelligence, and its outsized impact on big tech and the stock market as a whole. Investors have poured enormous expectations into AI, even as the broader economy shows signs of slowing. And that creates a fascinating tension between dreaming about the future and dealing with the reality on the ground. To help us unpack this, I'm joined by Callie Cox, Chief Market Strategist at Ritholtz Wealth Management and author of the excellent substack, Optimist to Callie. Callie's been writing some of the sharpest analysis on technology, AI, and market psychology.

1:05And this conversation actually builds on some threads we first touched on together back in episode 136. So in this episode, we're going to explore why the stock market isn't the economy, whether tech earnings can keep carrying the market forward, the risks of overconcentration in the Magnificent Seven, and what history can teach us about once dominant companies like a General Electric or like those of today. We'll also talk about where the real winners of AI might emerge and how investors should balance the story versus evidence. And lastly, we're going to consider what signs would show us that AI's impact is in fact real.

1:41As you can tell, it's a very thoughtful, wide-ranging discussion that I really think you'll enjoy. I don't want to delay too much longer, but I do want to remind you that I have a new book coming out next year called The Perfect Portfolio. You can go to The Perfect portfolio book.com. And there you can sign up for exclusive access to early excerpts, to subscriber only webinars, to some giveaways around the launch time. Lots of good stuff. The feedback of that list has been incredible. So I hope that you will go there and join me on this journey. But without further ado, let's get into my conversation with Callie Cox.

2:20Welcome to the Long-Term Investor. Today, we have back with us Callie Cox, Chief Market Strategist at Ritholtz Wealth Management and author of one of my favorite sub-stacks, Optimist to Callie. I mean, truly Wall Street quality research for the everyday investor. Callie, thank you so much for joining me here today. Yeah, thanks for having me on. I know we're going to have an interesting conversation. Lots to talk about. Well, for people who are longtime listeners of the show, if they listened to your interview with me, episode 136, we hit on a topic that I really wanted to dig into. And I think I even said something in the episode that had to do with big tech.

2:57And before we get there, let's build up a little bit. You've been writing quite a bit on technology and AI, and recently you've written that investors are all in on AI, even though the economic backdrop looks uncertain or shaky. What do you think Wall Street is doing? And have they become too dependent on AI to carry the market forward? Well, first of all, I just want to shout you out because at the very end of that last episode, you said we should do a longer episode on tech. And you kept your promise, even if you're a year and a half later. So good memory. Yes. I can tell listeners truly, I actually wrote something down after that that I'm going to read at some point during the episode.

3:36So do stay tuned to this whole episode. we're going to get into stuff that we started to just scratch the surface of, but you've written on a number of times at this point. Yeah. And to answer your question, I find this dichotomy so interesting because it really tells a story of why the stock market is not the economy. So the stock market, of course, is built on reality plus expectations. It's okay to dream a little bit because you're thinking about where the economy is going, where corporate profits are going. And if you're tuned into the AI story, I mean, number one, I think it's hard to make the argument against AI being a compelling technology.

4:11We're three years into this thing. We're finally seeing some adoption. And there's a lot of talk about what could be with AI. That's really exciting. And that's being priced into the stock market. That's being priced into these bigger tech companies, the hyperscalers, the Amazons, the Googles, the metas of the world. But at the same time, you look at an economic backdrop that shows slowing growth, higher inflation, partially fueled by tariffs, partially probably fueled by some more idiosyncratic stories underneath. And it provides this gap that Wall Street has been trying to explain that's partially natural because the economy is the economy.

4:49It's the value we create. It's a pretty hard black and white analysis of what's going on. And then you have the stock market that's building in such high expectations for this freight train of a technology. And the question is, when does one affect the other? Or I would say, when does the economy affect the stock market? And how does that bleed into the AI story and how these companies think about investing in this big technology? Well, and you mentioned the AI story. Is it all psychology and storytelling? Or are you seeing fundamentals driving some of these gains as well? You're definitely seeing fundamentals drive part of these gains.

5:29The percent of them, the share of them is really hard to quantify. But even if you look at GDP numbers, which are as hard and black and white and final as you get in the economy, you can see that there's a lot of spending going on among businesses, on data centers, on computing equipment, other indications that companies are investing in AI. I think the number was$1.4 trillion last quarter, which seems like a lot, by the way. It's nothing peanuts compared to consumer spending, which is most of the economy at$16 trillion. But even there, you're starting to hear the narrative of AI driving the economy, or at least AI investments driving the economy, which I don't think is quite true.

6:08I think that that's a bit of a stretch, but we are seeing it in the data. And the hope is, if this story is true, that the interest in AI and the spending on AI should continue. And right out the gate, you mentioned the stock market is not the economy. And something that I often find myself repeating for listeners is that when you look at stock market returns, it's usually some mix of change in earnings, cash paid to shareholders, whether that's dividends or buyback and changes in valuation. And people, when they're feeling confident, will bid up prices despite some weak signals. And I think you've done a really nice job capturing some of what the narratives are behind that, as well as the fundamentals.

6:48But the long term, earnings are what really dictate the direction of prices. S &P 500 earnings growth today, pretty heavily concentrated in tech. I believe semiconductors leading the charge there as well. I mean, how sustainable is it in your mind for one sector or really like one theme to carry so much of the market's earning growth? Well, when I say the stock market isn't the economy, I almost want to bite my tongue because that depends on your time frame. Day by day, the stock market is not the economy. Over weeks, over months, you could even argue that the stock market isn't the economy because that's where those expectations show up in prices.

7:23But over a long, long timeframes, and I know I'm talking on the Long Term Investor Podcast, so there are probably listeners with these longer timeframes. The stock market really does follow the economy more to a T. But when you talk to clients, a lot of them are thinking on a month to maybe year at max timeframe, even though they are investing for years and decades down the road. So that line, the stock market isn't the economy, is something I have to say over and over again, just put like a caveat beside it, an asterisk. But when it comes to earnings growth, typically you want to see all sectors carrying the profit growth that you see.

7:59Obviously, you want a strong economy. You want all cylinders firing at max. That's not what we're seeing right now. Tech is actually a large, large share of corporate America's profitability. And to be fair, this has been the case for about a decade. That share has just grown and grown and grown over time. And what you've seen is tech being a little more economically resilient to the ups and downs. And then other sectors like the retailers of the world, the materials companies of the world, the more industrial companies of the world, ebbing and flowing based on where the economy is. So right now, we're in a situation where tech's profitability is strong, could peter off in the next few quarters, which I'm sure we'll talk about in a few minutes.

8:41But tech's profitability is quite strong, And that's really holding up or masking some obvious weakness in other sectors. So like this quarter, for example, Q2 earnings reports. By the way, Q2 was a chaotic quarter, so asterisk that as well. But looking at S &P earnings, you have a lot of people singing the praises of 10 or 11 % year-over-year growth in earnings in a very chaotic quarter where analysts thought it would be around 2 % to 3%. I mean, that's a huge beat. But about half of that share above 2 % to 3%, that 7 % to 8 % point gap, is tech. It's just tech. So the rest of corporate America is doing better than expected, but it's not blowing growth expectations out of the water.

9:25And then when you look on a sector-by-sector level, you see some worrying stories that are more tariff-related, are more margin-related. You see it in retailers. We saw it in fast casual restaurants. Home Depot reported today and missed earnings for the second time in years. So it's hard to have a foundation that's only driven on one sector. And what you see over history is maybe one sector working better than the others, but eventually caving to the weakness of the others once we hit those economic crises. Yeah. And it feels like ever since the pandemic, what we would expect to happen in an economics textbook hasn't really applied.

10:08Well, I'm saying the pandemic. And what I guess I really mean is 2022. You had these kind of pockets of weakness and they were like rotating from different areas of the economy. And as a result, different types of companies and their earnings reports and their guidance were getting hit at different times. And today, I think Home Depot is a great call out where we all know the housing market is a standstill and the housing market is often sort of the engine that starts fueling the consumer. And if not for, say, ChatGBT coming to market and the AI boom, I think it's pretty common among our circles, or at least in financial circles, for people to say that AI sort of bailed out the market from what was otherwise looking like a weak situation.

10:50I guess, in your mind, what risks does it pose if AI adoption slows or disappoints versus what people are currently seeing? Well, this goes back to tech driving profitability and driving a lot of the expectations in the stock market. Again, the stock market's not the economy, but I like to think back to this Jim Chano's quote about how it's so easy to dream until reality hits and then investors put a discount on reality. It's so, so true, even though we haven't seen it in a while. We're at a place right now where a lot of investors feel okay dreaming about AI because the story is compelling, companies are spending.

11:28Growth is fine. The economy is slowing, but growth hasn't fallen off a cliff yet. But eventually those frameworks, those textbook theories and textbook fundamentals that we learn about the economy do kick in and they affect investors' ability to dream, to look into the future and hope for better days ahead, which is essentially what's going on with AI. That's really the crux of it. So I wonder when, and I think the bifurcation of the economy and the bifurcation of market fortunes has been really, really hard to follow. It's been one of the biggest question marks in my mind. But when I think about how I see the world, I always go back to consumer spending.

12:07How is the American consumer doing generally? What does the job market look like? Because if Americans are making money, they're spending money and we're the best in the world at spending money. And right now I see some worrying cracks in the job market that make me doubt the ability for consumers to grow their spending as much as they have in past years. And it makes me wonder if we are nearing one of those points where consumer spending could slow so much or the job market could break down so much that that ability to dream could disappear. That's what we saw with the dot-com bubble. First of all, not saying that this is a bubble, Also not making a comparison to the dot-com bubble or not trying to draw clear parallels there.

12:49But we had a compelling technology that turned out to be a world-changing technology for a bunch of different companies, drove a lot of profit growth in the 2010s. But it didn't preclude the market from crashing or it didn't preclude tech stocks from crashing 80 % because investors lost the ability to dream. So that's where we're at right now. And I think it's important to remind people that there are, again, pockets of weakness in the economy that have existed for a while. The housing market, for example. And when you have that, you just have a thinning margin on this base for these AI dreams and hopes that the market is running on.

13:26You know, the ability to dream seems so important. And when you were last on the show in early 2024, with technology driving everything, everyone was so easy or so willingly dreaming on technology and riding the wave. And I think the big shift, not that much has actually changed other than it seems like people are coming around to the idea that, hey, like the core business models of these companies, they haven't really changed much in a decade, even as they're chasing new ideas. So like, is it now becoming a little bit riskier to rely on these old engines for growth? But also, I think you're just seeing a bigger case for or at least a bigger acceptance.

14:07You and I have always believed in diversification. But I think investors, especially individual investors, are now maybe looking around and saying, hey, this maybe can't go on forever. Yeah, I think there's some skepticism there. And I certainly don't want to predict where the AI story is going. I think that that's a fool's errand. Whenever I talk about AI, I feel like I always have to throw a caveat out there that I am not an AI doomer. I think it's a great, great technology that's going to pay dividends for the economy in five to 10 years, most likely. But the path there is what gets really tricky because you haven't seen any company outside of maybe arguably NVIDIA capitalize on this new technology and start to make obvious sales and profits off of it.

14:48So you mentioned big tech and how they're stuck in their old ways. I mean, that's absolutely true. Meta makes a majority of its revenue on ad sales. Google is the same way. I believe about 65 % of Amazon's revenue is based on sales, based on people going on Amazon and buying this pet toy that they don't really need, guilty as charged. But I think people forget that big tech is spending, spending, spending on AI right now, but it's not a core part of their business. And in a way, they're kind of spinning the hamster wheel to see or like throwing spaghetti at the wall to see what sticks. And while that's fine, that's how you innovate over time.

15:25We're not there yet. So you really have to be tempered in how you think about individual companies in this race to adopt AI. And that's where the expectations come in. That's where the dreaming comes in. It's okay to dream. It's just when growth is slowing, when the market feels like it's topping out, then sometimes it's smart to keep diversification in the back of your head and rebalance out of tech, not selling it entirely, but taking some profits, moving them to other more unloved sectors. And I think that's kind of the spot we're in right now when it comes to thinking about portfolios. Now, when we're saying dreaming, typically people assume good dreams.

16:01As I referenced at the beginning of the episode, we had touched on something in our last recording together, and maybe it's more of a bad dream. And just for background, I wrote down some notes when I was doing your show notes back then. And so I pulled those up here that I'm going to read a little of. But for listeners, so I'm 40 years old, a few of my first stock investments, I mean, I was gifted like a share of Nike when I was 12. But it was around like my junior year of high school or senior year of high school where I started investing in individual stocks and in college where I did some more.

16:32And look, I didn't know what I was doing. But General Electric like was the name. And you think about a company that really just started out in electricity. It was their bread and butter is building the turbines, the generators, all the guts of the electrical grid. But then they started doing jet engines. They started doing medical technology, television networks. That's the one that really rings a bell in my mind. They even had their own finance arm. I mean, they basically were a bank during the financial crisis. The sprawl to ultimately move the needle on their core business really caught up with them.

17:04And they were a clear innovator at the time. But over the last two decades, the S &P 500 nearly quintupled, whereas GE's market value was cut in half. The last time we were recording, And I guess even now, you know, it basically split itself into three smaller companies. And when I look at the mag seven today, I'm not much like you are predicting a tech bubble per se. It's just hard for me not to draw those parallels from GE stories because I see Apple's iPhone throwing off huge profits, Google and Meta's ad business, Amazon retail. But they're also all going into TV. They're all going into groceries and health care and all these things that made them a dominant company start getting watered down.

17:45So very long intro into what I want to ask you to chime in on is for someone like a GE, what do you think investors can learn from looking at history of past dominant companies within the stock market? Well, I think you have to remember that this is how companies innovate. Good companies try new things and cut them quickly when they don't work. Of course, that's not as easy as it sounds. It's not as easy as like flipping a lever and shutting a strategy off. But these big tech companies are corporate Frankensteins. And all too often, we see it around us in the world. We see that Amazon owns Whole Foods.

18:19I mean, you can practically buy anything on Amazon, the app and online. Amazon also has Amazon Prime TV. Like you mentioned, they have a whole TV studio where they're actually developing original content out of that. It is hard to really pin Amazon as one specific thing anymore. And that's worked for them up until now. But if you're starting to think of them as Amazon, the AI company, then I think you really have to kind of catch your breath a little bit and think about that statement you're making. And we don't know yet in this AI race if that's a helpful thing or if that's a weight that they have to carry around, like GE that ultimately found that it was too big to innovate and, like you mentioned, suffered in a decade where the S &P did really well.

19:02The other thing I think about is that Amazon and these other big tech companies have their hands in so many cookie jars, and they're trying to manage all at the same time. So if they're focusing a lot on AI, then they might be pulling resources from other profitable parts of the business. That hasn't happened yet. Profitability is still quite strong among big tech companies, but it's a risk you have to think about, especially as AI spending ratchets up into this year and into next year. I mean, the amount of money that they're spending on their AI strategies is insane. So, it's always a good reminder to remember what you're invested in.

19:36These companies that are a third of your portfolio, if you're an S &P index investor, they're kind of going through their own trial and error periods too. And it's hard to know which one comes out the victor in this AI race in the end. Well, and I think one thing that also gets under-discussed is that the companies that use the technology from these tech companies might be the real victors. So if big tech is the one putting in all the research and development, I mean, I even think about my own job, the amount of benefit in time I'm saved from just basic AI tasks that I didn't have two years ago.

20:11It's enormous. And I'm just thinking of how are the other, say, 485 companies in the S &P 500 going to apply this to improve productivity and profits? I mean, how do you think about that sort of thing? And people will come to you and say, I want to make sure I take advantage of the winners of AI. That's usually what I'm thinking. Where's your head at? Yeah. And we get that question a lot, by the way. What we do to answer that question, because first off, I'm not a tech analyst. I can't get nitty gritty into tech companies. I always draw that line when we have client questions around it. But I kind of size and scope the universe for them.

20:49I remind them that AI is this compelling technology, but it exists beyond these big tech companies and these hyperscalers. and these semiconductor companies that we talk about all the time. Data centers are a big point of discussion right now, but they're actually a great example as to how broad the universe can be. Because when you think about data centers, you think about real estate. And usually the purest plays in this data center trade are REITs. But these REITs trade like real estate companies because they are. And people often forget that the broad comms of the world are a big part of the infrastructure when it comes to data centers.

21:24So if you apply some really deep thought to these numerous areas that AI touches in the economy and these numerous benefits and kind of chain reactions that AI can have in the economy, then I think you can come up with some really interesting spaces to invest in. And of course, we never recommend spaces to our clients. We're not that nitty gritty, and I leave that up to the advisors. But it is important to just really expand your mind and understand how big this story is and where the benefactors could be. Because big tech, as you said, may not be the leader. We don't know. And actually, based on history, it's usually one of the younger, more nimble companies that comes up and catches the bigger companies that are spinning their wheels trying to catch this innovation.

22:13Yeah. I think in any period, there's some data that I'll put into the show notes at the long-term investor.com where you see that anytime a company becomes one of the biggest companies in the world, their future returns typically go down. It's just harder to move the needle on size. And part of the reason they became one of the biggest companies is that they outperformed leading up to that moment. I think that when people get worried, I mean, I've found myself all year, the big story being like, think about how it impacts earnings. Think about how it impacts earnings. Because we had people worried about tariffs.

22:45We have geopolitical concerns. I think people get concerned about the concentration in tech or what if AI isn't all it's chalked up to be. But recessions, they're pretty normal. AI falling short of expectations doesn't mean devastation. I mean, it might even help separate the hype from the durable innovation. What are you thinking about in terms of those ideas? Well, concentration in tech poses a lot of risk here. So if you think about the fact that about a third of the S &P is concentrated in the MAG7 names, and many of them are powered by this AI trade, then AI headlines that threaten the MAG7 or on a day-to-day basis kind of question what the MAG7 is doing can hit your portfolio a lot harder than these smaller companies or sectors that typically don't move the needle as much.

23:35And look, it drives me crazy when people say like, oh, you're a long-term investor, ignore the daily moves because we're all human here. If our portfolio is swinging around by two to three percent, thousands of dollars per day, we're going to feel it. We see the headlines. We see the stress in markets. Ultimately, your portfolio success partially hinges on the decisions you make on those stressful days. So I think that there is a lot of risk there. And we saw that, especially with DeepSeek. I feel like that's a common example people bring up. But in January, Nvidia got slaughtered by the headlines around this new Chinese AI tech that was supposed to be super energy efficient and a lot faster and a lot actually more effective in computing out AI results or LLM results than the US LLMs that were already at the forefront of the conversation.

24:24And DeepSeek ultimately ended up being a temporary story. I don't know if it pops back up in the future, but it showed us just how much risk is bundled up in these surprise headlines around the AI story. And again, 10 years down the road, these headlines don't matter, but what they do is they kind of throw your portfolio around in the interim and they challenge you to really have a strategy and really have a good philosophy as you navigate these storms. So it's just something to think about. It's something where I feel like a lot of strategists and experts kind of brush it off and they say, well, the long term matters and that's it.

25:01And it's like, no, like we're all seeing these stock prices whip about and we're all more exposed to them than we've been in the past. So it's definitely something to think about. Yeah, I appreciate that perspective. I mean, sort of like when you look at long term returns and investing looks easy on paper, but it's really difficult to actually live through in the moment. And so much of our species thinking is tied to stories and trying to seek understanding. And a theme you've been touching on a lot seems to be like dreaming versus reality and investing. So maybe I'll just ask directly, how do you feel like long-term investors should balance story and evidence in this moment right now?

25:40Wow, that's such a good question because my analyst brain goes to quantifying that and you can't quantify it. I wouldn't be scared of stories. I wouldn't be PEs all the time. I think looking at the S &P's PE in isolation is a bad way to make judgment calls on markets. Because again, you can't quantify how much dreaming is okay in a moment or how high expectations could be in a moment. That's a really good way to get burned. So don't be scared of expectations. Don't be scared of stories in the stock market. If you reach a certain level of wealth, you could argue that investing in stories isn't a particularly bad idea if it's a small part of your portfolio.