Transcription
All right, let's get into our conversation with Tom Lee, co-founder, management partner, and head of research at Fundstrat Global Advisors. Tom, thank you for joining us.
Great to see you, and merry Christmas.
All right, let's get right into it. You've been vocal that investors are still underestimating how strong 2026 can be. What's why are you so bullish on '26?
I think the economy and stocks have been suppressed for the past few years. Part of it is, of course, that we've seen six, what I call, extinction events take place in markets. Everything from COVID to the supply chain effect as the economy restarted, to that the fastest inflation cycle in history, and then followed by the fastest Fed hikes in history. And then we've, of course, had a very controversial administration which put tariffs in place in April of this year that caused a miniature bear market. And then we've even had the US bombing Iran's nuclear facilities. I think all of these collectively have made investors very nervous about, uh, what I call investing in full risk, because these are what, six black swans that happened in four years. And I think on top of that, we've had a Fed that has not really given a green light about monetary easing. And I think the Fed's reluctance has actually suppressed business, quote, animal spirits, because the ISM has been below 50 for more than three years now. So I think that's all been a business cycle that has been pretty good, but not one that has been really expansionary. And I think that starts to happen next year.
It feels as if the market has become so concentrated or dependent or circling around a small number of stocks that to be bullish on '26 sort of mandates that you're well, tell me if you think this is true, indicates that you're bullish on the Magnificent 10 and AI stocks. Is that necessarily true? And are you bullish on the Magnificent 10?
Yeah, I mean, I think 2026 is going to look a lot like this year. Uh, meaning we are probably going to have many months where the market is, uh, actually down year to date. You know, I mean, this year we were down double digits at one point before the market recovered. I think that plays out next year, but for the reason I previously stated, I think that we end up a bullish outcome despite all the skepticism. And it does require large-cap tech and AI stocks to still produce earnings growth and not have a lot of PE reduction, so that you still get positive return. But I think the rest of the stock market, sort of the other 490 or so, can actually perform well because if the Fed is cutting and interest rates are coming down and the business cycle is sort of really starting, that's good for other stocks.
As you say, we've seen a lot of these black swan events, things that you would think would freak the markets out and make people worried. And yet I look at what has happened in the markets and my view of it is, it's not necessarily that it's, uh, suppressing sentiment. To me, it almost looks like the market is deciding to shrug everything off. So when you describe how, you know, perhaps these black swan events have made investors perhaps have less, lower risk appetite, to me, I'm almost kind of taking the other side of that in my head. Like it seems as if these things happen, these things that are concerning. One example would be what we're seeing with these AI circular deals. And it seems to me that the market is kind of swatting it away, shrugging it off, and the market continues to climb. And that's what we've seen this year, and we saw the previous year, and we saw the year before that. We continue to have this bull market despite what many would say are, are really, uh, concerning events. So, how would you think about that? How would you respond to my concerns there?
You're almost kind of mirroring what we're observing, but just with a different take. I mean, our take is markets climb a wall of worry. You know, historically, uh, when there's a lot of skepticism, um, stocks can rise. In fact, you know, markets actually peak on good news. You know, they don't peak when people are bearish. Markets peak when everyone's bullish and it no longer responds to good news, just like markets bottom on bad news. And, uh, I think many people are skeptical, but stocks have risen. It doesn't really mean markets are shrugging off the concerns. That's one way to interpret it. My other interpretation is, you know, it is like, maybe we're just talking about the same sides, just of the same thing. And, uh, but, you know, like if someone asked me, are we, is it worrisome? You know, I was a technology analyst in the '90s. So I covered wireless stocks starting in '93 and I witnessed the bubble that was created, you know, a decade in the making, really two decades in the making. And by '99, um, not only were there no skepticism, there was, uh, you know, excessive entitlement. Investors were expecting stocks to do explosively, and, you know, a 20% upside wasn't satisfactory, and valuations were already elevated and expanding. So, I'd say that if I was trying to compare this to the bubble of the '90s and, you know, and wireless was a central cast character in that internet infrastructure build, uh, where I don't really see the echoes of that today.
I think it's so interesting what you say there about, you know, we're looking at the same things and we're drawing slightly different conclusions about what that means for markets. Um, and we had a similar conversation with, actually, um, I mean, you were the chief equity strategist at JP Morgan. We spoke with their head of investment strategy, Michael Semblast, and we were talking about a lot of these issues and where he ultimately landed was he was quite bearish, or bearish. Um, and I just want to play you what he said and get your reaction. See what you think.
It would be kind of shocking if you didn't have some kind of profit-taking correction in 2026 at some point on the order of 10 to 15%. It would be, I'd be, I'd be really surprised not to see that. So that's his base case is some sort of correction, 10 to 15%. Look at your 2026 outlook. You've got an S&P price target of 7,700. We're at 6850. So that would imply, you know, a little over 10% um, rise next year. So two very different um, views. Where, where do you land compared to his view? What do you think he might be overlooking and, and where do you differ? Do you think?
Our outlook actually does call for a drawdown um next year. So very similar to this year, of probably closer to 20%. So I think we are going to have another miniature bear market next year, but then we're going to recover. I mean, let's take 2025. Let's say that at the end of last, at the end of 2024, and actually we did talk about, you know, the idea of a drawdown in 2025. But let's say that someone plays the clip. So let's say it's Michael Semblast, but you don't, let's just pretend he's saying at the end of 2024 and he says the market will be down 10 to 15%. That doesn't rule out where we are by the end of 2025 because, in fact, we did have a drawdown. And I think I'm, again, not saying I actually think Michael and I are pretty aligned in the sense that I think there is going to be a drawdown next year. He says he wouldn't be surprised, but to me, it doesn't mean that's the end of the actual bull market. And in fact, I think stocks fully recover.
So the, the wall of worry here that we're talking about, and that you outline in your outlook, um, you've got several elements in there. You've got, um, and these are the things that you describe as people are worried about, investors are worried about. So politically divided nations, social unrest, Supreme Court overturns, tariffs, new Fed chair. And then you have two ones here that I really agree with, that I feel like I'd love to have you dive in on: AI valuations, which I think a lot of people are concerned about, and then also 20% equity returns in the past three years, i.e., each year for the past three years, the stock market has risen by an average of 20%. Which may imply maybe we're running out of steam at some point. Could you just unpack what your concerns are in that wall of worry? Um, and do you think those would be the trigger of such a correction?
Let's start with the one that you just mentioned. The stock market, you know, it, we're up 16%. So, I think if we rally three percentage points, we'll be three years of 20% gains back to back. Um, and it's actually more common than we realize. Um, in fact, when we look at the last 65 years, you know, it's happened in 20 different, I think it's happened 20 times in different countries, um, and multiple times in the US. I'm sorry, 12 times. It means a lot of good news is priced in. I mean, of course, you know, stocks being up 20% a year, three years in a row, it's definitely pricing in a lot of good news. So to me, I do think that we have to consolidate those gains, and that's why I think a drawdown next year makes perfect sense to me. But, uh, because there isn't a lot of leverage in the economy, you know, the household sector has not really borrowed money. It's been expensive to borrow money, and even margin debt, it's risen, but it hasn't risen parabolically. So, it's actually essentially tracked S&P gains. Um, so that's it's not like people are borrowing faster than the market's been going up, especially if you look at a five-year, um, CAGR. So, I would be in the camp that as long as the economy is holding up, that drawdown is going to be viewed as a buying opportunity.
Now, on AI valuations, it makes perfect sense for someone to say a lot of the valuations for AI are probably absurd, because this is the nature of, like, of an exponential sector, right? If we look at an industry that could grow parabolically for 10 years, all of the future value is in the latter half of those years, right? So it's, and then we're trying to discount that back to today. And so stocks are going to look absurdly expensive. And more importantly, investors make a common mistake, which is that they assume that the existing universe of companies are going to be the central cast characters over the next 10 years, which is not the case. So the reason valuations don't make sense today is that one, of all the AI stocks, I'd say it's probably safe to say only 10% are going to be good investments. Maybe it's even generous, maybe 5%. And of course, um, there's going to be a new emergence set of new players, and in fact, the economic model might change. But it doesn't mean it's a bad investment. And we've highlighted this as generational trades in past reports. For instance, like if you look at the internet, um, if you bought the internet basket in '99, okay, so you bought it near the peak, and you held it to today, you actually still outperformed the S&P 500, even though 99% of the stocks went to zero. So it wasn't, it was a bad investment if you tried to pick a winner, but it wasn't so bad if you held it as a basket. So I think AI, it's probably going to be fair to say 90% of the stocks are going to do way worse than people expected. They were too optimistic. But I think as a basket, it's probably going to outperform.
That all makes sense to me. I'm with you. But it seems to be a little bit more nerve-wracking when we realize that a lot of the AI companies are the largest companies in the world. It's the big tech companies. I mean, I think Google is an AI company at this point, or an AI stock. Meta, Nvidia. I mean, these are the largest, most valuable companies in the world. Um, and the market really depends on their performance. So when I think about the idea that, you know, many of these companies and the expectations that have been pinned to the AI cycle, the fact that that could affect some of the largest, most valuable companies in the world, where we're seeing the highest concentrations in those small companies, the higher concentration than we've ever seen, uh, in history. To me, that makes it scarier what you just said. So I guess my question is, do those companies, do the big tech companies, the Magnificent 7, do they count in your analysis of AI valuations being too high and the possibility that perhaps we might lose out or that that the value won't actually show up for many of these companies?
I might even just add to your concern because there's, because there's a lot of capex here too. So these are, you know, a lot of the Mag 7 used to be asset-light businesses. You know, they, the remarkable, uh, equity, these are rent-seeking models. The fact that they could create growth with very little spending. I mean, R&D spending was there, but really capex was not there. But today, as you know, uh, AI is extremely capital-intensive and it's energy-intensive. And it's only justifiable if it's replacing real work somewhere else. Then you can justify, because now it's creating assets to replace future opex. You know, I'm going to give you a spin about what's happening that is not disagreeing with what you're saying, but it's probably observing a change in the reality. Okay, which is tech companies are becoming a bigger part of our life. Um, so naturally, they're going to have a larger share of spending. Uh, by the way, we wrote about that um in 2018, that in, if you go back to 1930 and you just use simple demography, okay, population tables, whenever the population growth rate grows faster than the prime age workforce, which means you have compounded labor deficit, you've always had a technology cycle. That is 1948-67. In 1991 to '99. In both of those periods, the population growth rate was growing fast, which is demand, faster than worker supply. And we entered the third epic or era of labor shortage, which started in 2018 and it's going to last to 2035. So then technology spend is a necessity because you don't have as much labor available. So there's going to be less wage spend.
Yeah.
Now, if I substituted the word and called this, um, instead of the word banks, tech companies, I called them financial institutions, we would not be saying there's a financial institution bubble because for every level, for every unit of GDP growth, there's a unit of financial spend. I mean, it's literally the other part of the ledger. And in fact, the financial industry has all circular spending. I mean, think about this. Real estate is valued as a separate asset, but every company needs real estate just to run a business. So why are we valuing real estate like in a GDP sense? Real estate should be an interim product, not a final product. Um, so I think tech is becoming so central to the economy, especially because of labor shortage, that we're, when we see tech intensity growing, people are flagging that as a bubble, whereas I'm actually just pointing out it's actually out of economic necessity. But it becomes a bubble if the multiple we're applying to the tech streams don't justify higher fair valuation. I think tech earnings are probably more valuable than Costco, for instance.
Yeah, agreed.
Or Walmart, right? But do you know Walmart trades at 37 times earnings and Costco trades at 50 times? So Nvidia trading at 27. I mean, is that, is there a bubble in Costco and Walmart? Cuz Nvidia is at 27 times earnings.
100%. And we've looked at that, those Costco valuations. It's crazy. I totally agree. But then I go back to what something that Aswath Damodaran said when he joined us on the podcast, and he said he can't see value anywhere. He thinks everything is overvalued when he looks at the stock market. So that's the other side. And I, as Scott and I have discussed, you know, we're not necessarily in agreement with him on all of that. Um, but that I think becomes a concern. And then to the, to the circular deal-making and the capex point, I think the concern, unlike the financial institutions, is like the, we haven't seen the AI product prove itself yet in terms of its ability, um, to provide the value that we're pricing in, I guess, is the, is the problem. We haven't seen that these data centers, one, I mean, are even going to be necessary to keep the workforce and the labor market going, as you say, to keep our economy growing at a fast clip. Therefore, it seems that we're making giant, giant predictions with not that much evidence, which, you know, we could call it a bubble, or we could just call it what I said, which is we don't really know what's happening, and yet we're spending tons of money. And so, if there becomes a moment where suddenly everyone says, wasn't what we thought it was, then that could be quite damaging to portfolios.
Yeah, 100% agree. Because, by the way, anything that is relying on future growth, none of us is an expert on the future. I mean, that's right. Like that, there's many roads to the future. Um, one thing I just want to point out, Benjamin Graham's book, The Intelligent Investor, which I did read, I don't know if you remembered his rule of thumb about what a proper PE is.
No, please.
It's 12 times plus two times the growth rate. That is in his book. I'm just saying when I, when someone says they're a value investor and they're saying stocks are expensive, I know they didn't read his book, because I read the book.
I love that.
But, you know, as you know, that's because he didn't believe things could grow 10% a year. You know, that's the real, like 10% is a lot of growth, um, back then.
Yeah. That was a pre-digital economy.
The second point I would make is when I did wireless in the '90s, okay, now I was in my 20s. Um, I was a senior analyst at the age of 23. So I was really lucky to be very young and actually a senior equity analyst. But when I was covering wireless, the industry only had 34 million cell phones in 1993. And the industry, telecom services, was dominated by long distance and local telephone, these things called the Bell operating companies. And they made all their money from two businesses. The Bells made the biggest profit maker for the telephone companies was the directory business, and number two was local business telephone. They made more money selling local exchange service to Chase than they did from any other business. So when wireless was happening in the '90s, as me in my 20s, my imagination was ignited, and you know, I talked about how, you know, you could do so many more things with cell phones, and we joked about how it would have changed the path of, like, the Revolutionary War, right, if Paul Revere had a cell phone. Um, but most of the money managers were in their 40s and 50s, and all the experts were in the 40s and 50s, and they mostly thought cell phones was an expensive yuppie toy. They said the economics didn't make sense. You could never fit that much traffic on cellular waves, and all the money was in long distance and local. So the telephone companies and the long-distance providers, including MCI, would do everything to protect their existing businesses and use regulatory, uh, strengths to make sure cellular never really grew. Now, look back, that was, of course, the wrong bet. And remember, cellular companies had to build, they had to spend $50 per pop to build out a cellular system. So if you took any city of 10 million people, you had to spend $50 per person just to build a basic system. It was enormously expensive, and cell phone penetration was 6%. You had to make a bet that you would have a lot of penetration. Uh, I think that I'm seeing people make the same arguments against AI. And I think one of the things we have to say is, which lens are you using? If you're using it through the lens of a 40-year-old really wealthy person, no new technology looks interesting to you because you're more interested in protecting your wealth and incumbency. But young people are the ones who change the world. Look at Chase Institute. Credit card spending growth only comes from people under age 50. And what are young people doing with AI? I mean, my daughter is, one of my daughters is in college, my youngest. They have adapted to OpenAI and ChatGPT in a way that I can't even fathom. And so those people represent the future vintage of AI adoption. Just like cellular adoption in the '90s, it was 70% of 20-year-olds had a cell phone, and it was like 5% of 60-year-olds. So of course, all my clients who were in their 50s and 60s said, you know, who needs a cell phone? They didn't realize that those 20-year-olds become 60, and that 70 became 90, and soon everybody had a cell phone. So I think we have to be more, we have to think about how the 14-year-olds using these models compared to us, because we're already, you know, we've already lived our lives and we've established our regimes and our. So it doesn't mean that AI stocks are correctly valued. I'm just saying we have to really understand that the future change is coming from young people.
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We're back with Profy Markets.
You said something, Tom, that really stuck out to me. He said that we went, we're in this labor shortage cycle from 2018 that will last through 2035. And I, I just, you can't avoid the catastrophizing around the destruction in the labor force from AI. Do you still believe we're going to be in a cycle of labor shortage even with AI? I vacillate because there's times where I'm, I like when I read a book like The Coming Wave, I panic and I realize like, wow, like we, we need to re-educate society. Um, but one thing that gives me hope is that we did at Fundstrat study another technological wave that wiped out at least 20% of the labor force, um, in the 20th century, which was frozen foods. So, what many people don't realize is that when Charles Birdseye created flash frozen, which, by the way, was a venture backed by Goldman Sachs, it was a VC-backed um company.
I love this.
And by the way, his name is Birdseye because he was an ornithologist. He actually was studying birds. Um, but he found that the Inuit tribe in Alaska had kept their fish super fresh because they were putting it in a frozen saltwater solution that flash froze the fish. If we look at the labor tables from the '20s, 40% of the US labor force was employed on farms. It was literally, we spent most of the economy was people working on farms, and most of the service sector that was defined back then were household servants, people working for someone else. Food was over 25% of the wallet prior to frozen foods being, uh, widely, you know, mass market, because most spoiled on the way to the supply chain, and so grocery aisles were mostly fresh, and what they, what was frozen back then had freezer burn. It was terrible. So, um, flash frozen allowed, suddenly the cost of food to drop dramatically because you had less spoilage, and the number of people working on a farm today is down to what, 2% of the US workforce. So flash frozen was the really the key innovation that brought down the cost of food from 20% of the wallet to what is it, five or 6% today, and reducing farming labor from more than, I think it was 40% of the peak down to two. An economist in 1920, okay, let's just pretend on CNBC in 1920, there is none, but let's say there was a CNBC in 1920, and these economists were saying, frozen food, if it comes along and it, it's going to wipe out 95% of all farmers, this is going to wipe out the US economy, the US economy can't survive, uh, frozen food. And instead, it freed up time, right? And it created, it allowed people to be repurposed, and it created a completely new labor force. So, I, so Scott, to your point, I think that there is an adverse outcome, but then when I look at past episodes of huge labor disruption, it's actually had positive outcomes.
Every technology thus far, it's followed the cycle you're talking about. Some short-term destruction at labor, and then profits and innovation get reinvested, and we reinvent ourselves. But I want to, we're about the same age, Tom. I want to walk down memory lane in the '90s. I think you were, you were a telco analyst with Kemper and then Solomon. Is that right?
Yeah, that's right. And I was raising money for internet companies, that, the internet company that started e-commerce companies in the '90s. And I can't help but this smells a lot like Teen Spirit. I feel like I've been to this movie, and I have this certain muscle memory. And I might be wrong, but I'm curious if you would, if you think my timeline lines up with your, where you think we are. And that is, the economist perfectly called the dot-com bomb. They said how it would happen, how it would unwind. They were exactly right. But they called it in '97, and the NASDAQ doubled between '97 and '99. And what you said also that really struck was that the market seems to be climbing a wall of worry. And that is, in '97 and '98, we were just very anxious. These things are overvalued. There's no way we can sustain this. And the markets kept going up. And then in '99, we had this, this zeitgeist where all the short sellers, all the long hedge, all the hedge funds, I mean, Julian Robertson just like threw in the towel and gave up and said, I can't predict this market. And then there were all these articles, I remember one specifically in the Wall Street Journal saying, maybe we have moved to a new economic model that the internet has ushered in, and we should be thinking about things differently. And then, wham, the market crashed. So if I were to look back and try and equate this to the '90s and the internet, you know, the internet timeline, it feels like we're more like '97 to '98. A ton of catastrophizing that might indicate a surge up. My sense is when prices, PE multiples are crazy, which I would argue they are right now, they go insane before they crash. Does this timeline, is that even useful to think about this economic history? And does that timeline, sort of where '97, '98, not '99, uh, line up with what you're thinking?
It does, Scott. We both have experience of 35 years or more, uh, in markets and in technology. And we have to keep in mind that the median tenure of a portfolio manager today managing a fund is nine years. So they've experienced the markets really only since 2015, you know, being generous. So to them, the '90s is only a legend that their bosses talked about or things that they heard, and it's become second and third-hand stories. Now, when I was a wireless analyst, there was so much meat to the stories in the '90s, and like by the, in the '97 period, like real things happening, TDMA adoption, the quality of the customers were good. Um, there was real spending taking place. It wasn't, um, startups paying for everything, you know. But by the late '90s, the customer quality had already essentially exhausted the postpaid world. You had to suddenly go into a prepaid model. And, you know, technology, what we called it, bleeding edge. There was innovation coming, but there wasn't apps and services to support it, like, you know, picture messaging, and, you know, these were still years away. So, uh, I'd say that it, it, there is going to be a moment where, like, we've all gotten so accustomed to stocks going up that we insist that that's the new regime. Like that's what you're talking about in like 2000, right? That's when everyone capitulated. But that's not what I encounter today. Um, you know, when we talk to our institutional investor clients, this is a market that's frustrating to them because they don't really want to be buying, uh, and buying expensive stocks. There's a lot of discipline in place today, and I think that that discipline is the reason markets are climbing a wall of worry, because I think there's, as you know, a lot of cash on the sidelines, sentiment is still really bearish, and a lot of people are claiming that we're at a top. But again, I just, you know, in my experience, you know, people are not bearish at the tops, they're bullish at the tops, and I don't really find that many bullish people.
When people talk about the types of jobs that AI will, quite frankly, destroy, I think they're describing the analysts at Fundstrat. So tell me, what is actually happening on the ground at Fundstrat? How are you using AI, and what, if any, impact is it having or do you think is going to have on your human capital?
Wall Street itself has actually been a victim of technology because, um, you know, first, many investment firms have been using essentially versions of AI systems for a long time, right? They've been investing in quant systems and models, and the sell-side firms have invested in technology to replace labor constantly. I don't think there's been a year in my career on Wall Street that money wasn't being spent to actually reduce the labor intensity of the job. I mean, I remembered when I was at JP Morgan, you know, in the '90s and the early 2000s, trading occupied a huge percentage of the cash equities business real estate. You know, it was a couple floors, and then one day went to electronic systems, and like the number of traders went to like, you know, a tenth of a floor. So I think that's the nature of Wall Street that every job is eventually automated away, and so value capture, uh, is shifting around. In the '90s, when I started, equity research was a back-office job, you know, it wasn't like, cuz I went to Wharton undergrad, I, and I graduated, I wanted to get into research. Firms weren't really actively hiring for research. Research was an apprenticeship industry. You had to like find a job and find an analyst that would hire you and take you in. Of course, research has become a much more important business today as other parts of Wall Street became commoditized. But, you know, when I graduated in the '90s, traders were the highest-paid people, the sales trader. They were like the masters of the universe. And of course, now it's just a, it's just computer code. So I think you're exactly right. In the future, a mediocre research person is not going to be any better than a mediocre OpenAI like or LLM, right? So, uh, Wall Street needs to constantly evolve. I know that at our company, we are using AI at so many levels. It's not just research, and we are using it to ingest data, but it's really the how we manage our data now, and even how we manage our customer service experience. You know, because Fundstrat has 11,000 RAA, um, and family offices plus around 400 hedge fund clients. So we, but the way we manage them and identify their needs, um, we are using AI. So, um, I would say I have not found any of the AI models that have been shown to us and that we've trialed, cuz everybody wants Fundstrat to adopt one of their models, has not been good at stock picking. We actually run three ETFs. Fundstrat Capital has Granny Shots GRNY, GRNJ, which is a small mid-cap version, and GRNI. GRNY has a one-year history, has outperformed the S&P by 800 basis points this year. Um, and it, and none of the AI systems that have been shown to us have actually outperformed our own process for stock picking.
What would you say makes a great researcher and a great analyst? And then I want to get into crypto. Um, so this is one of my final AI questions, but when you talk about AI is going to replace the analyst, um, what are the kinds of skills that makes you irreplaceable as an analyst? What kinds of things should, uh, white-collar workers, working professionals in general, be trying to work on and be trying to hone in order to not be replaced by AI?
AI is very good at looking at the past. So if you need to build a model, you need to recall data, even say, give me the last 12 times something happened. That is AI. But as you know, to do true training, then you need to have it work in the future. Now, the future has not a binomial outcome, it's multiple forward scenarios, and the probabilities are unknown of each future event. Okay? So you're dealing with so much uncertainty that I don't know how a probabilistic way to give you a single point answer would ever work. I mean, to give me an example, someone will say, this is the fair value of a stock, and they say this is the PE and this is the E. And I, I can never understand that because I'm always wondering which E are you using, and you know, I mean, like, cuz price is today, but then which forward metric, and then how do you discount it? How do you explain to AI that you have to look at 10 years of future earnings, but you don't know which future earnings will actually matter the most, uh, and then how do you assign the weights? I mean, that's really what we do at Fundstrat. We're constantly assessing the probabilities of future events and then deciding, we do have to pick a direction, right? Then we say, this is the path we're going to take, but it's a guess. Um, so I think that the best qualities of a researcher, at least in my opinion, are, uh, you do need to be unemotional, but you also need to know the difference between conviction and being stubborn, because stubborn is riding something when and believing in something when all the facts have changed. Conviction is basically riding through the volatility. And it's not easy to tell the difference until history has already passed. And I think, you know, the third thing that's really important in markets is to know what's already priced in. I don't know if AI is going to really have a good sense for, like, if all, if AI is the only thing managing money in the future, I think a human will beat the market because all the AI systems will be predictable. You know what I mean? Um, and then you can spoof them all. Um, so that, like, that's really where I think human judgment matters, because, you know, I'm constantly surveying our clients and I'm in constant touch with them. So I, I kind of know where the money is and what the bets are and how they react to the Fed, and I don't know how you can program AI unless it is, well, they'll get very good, but they really have to think not just on a specific outcome, but on a series of future outcomes, and that's what we're always sort of obsessing over.
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Speaking of future outcomes, last month, I want to talk about crypto. Last month you said you think Bitcoin could go as high as $200,000 in January. We're currently at $94,000. Uh, it's been a rough couple of months for Bitcoin and for crypto. Uh, where do you stand on Bitcoin right now? Do you still believe that we could hit $200K in January? Um, what do you make of what's happening in the crypto markets?
Well, crypto's had a rough year. It was actually having a great year until October 10th. Uh, because on October 10th, Bitcoin was up 36% for the year. And now it's currently, I think it's like flat for the year. Um, so it lost a lot of its gains. Uh, I'm still very optimistic. Um, because crypto still has its best years ahead, but crypto should have had a good year this year, and it was on track to until there was a liquidity crisis on October 10th. That was a bigger wipeout in terms of liquidation than any event in history. The most recent one before this would have been 2022 with FTX. And that wipeout pales in comparison to what happened on October 10th. But in 2022, it took eight weeks before crypto, the smoke cleared. The leverage wipeout was enough in the mirror that crypto prices began to recover. This week is the eighth week since that crisis. Um, and I think crypto prices are beginning to actually recover. Uh, that's why I think Bitcoin can double from here by the end of January. Now, many people don't expect it because of the four-year cycle. Um, and that's going to be the big question. If Bitcoin breaks 125 in January, there is no four-year cycle.
What did happen on October 10th? Like, everyone knows crypto markets got hit. It seems unclear to people what actually happened. And as you say, it was one of the largest liquidation events that we've seen in the history of crypto. What happened?
I'm going to give you what, what we've been able to piece together, and I would say that it's like a 90% correct because, you know, there's going to be 10% you don't know if there was something else.
Just to clarify, is the reason we don't know what's happening because of the anonymity of crypto? We don't know who owns which wallets, and so it's harder to track what's actually happening.
Well, it's that and plus, you know, um, you know, if, when we look at liquidation events, like in for, in the stock market, 90% of what someone will explain is probably correct, but 10% like 90% it would be 90% correct, say that the February to April decline was largely due to the Trump tariffs.
Yes.
But the other 10% would be like, well, stocks were already expensive, and they were overdue for a correction. So that's, that's what I mean by 90/10.
So give us your 90%. What do you think happened?
On October 10th, there were two things that happened. One was a triggering event, which was Trump announced, you know, a re-escalation of tariffs with China, like a tripling of proposed tariffs. And, um, because markets were closed historically, uh, crypto is what reflects reaction to a macro event. Uh, when you're already aftermarket hours, like if the S&P was open, it probably wouldn't have been got punched as hard, but crypto prices fell. Now, crypto prices falling, the system can handle that, because, you know, crypto is hypervolatile by nature, so large swings in prices shouldn't really overload the system, and even volume shouldn't overload the system because crypto trades, uh, you know, there's so much automated trading. However, there was an algorithm in place that actually, what I call, a glitch happened on a on a specific exchange. Okay. Um, many people use leverage in crypto. I mean, it attracts leverage trading, but people put up collateral so they can do leverage trading. One of the collaterals is stablecoins. Okay. And stablecoins are a pretty safe collateral because, hey, if it's Tether, it trades at a dollar. Uh, it's pretty safe collateral. And so you can borrow a lot against safe collateral. And if it was USDC Circle, that's also a really stable coin because it's, uh, backed by dollars. However, a, there was a popular stablecoin called USDA. It was an algorithmic stablecoin. Okay.
Okay.
And on one particular exchange, because of the shock of Friday, internal prices, like people's bid-ask of that stablecoin actually got out of whack. Suddenly the price went to 65, even though it's supposed to be essentially worth a dollar. So, but within one exchange, that the quoted price dropped to 65. Well, that meant that all the collateral for every account that used that particular stablecoin to borrow money was now in deficit. Okay? Even if it was just one dollar that traded at that price, it was already putting every single piece of collateral at risk, into deficit. So then something called ADL was triggered, automatic deleveraging. And so in one exchange, everybody who had who had used that stablecoin as collateral basically got wiped, their accounts liquidated. Well, what were those accounts long? They were long altcoins and all these different cryptos that suddenly got dumped onto spot exchanges. So then on all these other exchanges, suddenly some altcoins suddenly went down 99% because there was a lot of selling from ADL, but it triggered a domino effect of all these other exchanges triggering other ADLs because spot prices of all these alts dropped. So, that to me was a glitch because it was like an illiquid quote that didn't represent a true VWAP triggered an ADL that triggered a cascade of ADLs, and that led to millions of accounts being literally zeroed out. Um, it won't happen again, I'm sure, because in the future, I'm sure they will use a composite set of prices and or if there's a variance between what's quoted internally versus on spot, or if it's a volume-based measure. So that's why I don't think it would happen again. But that's what happened on October 10th.
Okay, we finally got our answer. I've asked this question to many people and I never get a proper answer. My takeaways from that are that, you know, it seems vulnerable, this asset class that is, you know, is supposed to be a hedge in a lot of ways. We are learning, in various ways, is extremely vulnerable to what seems to be almost nonsensical mechanical glitches. Which, I guess, that is my takeaway.
In 2020, the price of oil went negative, right? I mean, oil is the most liquid commodity in the world, and it traded at a negative price. So these glitches happen in all markets. But it does happen in crypto because it's a, it's a gigantic place where people are trying to experiment and create, you know, what they view as free from censorship and interference. But of course, every event's going to bring something new. And you're 100% right. It, you know, it's terrible that it happened. Um, but again, I remembered oil was negative, you know, and people actually were able to buy negative oil. They were paid to like take oil.
I guess I'll wait for a negative stock price.
I'd love the opportunity to get. Yeah. Negative stock. Remember, remember bonds? Corporate bonds had a negative yield in Europe. You were actually paid to own, like an issuer was paid to issue a bond.
Can you identify any sectors or geographies that you think are dramatically over or undervalued right now?
Undervalued, uh, I think is small caps because there is real earnings growth now coming, but there is no money flows. So small caps are a whole group that professional investors can afford to ignore because no one else is buying them. You know, the amount of active money in small caps is like at record lows. Uh, I think financials are also dramatically undervalued, Scott, because, well, this is where we could be wrong, but in my view, I think the financial sector is actually becoming a tech sector. That as money is becoming more digital, and as AI implementations are heavily, heavily taking place in financial services, it's going to make companies, it's creating an advantage for the companies, the companies who issue capital, and in, and companies like JP Morgan, probably, as we just discussed earlier, could really dramatically reduce their dependence on humans, which is their largest expense. So I think financial companies are increasingly going to look like tech companies, and their multiples may become more like tech multiples. So that, to me, is one group that in the future could have a 30 PE, even though they used to trade at 10 times earnings.
We've been talking with a lot of different people in the markets. We've been talking with renowned professors, investment strategists, economists. We talk with a lot of people. Um, most of them are somewhat bearish right now. You are one of the only real bulls that we've talked with. I've seen you described online as a permabull. That was what Bloomberg called you. What do you think about that label? Um, and how, how is it that you are bullish right now, uh, in a sea of bears? And what do you think that says about who you are?
I was first called a permabull in 2009. Um, and in fact, it was major newspapers that were using it as a mocking term. Here's what's interesting. 16 years later, what was the right call to be? The optimists have won. And yet today, if I had to say what proportion of investors are bullish versus bearish, it's really risen in the last year. In fact, it's kind of close to the 2009 levels. I think people are already betting on the fact that we're in a bear market. Um, and now many people were convinced of that in 2022 because of the Fed hikes, and they just never changed their views three years later. Um, but as you know, what made people a lot more bearish is also because President Trump is a very unpopular president. He's a very divisive figure. I'm a registered independent, so I have never tried to let politics be involved in how I view markets, but, uh, it's, I can't help notice that I think that political lens plays into many of our clients' views around markets. They tend to view, when Biden was president, there were a lot of people who are critical of Biden. I thought the economy, I cared, I've cared about the economy. I thought the economy was fine. I think the economy is still doing fine under Trump. So that's kept me, I use that as one level of coding that I think has kept people bearish. Uh, but, you know, I think America is, as long as it's a place of innovation, and we are, because we're at the center of AI, I think it's pretty bullish. But, but you guys have raised the key point. I mean, there's a chance that this AI is a disaster for labor markets, and if it is, the US will be the least scathed, but everyone's going to go down.
Tonley is the co-founder, management partner, and head of research at Fundstrat Global Advisors, a leading independent research firm. He has more than 25 years of experience in equity research and has been top-ranked by Institutional Investor every year since 1998. Prior to co-founding Fundstrat, he served as JP Morgan's chief equity strategist from 2007 to 2014. Tom, I, I wish we could do this for three hours. Maybe next time we will. Uh, really appreciate your time. Thank you.
Thanks, Tom. Good to see you.
Yeah, next time.