Transcription
Today's number, 104,000. That's how many pounds a sperm whale that washed up on an Nantucket beach this week weighed. Oh gosh. This just everybody sit back and buckle up.
Okay, so I've never had an unplanned pregnancy, uh, Ed, because when my sperm [music] finally reaches the egg, the egg swipes left. My sperm really aren't like swimmers, Ed. They're more like a slow jogger being chased by a lame dog. Um, my sperm are not really swimmers. They're more like uh an old man browsing at a Costco who's looking for gluten-free peanut butter who just had cataract surgery. Like, it's well-intentioned, but it's just not going to reach the goal. [laughter]
>> I could do this all day. I could I By the way, I made up the last one myself. Ed. [laughter] [music] Ed, do you have a nickname for your for your sperm?
>> No, I I I'm not quite there yet. I'm not really going to play ball with you on this one. [laughter]
>> Also, let me give you a little tip. Just just while we're barreling towards cancellation, even Claire looks horrified. It's important and it's fun that every time you orgasm, you yell out the same thing. It's really important. You have to come up with the same thing. This is the part where you go, "What do you yell out, Scott? [laughter]
>> I told you I'm not playing ball with you. >> Ed's got his face in his hands. This is not CM. Joe Kernan.
>> I'm not I'm not going to do you the service of asking the question.
>> Surrender, Dory. That's what I yell out from the Wizard [laughter] of Oz. That's what I yell out. And my other Wizard of Oz references, I I yell out, "I'm melting." [laughter] [snorts] That's why the fans tune in.
>> That's why they tune in. Next up, JP Morgan, chief economist for the last time. [laughter]
>> Uh, how are you, Ed?
>> I'm doing well, Scott. How are you doing?
>> I'm good. I've been in LA the last few days and I'm at the Beverly Hills Hotel.
>> Nice.
>> Where they're charging me $1,800 a night so I can have a construction site above my room.
>> But they they stopped the construction. I mean, just off Mike here, you gave the front desk a call. He asked them to stop hammering and they did it. Pretty baller. Good stuff.
>> Yeah. No, I I carry a lot of weight here. Yeah, it's [laughter] uh they're very scared of me.
>> Number one client. Um, so what what have been the highlights from LA just before we get into this conversation?
>> I had a dinner last night with like a small dinner with eight people and I'm totally name dropping. What the Um, and Larry David. I sat next to Larry David.
>> Wow. How was that?
>> He is literally the same person in real life. It's not a show. It's a camera following around. He showed up. He's like, "Nice to meet you." He's like, "Why do they serve odd derves?" He like goes into a bit. He's like like he's like why would I like I hate Uber. Do you hate Uber? Let me talk about Uber for He's literally I'm like oh my god it's the show. The guy just shows up and starts doing these bits. Uh but he's very funny. He seems pretty nice. His wife is lovely. I don't know. I enjoyed
>> How did you wind up at a dinner with Larry David?
>> I'm what you call right now like an intellectual support animal. And that is all these rich people think it's interesting to have me over for dinner [laughter] and talk about my book. Like so I think there's two or three of these people every year where they're like, "Okay, let's all get together and and also at the dinner was my role model Sam Harris and I always enjoy seeing Sam."
>> So when you get invited as the intellectual support animal, do you feel a pressure to provide the intellectual support?
>> Yeah, that's why you're there.
>> Is that fun? That sounds stressful. Maybe that's why Larry David was doing his bit. He was the comedic support animal.
>> The answer is yes. And I find as I get older. They called me and they were going to invite this fairly famous tech couple and I said, "No, I'm like, I just don't want to I don't want to meet them. I don't want to talk about them. I don't I don't I I find that stuff is increasingly intimidating me and I don't want to I mean, you know what? I'd rather just stay at home and watch Netflix and have some big Filipino man reheat my soup six or seven times and just sort of start peeing in bottles, grow my nails really long. [laughter] Surrender, Dorothy, [laughter] should we should we get to AI and the economy? Ed, [laughter]
>> you want to move on now?
>> Somebody gave me mushroom chocolates over the weekend. Just saying. [laughter] Just saying.
>> Okay, well that explains a lot. All right, let's get to the economy. [laughter]
>> Okay, now that we know what happened in LA this weekend, here is our conversation with Michael Semblas, the chairman of market and investment strategy for JP Morgan Asset [music] and Wealth Management. Michael, thanks for joining us again on Profy Markets. Good to see you. Morning. So, I'm going to dive right into the questions that we have because we've only got you for so long. Um, just some context. So, last [music] week we had Professor Asworth Deodorin on our podcast. He presented what we think is kind of the most bearish position we've ever seen from him. And this is a very level-headed, calm guy. Um, who basically told us that he thinks that everything in the stock market is overvalued. He said there's no place to hide in stocks. And I'm just going to play you a short clip uh that kind of summarizes what he thinks right now.
>> To the extent that there's going to be a correction, there's no place to hide in stocks. I I can't see a way because if the mag 10 go down by 40%. It's not like the industrials are going to hold their value while this happens. The panic that that's going to create is going to ripple through stocks. You're an investor primarily invest in stocks and bonds. My advice is even though historically you might never have invested in non-financial asset categories, this might be a time where you think about, you know, kind of at least moving a portion of your portfolio know bigger chunk than ever into cash or something close to cash or maybe even collectibles, things that I I've never owned collectibles, but you know, for the first time in my investing history, I'm saying maybe I should hold something that is not going to be affecting inflation. goes to 10%, there's a mark in an economic crisis that is cat potentially catastrophic.
>> So, we were very u struck by everything he said in that interview. Um, what do you think, Michael? Is is he right? Are you concerned like he is? What are your reactions?
>> It's hard to react to somebody that doesn't have a long-term track record of this is when I bought, this is when I sold, this is what I bought, this is what I sold. You know, professors are basically running fantasy baseball teams by coming out inter intermittently and telling you what who what their trades are. It's not real money. It's not real life. And so, you know, the purpose of Morning Star and Liipper and a lot of other entities out there is to kind of track the people that actually manage money. How do they do over the long run? Um, and things like that. So, it's it's a little abstract. I a better example might be the cash stockpile that's that's accumulating at Berkshire Hathway is probably a an a much better indicator of of people that are having trouble putting money to work because they can't find any value and certainly it's challenging right now. There's a ton of dry powder in the in private equity and venture that still has to be put to work and so it's a challenging time. um his his premise of I think I heard him say 10% inflation like I'm I'm I'm not prepared to quite buy into a 10% inflation forecast nor am I prepared to buy into the the certainty of a 10% sorry a 40% correction in the MAG 10 or MAG 7. Those stocks have gone up a ton and a passing wind could cause profit taking right um similar to what took place earlier this year with the dollar. Dollar went down 10%. It was at its post financial crisis high. As soon as any asset falls by 10%, Nuriel Rubini and the rest of the people come out of the woodwork and say, "Okay, this is it. This is the big one. Everything's going to go down from here." And then, of course, the dollar's been flat since then. The dollar has been actually flat since our podcast in May. So, the last time I was on this show, you know, I think people have to have some kind of discipline to recognize that when assets are trading at 20 to 25 year highs, they can correct by 10 or 15%. it it doesn't necessarily unfold and unravel into the big 40% corrections that we had in 2009 and then he had in 2001. So it's it sounds I mean we're positioning more defensively than we have but it you know what he's describing there is is a bridge too far. Plus, our normal balanced and conservative portfolios already have 30 to 40% in cash, cash equivalents, gold, very diversified hedge funds, municiples, um, some short duration preferred and things like that. Just to play defense for Asaf, you know, we that clip that we got was the most bearish string of sentences that he he uttered. um otherwise I think if you listen to the full podcast it would sound less hyperbolic perhaps but you know in some he's concerned um but also so is everyone else and right now this this AI bubble more and more people are talking about it more and more people are googling it we're now beginning to see a little bit of a correction in in tech stocks as we speak
>> small
>> uh small [snorts] um the fears of this AI bubble are quite strong or stronger than they have been before. Um what do you make of those fears? Do you think that they are warranted? Um and how are you at JP Morgan uh thinking about it?
>> Something like 75% of all of the revenues, profits, and capital spending since November 2022 have come from 40 AI related stocks. So there's there's there's almost no justification to spend time on anything but this. And I try to be an even keel kind of person, but the meta number threw me. You know, a company announcing that they're spending 65 to 70% of their revenues on capital spending and R&D without even knowing what the destination is that they're going to. As an investor, that doesn't fill me with a lot of good feeling about where we're going to be two years from now. And it was only two years ago that they did this. they reached the same peak of 65% of revenues investing in the metaverse, which obviously hasn't really turned out to be anything. So, um, there's a lot more behind this particular generative AI boom, but the numbers I I put together something, Scott, I think you'd appreciate this that you like this kind of historical context. The tech capital spending in 2025 is equal relative to GDP of the moon landing, the Manhattan project, the interstate highway system, electrification of farming, the tribal bridge, the Minttown tunnel, the Golden Gate Bridge, and the Hoover Dam
>> combined. Yeah.
>> Yeah.
>> There's all these futurists hovering around like bats telling us how all of this is going to magically make some fantastic future. And there are surely bits and pieces of evidence here and there of real productivity gains coming from this. But um this is a this is a scarier version of the ICT revolution of the early 90s. The only silver lining that I latch on to is that whether it's 2001 or the casino buildout, airlines, fiber optics, um the the the the Calpine gas turbine era, all of those capital spending booms were financed with debt. And this one, with the exception of Oracle, is being financed with internally generated cash flow. But that simply means it can go on for longer before it gets unplugged by the debt markets. It doesn't relieve you of the ultimate need for there to be substantial profit generation to remunerate the trillion two of capital that's been spent since November 2022.
>> I want to recognize I'm I'm feeling defensive around my colleague. I've been following ASW for 20 years and he does the work around valuations and there's few people in the alternative investment space or investors that at least in my observation have been more right more often than him and it did rattle us cuz he generally I want to acknowledge your point uh it's easier to sound smart when you're a catastrophist you just sound smarter right and the the best traders the best historians the best politicians have aired on the side of asking themselves what could go fight, you know, and cuz the markets over the medium and long term are up and to the right. So, I want to acknowledge that the I want I want to put forward a thesis and have you respond to it. And that is if you look at every single of the company one of the companies we're talking about, they have all had years where they're down 50 to 70% in that 12-month period. And the thing that's scary now is if a company like Nvidia, which hasn't had one of those years, I don't think, or maybe it did in 2022, if that happens to a company that's now got the market cap [snorts] of the GDP of whatever Germany, that that that might take the entire market down that essentially America has become so fragile because it is now a giant bet on AI. And if open AI which you know I mean 60% of cap 60% of revenues on capex is one thing as far as I can tell open AI is about at you know 30 times 30 times the revenue going into capex. If open AI or some big customers here's the thesis and you you tell me where I got this wrong. Some standard S&P companies PepsiCo Caterpillar PNG announce look AI is great but we are out over our skis. We're not seeing the return we'd hope for. We're scaling back the investment. Open AAI in the secondary market trades way down and then o and then Nvidia is is goes down 60% which would not be unusual. it wouldn't look cheap. And then we have a $3 trillion destruction in the capital markets and we basically overnight have flat markets, GDP growth of zero and the whole market, you know, if these companies sneeze, we're not catching a cold, we're catching pneumonia. Has the thing that worries me the most and I want to get your response is we have inadvertently turned our markets into into a very fragile house of cards. There's the S&P 490 and there's the S&P 10 and right now everything is banking on these 10 companies living up to these extraordinary expectations. Your thoughts?
>> I agree with most of that. Um, one of the data points that was really disturbing is two years ago someone talking about GDP growth would not have mentioned tech capital spending. It would have been a rounding error. Last quarter it was a third of GDP growth and US GDP growth would already be 1% if it weren't for this tech AI buildout. And you know how people get upset when the private sector gets bailed out by the public sector. I would argue this year Generative AI has bailed out the public sector like the you know these the hyperscalers bailed out the Trump administration because without them they'd be staring a 1% GDP growth number in the face
>> and having to explain it which they're in really no position to do. And by the way, I don't think it's a coincidence that uh we we track all of the country product tariff matrix combinations. Um the AI infrastructure about 70 to 90% of those imports are exempt from tariffs right now. So the the those sectors and companies have also done a very good job navigating however one has to these days um Washington in order to get their imports which are critical to their survival exempt from tariffs. So, yeah, I'm I'm nervous about it. Um, again, the the the fact that it's being financed through cash flow means that we don't have quite the same risk of a sudden seize up because, you know, bonds can't be placed. Um, you know, you're not going to have a hung bridge loan that that gets like the broker dealers in trouble and have to go to the Fed's primary dealer credit facility. You're not have something like that. Um, Oracle is really the only one that's financing any material amount of this through debt,
>> my understanding. So, Oracle is is raising a ton of debt and it's it's, you know, capital markets are concerned about this and that and we're seeing that reflected in the stock price is essentially underwater since the um since the the deal with with OpenAI was announced for my understanding though is that the other big hyperscalers are going out and beginning to raise debt. Um, I mean, we just saw a big announcement from Amazon. I think we saw that from Meta a couple weeks ago as well. I don't know the exact numbers, but my understanding is they are going and financing this with a ton of debt. Perhaps not debt that they necessarily have to raise. Perhaps they have the cash surplus to to to finance this, but they are going and raising debt. And it's record amounts of debt that they are raising. Is that wrong?
>> Of the 40 companies I mentioned, there's AI stocks. 30 are technology what you and I would agree are technology companies. Five are capital equipment companies like GE Vernova that make the turbines. And then five are utilities. Let's look at the 30 AI stocks. Something like 25 of them actually have negative net debt to Ebbitar ratios because they have more cash and cash equivalents on their balance sheet than debt. So for the most part, um the debt's not an issue. The Oracle is an exception and is in part a reflection of the fact that or that that Ellison's been buying back stock for 15 years and you know taking taking money out that way. At some point Oracle is going to have to be recapitalized if it's going to be borrowing like this. The Meta deal was interesting and when I explain how I view it, you'll probably say, "Well, that that's even scarier than if it was Meta."
>> I hear it. The meta partnership with Blue Owl that borrowed 27 billion in the investment grade bond markets was an SPV with a strange French name and the debts not consolidated onto Meta's balance sheet. Initially, I was concerned that that was some kind of slight of hand. It's not. It's worse. They basically have walk away rights every four years and a declining residual value guarantee. Blue Owl's holding the bag. So, Blue Owl is at risk. If at any point Meta basically says, you know, this this we're not getting a return on this particular data center complex, we're out. And Blue and the people that have put up the money for Blue Owl are the ones holding the bag. So I think S&P was right to kind of withhold consolidation of that obligation, but it says it says a lot about the underwriting discipline that's taking place in in you know in private credit and in other places that are financing these data centers because they're the ones that are taking the risk. It's essentially releasing risk the likes of which you've seen forever in the commercial real estate markets.
>> So it sounds like someone is on the hook. In this case, it's Blue Owl and we're probably seeing equivalence in these other debt deals. And by the way, we're seeing this kind of reflect in the stock right now. Blue Owl is publicly traded and it's been it's declining this week. Um, but is the conclusion then? Because it sounds like you agree with ASW. We are seeing some we're seeing some form of a bubble. People are exuberant. There's a lot of hype and a lot of excitement that isn't fully tethered to reality right now when it comes to AI. But it sounds like where you disagree is the extent and scale of the damage that we're going to see if something blows up or at least the likelihood that there will be some sort of blowout.
>> Last year was a perfect example. My forecast for the year was the Trump people were going to break something. We'd have a 15% to 20% correction, but stocks would end the year higher than where they began. Um it happened within 50 days 50 days of the inauguration. They broke everything. Um markets went down. They eventually came back. I I wouldn't I wouldn't describe any of the subsequent recovery as as as the byproduct of administration policy, but I think I think you and Scott are right, which is 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. The the big question is if you told me the draw down is 12%. I don't really have to make any substantial portfolio allocation changes here. We can we can work through that with the way that we manage money. If it's 40, that's different. And so that's the that's essentially the big call that asset allocators and Orisa plans and endowments and foundations have to make. Are we looking at a 12 to 15% correction or are we looking at something that's going to end up at 40 right now? uh with with a little bit of Fed easing and and some steady momentum, I I'm I'm I'm more inclined to think of the 12 to 15 and the 40. We'll be right back after the break. And if you're enjoying the show so [music] far, send it to a friend and please follow us if you haven't already. Support for the show comes from Betterment. Creating a better future for yourself, your business, or your family requires more than imagination. It requires planning. The experts at Betterment are committed to helping you plan for all the big events in your life. Whether that's starting a family or looking towards retirement. And Betterment knows that every investment journey is different and every investor has unique needs. That's why they go beyond traditional target date funds to offer personalized glide paths. This consists of expert build portfolios that are automatically rebalanced over time. And that means your investments still shift from more stocks to more bonds as you approach retirement. But your journey is personalized so it adjusts to your needs rather than sticking to a fixed path. Whether it's saving for today or building wealth for tomorrow, Betterment helps people and small businesses put their money to work by automating to make saving simpler, optimizing to make investing smarter, and building innovative technology backed by financial experts. So be invested in yourself, be invested in your business, be invested with Betterment. Get started at betterment.com. Investing involves risk. Performance not guaranteed.
>> We're back with property markets.
>> I just want to unpack something you said about the Trump administration would not have nearly the cloud cover for some of the things he was doing. If if these 10 companies were off, the S&P would be flat or down. GDP I the stuff I've said is that we'd actually be already be in a recession.
>> Y
>> So he has a vested interest in this boom continuing, right? I won't even say this bubble but this boom continuing doesn't that I feel like all paths lead to the same place and that is the government will back the debt to continue to make these extraordinary capital purchases which in my view weakens the strength and integrity of the US debt markets or treasuries and is like a further move into socialism. But I predict he is going to back uh these companies. Not the other, not the real economy, not the main street economy, not the 490 companies in the S&P that got to actually compete in the capital markets. But he has such a vested interest in the in the music continuing here that the government will step in and offer in some way to back the exceptional capital expenditures such so they can continue to make them and that is only inflating the bubble to very dangerous territory. your thoughts on that thesis?
>> That would worry me if I saw it. Um I would they've done a couple things so far that I would in fairness put in different bucket. I like I you know Jamie is a very inspirational CEO and one of the things I admire most about him is he calls it like he sees it, right? So um they've done a couple of deals with MP Materials and Intel. Both of those deals fall under traditional industrial policy of of trying to rescue supply chains that are rapidly diminishing in the United States with respect to domestic semiconductor production and critical minerals.
>> I think you're being generous when they pick one company and take a stake and they take a golden share in one steel company. I would argue that is not structural or there's not a systemic strategy there. That's the blood sugar of a man who thinks he can run these businesses better than the private sector. I'm going to disagree with you on that one and NP materials in particular. Um I mean they they have provided a price floor on on neodymium and praise demium which is needed by the US military. It's the last man standing in that sector. Um I if you told me that that an adi a presidential administration had to administer an industrial policy to pick winners and losers, this might be the last administration I would want to see do that. That said, you know, you don't get to pick your time and place. And as things stand right now, China has a chokeold on those critical minerals. And whatever administration is is in power is responsible for making sure uh particularly with China flexing its muscles on export controls that we start the process of trying to rebuild both mining and processing of critical minerals. If you can't do that, you've got a wide range of both renewable energy and military applications that will soon become untenable. That has to be done. I I would have preferred for Eisenhower to do it. Okay. But, you know, I'm 63. So, uh I probably would have preferred for George Bush Senior to do it. Um right. I'm not sure I would have wanted Obama to do it. Those I'm not sure I would have wanted Jennifer Granholm to do it. Um so, but you don't get to pick your time and place. Intel was different. There's there's no guarantee of demand. There's no price floors. It's basically just a cash infusion. And based on everything I understand about Intel, their problem isn't money. So, the worst thing about that one is I don't even think whatever it is they did is going to be very impactful. But I I and I but I do expect to see more intervention by the administration in in companies that represent the the tail end of surviving supply chains, whether it's ship building or anything else. And and I'm actually I'm I'm not a I'm not a heritage KO guy. So I'm in support of that.
>> you oversee and kind of set the strategy and the narrative and the theme for one of the deepest pools of capital in the world. What other than just moving to cash and maybe that's the only thing you can do. How do you I don't want to say become defensive but just recognize that traditionally when stocks are this fully valued the markets tend to have a pretty serious correction or go flat for 10 years like how is your recommended asset reallocation what has it been what are you recommending to those deep pools of capital uh other than just going into cash
>> so the answer to that question I think you'll find interesting because it's less about changing the asset allocation of of the different portfolios it's more about explaining to clients that they they may be better off switching from balanced to conservative or from growth to balanced. When we define the risk contours of a balanced portfolio, there are certain parameters that we can go outside of but usually tend not to want to do. And so if if if we're really feeling that the risk return of a growth portfolio is changing, we would rather have the student body, you know, change from being premed to pre-law and migrate down to the balanced portfolio risk rather than have to turn the balanced portfolio or the growth portfolio into something it isn't. because there's always going to be people with generational money or or or quite frankly this the city of Chicago, Cook County, Illinois, New Jersey, plans that are kind of on paper in extreme distress. [clears throat] They their inclination is to take a lot of risk. And so I don't want to change what a growth portfolio does because there are people that are going to allocate to that and have have every right to expect a growth portfolio to be positioned the way a growth portfolio looks. So part of our job is to explain to whoever wants to listen that that the risk return is skewing because of where the valuations are. So you might want to kind of move down the portfolio chain.
>> What does a balanced or more defensive portfolio look like for those I mean just at a very high high level general level like what is that portfolio look like bonds versus stocks
>> you're talking about 30 to 40% of the portfolio being in some combination of cash short-term A1 P1 commercial paper um m municiples for taxable clients um super diversified um hedge funds like 30 to 40 of them where where like the V turns out to be something like five or 6%. Um and uh some preferred stock things like that. So you you're kind of taking a lot of the directional beta risk out of it. Um you you would
>> you know you're obviously positioning much more defensively. Healthcare is trading at like the cheapest valuation on record relative to itself and relative to the market. So if you're going to take a position someplace, go someplace where you can be paid for the risk a little bit better, you know? So stuff like that.
>> How is tech uh valued at large right now in terms of paying you for the risk? The first thing people tend to do is say I'm going to look at the PE of tech and then I'm going to look at the PE of something else whether it's industrials or basic materials consumer discretionary or staples. But for a hundred years people have been adjusting PE ratios for growth like for earnings growth and ROE and ROA and capital efficiency. So if and one of the things we do and we share this in all our publications is we plot both stocks and sectors and industries with return on equity on the x- axis and either PE or price to book on the y- axis. And so there's a lot more consistency to the way the market's valued once you adjust for earnings growth. Now you may think the slope of the curve is too steep and I wouldn't disagree with you but to just kind of look at PE differentials is really missing the point that even before this generative AI boom and we roll back the clock to 2019 the tech sector had double the margins of the rest of the market. They had become the things that the tech investors of 2000 would eventually dream they would be which is highly capital efficient lowemployment businesses with huge operating margins. So that's what they were even before this whole AI boom started.
>> Yeah. Something that I was thinking about after we spoke with Assworth. I mean his his core valuation tool is the equity risk premium which basically you know he's taking the the rate of return on stocks minus the risk-free rate and that and he sort of plots that out.
>> Yeah.
>> And you don't you you're not a fan. [laughter]
>> It doesn't have any nuance to it. It doesn't look at earnings growth and it doesn't differentiate between sectors and you know and it's I understand why people want to look at it over the really long run. It can be obviously a helpful tool.
>> Yeah. I Well, I think it's it's helpful. It's helpful when you're trying to take a bird's eye view and understand where we are in terms of sentiment. And the thing that kind of surprised me is, you know, we're at around 3.7% by that measure. And, you know, to be fair to him, he says, you know, anything below 4% is a little bit dangerous. But we're also nowhere near where we were in 99 when it was around 2%. And, you know, you you're someone I mean, you were a managing director during the the the.com boom and bust. you were you were the chief investment officer of JP Morgan during the 2008 financial crisis. So you've seen these cycles before and I think what we're describing here is like how do we put this in the context of not just tech versus industrials versus consumer but how do we put it in the context of all of history and what does this look like compared to previous crises and previous cycles.
>> I couldn't sleep in March of 2008. like I couldn't sleep. Um the things that we were seeing on a daily basis were so bad. Um and and we knew that it was infecting the entire like network of the financial system and we went underweight both stocks and high yield. The only mistake we made is we didn't do more of it. Just to show you how hidden those risks were, JP Morgan, which is an exceptionally run bank, bought a couple of billion dollars worth of Fanny and Freddy preferreds that summer for its own balance sheet three months before they went to conservatorship. Right? So that's how hidden the the depth of the problems were. Um 2001 was easier because the companies weren't making any money. And so as long as you had some degree of discipline and support from your investment committee to to to go through a period of temporary underperformance as the market was rocking, you did fine, right? And so that in a way that was the easiest one. Um uh I I remember um we had this annual MD meeting and um the chairman at the time invited a company to come speak to us in 1999. He invited a CEO to come on stage and address all the MDs and he was the CEO of a company called the globe.com. So I pulled up the globe.com on Bloomberg and I hit dees and it said this company has no business model at the time. [snorts] So we're sitting there like the chairman has invited a guy who runs a company with no business model to address us. I think we're underweight now. Right. I mean so that that was [laughter] pretty easy. Th this this is this is a harder one. because you know in many ways Google's one of the most successful companies in the history of the markets. Um I I personally think their AI related language model products are better than everybody else and I think they're the long-term winners in this race. And so I I have a lot of respect for what that company's accomplished. Um you know I I have similar feelings about what Amazon and and Microsoft are doing. Um, but like Microsoft signed a deal recently with Constellation Energy to turn back on a nuclear power plant in um
>> Three-Mile Island.
>> Three Mile Island. They've agreed to pay something in the neighborhood of $130 a megawatt hour. Now, most of your listeners don't know what that means. That's double wholesale power prices for for an average 20-year, you know, PPA agreement. The other risk that we need to acknowledge is we're getting closer to a power wall that will prevent OpenAI from getting anywhere near like they've announced partnerships with Broadcom, Oracle, AMD, and Nvidia that would require 30 gigawatts of power, which is the equivalent of 16 Hoover Dams. Like, that's just not going to happen.
>> [snorts]
>> So what what we're trying to figure out is how much of what's in the price of this whole AI boom is the expectation that these announcements are actually going to come to fruition under some 3 to 5 year time frame because it's impossible.
>> Yeah, it seems it seems kind of obvious to almost everyone that the I mean if you look at the numbers when you see the the amount of power that it's going to take to build out AI the way OpenAI would like it's like oh yeah that's that's not possible. And you know, one of the things that we've been talking a lot about recently is that crazy interaction between Sam Alman and Brad Gersonner. I don't know if you saw this, where Brad Gersonner says, you know, you're going to spend, you're making $13 billion in revenue. You you plan to spend $1.5 trillion over the next few years. How are you going to pay for it? To which Salman responds, if you want to sell your stock, you can. Be my guest. There are plenty of other buyers out there who would love to buy OpenAI stock.
>> [laughter]
>> It sounds like what happens when when there's a syndicated loan um distribution now on Wall Street, there's so much demand that if you press the button that says on the syndicate call, I have a question about the documents, you get disconnected. Like if you have a question on the docs, we you don't need to be part of the syndicate. So that those I would agree with you. Those are the signs that are kind of telling me that we've entered into a period where where the risk-taking isn't there. Um that the underwriting has gotten sloppy. Um when we look at like in the inards of the private credit markets, private credit five years ago was substantially different than leverage loans in really boring ways having to do with maintenance covenants, IP blockers, and all sorts of stuff. And over that 5year period, it's converging rapidly towards the leverage loan market, which basically doesn't apply much of an underwriting wall at all. You know, so we're we're we're kind of preparing for a uh um profit taking spark that comes from things we might not be able to anticipate, a violent, you know, correction in over bid assets. um and then some period of kind of recovery and calm that follows.
>> In a previous life, Michael, I used to take boards and management teams outside and do scenario planning as as an exercise for how they allocate their capital. And if I were going to do this for a bank or anyone else, there's a couple scenarios I want to outline and you tell me if they're realist realistic, if you think they might happen, and if so, how to respond. The first scenario is all right. Built into these baked into these valuations of these AI companies is what I've read the assumption that they're going to be able to find or inspire across their clients 3 to 5 trillion in incremental revenues or efficiencies. Now I don't see a lot of AI moisturizer out there. What I do see is companies saying okay we're cutting our legal expenses. We're cutting compliance. There's real savings and efficiencies. which is sort of Latin for layoffs. And if you think that 160 million people in the nation work, if half of them are in industries immune to AI, chiropractors, you know, welders, 80 million are quote unquote vulnerable. If you were to not inspire, which I have not seen, a ton of incremental revenue growth from AI products, but but all efficiencies, say a trillion a year, $100,000 average load per job, you're talking about a destruction in the labor market of 10 million jobs a year across the 80 million jobs that are vulnerable or a 12 a.5% labor destruction per year in certain industries, which may not sound like a lot, but that's chaos. or or these companies valuations get cut in half. I I see this as a pretty definitive fork in the road. Either pretty much chaos in the labor markets for the next 3 years or these companies adjust down their expectations and valuations. What are your thoughts on that scenario?
>> Those are some important questions. Um [laughter] that says it all. The first kind of thought piece that OpenAI published after GPT was released was a piece that kind of jumped out and said Generative AI is going to be complimentary to workers and not destructive. And I remember thinking, uhoh, it's going to be bad [laughter] because they they they they were ready to go out of the gate with a paper to defend the labor market of this stuff like right away to try to get out in front of it, which which which demonstrates that they kind of knew what this would would be able to do to certain industries. You know, the other thing that happened uh and I wrote about this a couple months ago, there was a couple of papers that came out. There was there's this chart showing that the um unemployment rate for reaching college graduates for the first time in about 60 years is higher now than the overall unemployment rate rather than lower. So the first two pieces that come out say it has nothing to do with generative AI. So you know you go to the back and you like who wrote this piece and as you unravel the threads they're Silicon Valley think tanks. And so then I kind of went to David Our and Darren Osamoglu at Harvard at MIT and um um John Bjolson at Stanford. You get a different answer which is yes, it's kind of looking like generative AI is beginning to affect um uh those young college graduates. So so we're starting to see that. We made this pyramid of things about AI and the bottom of the pyramid is the most ubiquitous thing you can find which is like futurist forecasts and all sorts of stuff and then as you go a little narrower it's um study lab studies of AI doing non-b businessiness related things. They're great, right? It's it plays chess. It plays go. It plays It can do all sorts of non-b businessiness related things extremely well. It can play your Wordle for you, right? Then now let's see how does it do in actual business related tasks. Pyramid's getting narrower, but there are some studies out there showing this in a lab setting. Then you want like surveys of adoption, but then you get those kind of bland, you know, cream of chicken soup pieces from McKenzie where all they do is call companies and say, "Hey, do are you using it?" Right? And you [snorts] don't really learn anything from that. And then you keep going up the pyramid to hardcore stuff where what are the revenue and profit and productivity consequences of doing this stuff? There's only a handful of those. And what you can't find at all is the top of them pyramid which are pathways explicit pathways to profitability for generative AI adoption for the hyperscalers. [music] We'll be right back. And for even more markets content, sign up for our newsletter at profgmarkets.com/subscribe. Support for the show comes from Gruns. Even when you do your best to eat right, it's tough to get all the nutrition you need from diet alone. That's why you need to know about Gruns. Gruns isn't a multivitamin, a greens, gummy, or a prebiotic. It's all of those things and then some at a fraction of the price. [music] And bonus, it tastes great. All Grun's daily gummy snack packs are vegan, nut, gluten, dairyfree with no artificial flavors or colors, and they're packed with more than 20 vitamins and minerals, made with more than 60 nutrient-dense ingredients, and whole food. Grunt's ingredients are backed by over 35,000 research publications. [music] And the flavor tastes just like sweet tart green apple candy. And for a limited time, you can [music] try their Grunie Smith apple flavor just in time for fall. It's got all the same snackable, packable, full body benefits you've come to expect. [music] But this time, these taste like you're walking through an apple orchard in a cable knit sweater, warm apple cider in hand. [music] Grab your limited edition Gruny Smith apple groans. Available only through October. Stock up cuz they will sell out.
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>> I think China's pissed off. I I think they're sick of trying to figure out the US China relationship, plan their economy, and they're diversifying away from us. 24% of their exports used to come to the US, now 17. But they really feel as if they have, I believe they feel we have declared economic war on them. and that they are going to punch back. And one way they might punch back or what I would do if I were she, we run companies for profit. They sort of run companies for control and geopolitical advantage. And if I were them, I would begin a government sponsored drive of capital and strategy to essentially engage in what in the 80s they did with steel, but with AI and engage in massive AI dumping. and that is create a ton of LLMs that have near par technically to US LLMs and then dump them into mark the market you know uh kind of these openw weight open-source LLMs that basically
Do what China does, and that is offer 95-97% of the premium, high-end US product for 5% of the price. And then essentially cut, go for the jugular. Just flood the market with open-weight LLMs and AI products for near-free. That takes down, massively erodes the margin power of these companies, takes them down, and thereby takes the US economy down. Your thoughts?
So, the outlook for this year has four major risks. Number one is the power constraint wall. Number two is the thing you just said, which is that China basically scales the moat on its own. As recently as three years ago, that scenario you just described would have been impossible.
Um, China is the world's leader in a lot of things. You know, fish, they've made more fusion advances. They're ahead in genetic testing of certain new drugs. They have, there's a really cool thing that looks at the complexity of exports. Um, it's, I think the, it's one of the Harvard labs that does it. They've converged now with the United States. So, the complexity in the industrial complexity and sophistication of their exports has matched that of the United States. But as recently as five years ago, they couldn't figure out the semiconductor thing. And through a combination of ingenuity and theft, they have now acquired, um, a lot of things. There's a long list of people that used to work for, for, you know, either TSMC or ASML that are now working for Huawei. And Huawei has announced that next year they expect to sell, to your point, got a chip cluster that matches or exceeds the performance of what you can get from Nvidia.
Um, now it's got more, it, it matches the power, the chip on a per-chip basis. It's only, let's say, a third as powerful, but they say, "Fine, we'll just use three times as many chips." And so that's, they're, they're trying to use a combination of brain and brawn to do that. I, I, that feel, that kind of still feels twina's on a really long-term journey, and I would agree that that is very much explicitly their goal.
I want to talk more about the your 2026 outlook. Um, so you mentioned that the number one risks, or the number one risk is power constraints. We don't have enough power to build all the things that we want to build, particularly AI. You said number two is China. Uh, what else should we know in terms of risks?
Well, the two other ones is the, the, the more that China is able to [sighs and gasps] rely on its own chip ecosystem, the, that means that number three risk has to be Taiwan. Because, um, you know, the, the Taiwan essentially was always protected by the fact that China relied 90% for its advanced chips on Taiwanese output. You know, the, the day we wake up and that number is below 50%, I think you have to start to re-evaluate some of the geopolitical contingencies around this whole thing.
Um, there's great work. CSIS is the best think tank in the world on this kind of stuff. And they showed us some data. Something like 85% of Chinese military assets are in the Taiwanese Strait. They have been partnering with Russia to do drills on how to drop heavy equipment out of specially designed parachutes from helicopters. Um, you know, that this is, this is moving in another direction, in another clear direction here. Uh, and again, you don't know when, and you don't know how, and you don't know why. And maybe it's a quarantine, maybe it's a blockade, maybe it's not a full-out invasion. But there are going to be some challenging times for the West within the next five years as it relates to its almost exclusive reliance on this, you know, Nvidia, ASML, TSMC partnership.
And then the fourth one is the stuff we've been talking about, which is this kind of collective metaverse moment where investors in aggregate say, like, "Okay, it's not a waste of money, but the, we don't, we can't see the ROI. We're going to take profits until we have a clearer vision of where this is going." I, I'm still digging through it. There was a, for every good paper, there's a negative paper, right? So that, for every good paper on AI adoption, there was one that you should read. It came from this group called MIT Nanda NDA.
Yeah, the 95% one. Yeah. Like, you know, I read through the details on that one, that, uh, those are a lot of companies that, that kind of tried it, played around with it, and said, "You know what? We're just going to keep doing things the way we're doing them."
The other, um, thing that the outlook mentions, there are three forces that will define next year's market. Um, they are, according to your report, AI. We've discussed that. I think everyone understands that. Global fragmentation and inflation. Describe global fragmentation and inflation for us.
Let me just summarize by saying, like, the, the Fed is is facing a peculiar fork in the road here. It's not a violent differential, but there's a meaningful differential right now between, we look at the PMI surveys, right? The ISM and PMI surveys of prices paid. Those are going up. Uh, the PMI survey is on labor, they're going down, right? So what's a Federal Reserve to do when you have a dual mandate that are going in opposite directions?
Um, historically, the Fed has almost never cut rates when prices paid surveys are going up. Why would they? Right? I mean, you'd be easing into an inflationary environment. Um, it looks like they're going to do that, and it's a, it's a huge gamble. Um, the gamble is that the inflationary increase is tariff-related, and once it makes its way through the system, it will not ignite some kind of wage-price spiral, and inflation will be coming down by the spring, and the Fed will be vindicated. But that's, that's a big bet, and that's the bet that's, you know, that we're looking at as we're heading into, you know, the end of the year and early next year, and the markets are pricing in a couple of cuts here, uh, because of that.
Um, I'm, I'm less worried about tariffs than immigration policy as it relates to this stuff we're talking about. I, I think the president is less committed to some of these things than he appears to be. Um, they're, they're already adding massive numbers of products to the exemption list of tariffs. So, I think the tariff stuff will turn out to be less damaging. But the, um, the latest data from the Fed is that 50,000 payroll growth is is inflationary. Like the nu of inflation for wages is 50,000, right? So they, yeah, they shut the border. We all understand what political forces they were reacting to. But the United States needs people to grow. And if, if, if you get wage inflation at 50,000 payroll growth, you have a labor supply problem. And so they're, they're gonna have to, they're gonna have to make a change soon on that one, or else they're going to have bigger problems.
Yeah. The report also says it says, um, tariffs are here to stay, no matter what the Supreme Court rules. What are you thinking about in terms of the Supreme Court ruling on tariffs right now?
You know, Gorsuch has been kind of tilting his, showing, I don't know the poker analogy because I don't play, I don't gamble. Um, but what, what is it? The thing where you hold your cards and people can see what you have, or something? I mean, he's, he's been showing his cards a little, um, during, during the hearing, and, um, I think he and Barrett will side with the Liberals, and, um, that would reduce the effective tariff rate from like 15 to 7, and then they would try to replace two or three percent of them with some other clauses, but a bunch of them get defanged and are not so easy to replace.
Do you think there might be a ruling where they have to pay back the tariffs to the companies the tariffs were imposed on?
I do, over some period of time. And, you know, they would make that as difficult as possible. And, you know, that it would be extremely messy. Um, you know, it would be, you know, think, think about the messiness of the PPP loans as people started to kind of clean up after them. I mean, the, it's, it's, it's a messy thing to do. And of course, the, the Doge people cut a lot of the staffing as it relates to the enforcement and tracking of this stuff. So one of the reasons the tariffs haven't been quite as much of an impact on the economy is a lot of companies are recategorizing goods so that they fall under different tariff buckets that they may not necessarily be supposed to apply to. But if you've gutted the enforcement of the people that look at that, then that's what companies are going to do.
So, um, you know, earlier in the year, a lot of people were trying to convince me that there was this holistic vision that they had about what they were trying to accomplish. And I'm, I'm, I've struggled with that because I see too many policies that conflict with each other. Like, if you're really trying to attract foreign direct investment, why would you expel all of those South Korean factory workers? There's just too many policies that don't seem to be aligned with what the administration says its goals are. So, which has given me less confidence that that they, that there's a kind of a playlist here that is all adding up to some big coherent grand vision. You've got to work overtime to justify how it all makes sense and how it all plays into a specific strategy, and then which leads you to believe, "Okay, that's not what's happening. This is, this is policy by tweets."
If you have time on the weekend and you really want to, you know, read something interesting, the Washington Post had an editorial recently from every single living prior surgeon general about what they thought about the leadership at HHS. And, uh, I'm not going to go into any more detail. [laughter]
Okay, we'll check it out on our own time. Um, just start. Final question from me. Scott might have one as well. Um, we've talked about some kind of concerning stuff on this podcast, and you said that you thought it was, and correct me if I'm wrong, you thought it would be unlikely to see some sort of profit-taking event to the tune of 10 to 12 to 15%.
No, that's the one I thought was likely.
I, I misspoke. That's what I meant. That is a likely scenario. You, that's almost your base case for next year. And perhaps there is a, a more shocking event, like 40%. But you're thinking, you know, you're going to see 10, 12, 15% correction. Um, for, for someone who has kind of a regular portfolio, a regular investor who is, you know, dollar-cost averaging into the market, into the S&P, they've been doing that for a few years, maybe they haven't looked at bonds too closely in the past. What is your general advice for those people going into 2026? How should they think about their portfolio and how should they invest right now?
Well, you know, based on what we've just discussed, it would make sense to start accumulating some dry powder to take advantage of whatever opportunities may exist. A lot of times when you get sell-offs like that, a bunch of things sell off. All of a sudden, you start seeing industrial and utility preferred stock sell off two to three points, which is can be the equivalent of 50, 60, 80 basis points. So, you know, um, having, having some spare cash and and credit to be able to draw on when these things happen can be helpful. Um, a lot of these things tend to be very V-shaped, right? If you look back at almost every single one of these corrections, including the one that happened last year, there's this rapid, violent unwinding of risk. Uh, I think a lot of the hedge fund, the big risk parity funds are kind of, um, partially responsible for that. But then it tends to snap back where it comes back roughly at the same speed at which it declined. In, in that regard, individual investors have an advantage over some of the large institutional investors. I mean, the average, the average endowment or foundation meets quarterly. They're not even set up to respond to some of these things.
So, um, I think it's, you know, in retail investors have at least the flexibility to try to act when these things happen.
Make the bull case for 2026. You start seeing more concrete evidence of of AI adoption that companies are willing to pay for, and you, you start seeing productivity benefits that are based equally on revenues and not entirely on the backs of lower rates of hiring. Um, China starts to cut back on its excess production policy. They announced this involution campaign a few months ago that's designed to make Chinese companies more profitable by telling them to stop overproducing. I'll believe it when I see it. Um, you get fiscal stimulus in Europe, in part because Trump is basically forcing them to defend themselves. Uh, another policy that I think is long overdue. Um, Europe agreed in 2006 to spend 2% of GDP on defense, and it took them until 2021 to finally get there. And, uh, so you're starting to see more defense spending in Europe, which is stimulative. And, um, and then in the US, the Fed is vindicated where inflation starts to roll over, aided and embedded by an enormous amount of multifamily and single-family real estate supply, pushing down housing-related inflation. And, and the administration figures out, through some combination of relaxation in certain regulations and things like that, to to ramp up US oil and gas production. So energy prices come down. So that's, that's kind of your, your bull case.
Michael San is the chairman of market and investment strategy for JP Morgan Asset and Wealth Management, a global leader in investment management and private banking with $6 trillion dollars of client assets under management worldwide. He's responsible for the development of market and investment insights across the firm's institutional funds and private banking businesses. Michael joined JP Morgan in 1987. He previously served as chief investment officer for the firm's global private bank and head strategist for emerging markets fixed income. And you can discover more of his insights by reading Eye on the Market or listening to his podcast by the same name. Michael, uh, always really insightful. Uh, really appreciate your time. Thank you.
Good to see you, Michael.
Thank you very much. Good to see you, Scott.
Ed, what'd you think?
Uh, I thought that was very. He knows everything, which is so. It's so helpful. Um, I mean, he's kind of overseeing one of the largest portfolios in terms of aumumumumumumumumumumumumumumumumumumumum in the world. So I mean, he's got so much data. Um, I, I, I'm, I think I agree with him on pretty much everything he said. I mean, our reactions to the interview, I thought it was really striking, but I didn't feel quite as bearish, um, as, as Professor Deodum was when we interviewed him. I feel like Michael's sentiment is more where I'm at right now, in terms of valuations. Um, where I'm kind of expecting some sort of correction, but not something that is kind of going to cause a, a major, major crisis. So, yeah, I thought that was informative, made me feel maybe a little better. I think he's very measured because he, the last thing he wants to do is spook, you know, the $2 trillion in value or in assets they oversee. But he sounded, he sounded measured and a little bit, I don't want to say nervous, but and I might be, it might be just confirmation bias, but whether it's Sam Altman or Alex Kart getting defensive, or Deodum saying Asworth is the least panicked person I've ever met, and then Michael sort of, Michael seems really measured, not to a fault, but really measured, like, "Okay, I don't want to, I don't want to spook all the capital I oversee, but I'm having a tough time defending this market." Um, and I think part of the reason he's in the position he is, is this guy is just, he's very measured. He just doesn't scare easily, right? But I don't know. And again, I, I can't figure, I can't suss out [snorts] like when I hate everyone around me, I know it's my depression. Like when I literally hate everybody. Um, I know it's my depression speaking, and I'm pretty convinced now we're in for a serious, pretty rocky road in the next 12 months, and I can't, I can't suss out my old man boomer anger from the actual data. But the data, I just think looks, I think if the market goes down 40%, if the NASDAQ goes down 40% in the next 90 days or 100, we're going to be like, "Well, of course it did." I think it's going to be like the most obvious thing in the rearview mirror that it happens. So, but anyways, back to Michael. I, I like him because he's measured and just, I like that he pauses and thinks about questions. He wants to answer them, answer them correctly.
I appreciate that too. Yeah. And, and you know what he saids with what you're saying. I think he, he is anxious and kind of expressed that. I mean, he said that his base case is a 10 to 12 to 15% correction, which is kind of a big deal in and of itself. I mean, the question is, do you think it's going to be like that, or do you think it's going to be 40%? Which again, he didn't rule out. He said that it was unlikely. He doesn't think it's going to happen, but he didn't fully rule it out. I think the, the, the part that he's gotten right is that there is crazy amounts of leverage and debt that's being accumulated, but only in certain contained spaces. So, he mentioned Oracle. I've talked about how OpenAI, they haven't gotten there yet, but they're going to have to raise huge amounts of debt in order to support the amount of, um, AI that they want to build and spend on over the next few years. Uh, he mentioned Blue Owl and the idea that Meta is raising debt, but using these SPVs to sort of protect themselves. So I think where he's probably right is that the debt and the leverage that we're seeing isn't quite as systemic as we've seen in previous crises, which is probably going to be a good thing. It means that whatever correction we see is going to be at least more contained than it has been in previous crises. I think that's quite a, a sound analysis. The question then becomes, well, how much more debt are we going to see in the pipeline? I mean, is it just Oracle, or are we going to start seeing crazy amounts of debt from Amazon and Microsoft and Meta? Are they going to ramp it up? Um, that, that, that's sort of the next question. But in terms of his views on like what the implosion will look like, um, [music] I think he, I think he's pretty spot on.
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