Strong AI Fundamentals, Collapsing Stock Prices - What's Really Happening

Hello and welcome to Being Exponential. Today we're going to be talking about the AI sell-off, especially in light of Google earnings that just came out. Google released some stellar numbers, the big one being an 82% year-over-year increase in their cloud business. So it it really shows that the fundamentals for the AI trade are there. However, sentiment does not show that. Luke, I'd love to get your insight on that specifically from the vantage point of Google and then also Intel, which also recently released. >> Okay, so let's first talk about why the very strong results that we're seeing in the AI complex are not leading to very strong price action. And then let's talk about why that is nonsensical and why you need to be buying into this nonsensical sell-off. So, first off, why on earth I mean so Alphabet reported I mean this was a fantastic quarter. They smashed across the board. 82% growth in that cloud business, operating margins up to 35%, record operating margins across the whole business of 34%. Google search a little bit of a mess, I don't give a crap about that. YouTube was a big beat, very strong there, that's much more important. Tesla, well no, more importantly on the Alphabet front, they hiked their CapEx guidance, right? I mean they went from 180 to 9 180 to 190 billion for this year to 195 to 205. So, at the midpoint 185 to 200, that's an 8 .2% increase in 2026 CapEx guide. And then they said 2027 is going to increase significantly from 2026 levels. So, that's a big spender saying we're going to keep spending big. Then moving on to Tesla, their results not so great, but the read-through for the AI stocks is positive because they reaffirmed their 25 billion-dollar CapEx target for 2026 and said CapEx is going to increase for the next 2 to 3 years. So, that's another big spender saying we're going to keep on spending. Intel, great results. They had um I mean, great results across all of their operating segments. Texas Instruments had great results. Uh I thought STMicroelectronics put up great results, too. You know, that stock got crushed. So, obviously we heard about TSMC last week, and we talked about ASML last week, too. So, like there's been a lot of really good results, and yet these stocks just cannot catch a bid. So, why is that? Well, for me it's all about spending durability. Wall Street is concerned about spending durability. Now, I thought those concerns were going to be addressed, maybe even eviscerated, uh by the big tech dogs stepping up to the plate and saying, "We are going to keep spending." But, we got like Alphabet did that. They stepped up to the plate and said, "We're going to keep spending more than anyone thought." Tesla stepped up to the plate and said, "We're going to keep spending more than anyone thought." And still AI stocks are I mean, they didn't get crushed in response to that. They actually did okay, but they didn't like rally, rebound in a massive way that I kind of expected them to. And why is that? Well, it's because of what's going on in the Middle East. And not specifically like saying, you know, Trump launching missiles and the Houthis getting involved and, you know, the Bab el Bab el Mandeb or whatever the heck that strait is over in the Red Sea, that's shutting down. Really all that matters that much for for the AI build-out. What it does matter for, and then eventually matters for the AI build-out, is it matters to interest rates. So, on the same day that, you know, in the morning after that we got these great Alpha results and Tesla hiking their CapEx and all that great stuff, the 10-year Treasury yield spiked to 4.71%, and the 30-year Treasury yield got up to, I think, almost 5.2%. I think 5.19, 5.18 was around the high of the day. That's worrisome because or least this is the bare case. The hyperscalers, the big spenders, they have drained their cash resources. Alphabet's free cash flow went negative this quarter. Tesla's free cash flow went negative this quarter. When Amazon, Microsoft, and Meta report, we will probably also see that their free cash flow has gone negative. So, this was an entirely cash-financed capital spending spree that now, if it is going to get bigger, has to rely on debt financing. Debt financing is interest rate sensitive. So, all of the sudden, the AI infrastructure build-out, which was not at all rate sensitive beforehand, now has an element of rate sensitivity to it because if indeed this pie is going to grow, it is not going to grow because of more cash, it is going to grow because of debt coming into the picture. And that is why AI stocks have failed to rally despite positive confirmation from the big spenders that they are going to keep spending. So, that's the first part why the sell-off is still happening. The second part why this is nonsensical is much more important for people to understand. This is completely nonsensical because a 4.7% 10-year Treasury yield versus a 4.5% 10-year Treasury yield, or a 5.2% 30-year Treasury yield versus a 5.0% 30-year Treasury yield is not going to change diddly squat for Mark Zuckerberg and his calculations about Meta is going to spend over the next 2 to 3 years. It's not going to do diddly squat for Satya Nadella and what Microsoft is going to spend over the next 2 to 3 years. It's not going to do diddly squat for Elon Musk and what Tesla or SpaceX are going to spend over the next few years. No, no, no, no, no, and more no. These guys are not going to get rocked off their horses because the 10-year Treasury yield went up 10 or 20 basis points. Heck, they probably won't get rocked off their horses if it goes up 50 basis points or even a basis points. We are going to need something like an economic catastrophe where all the wheels stop turning it at the same damn time for these guys to get knocked off their horses. These guys really do believe, and I think they're right. You can argue with them, and there's, you know, we could have beers for 6 hours and talk about whether or not they're right about this, but they firmly do believe, and I think they're right, that they have to win that this is existential. They have to win this race. They think that if they do not continue to spend that they are going to lose, and that their businesses are going to get obsoleted. Alphabet is scared to death that if they do not spend $205 billion this year and more next year, 250 let's call it next year, that Meta will step up and spend that much or OpenAI will step up and spend that much, and then the fear that ChatGPT obsoletes Google Search becomes a reality, and Google Search goes to zero, and ChatGPT dominates the entire information world, and Google Cloud loses share to Amazon Web Services and Microsoft Azure if they keep spending, and all of a sudden Google Cloud becomes obsoleted. You get rid of Google Search, you get rid of Google Cloud, and what is Google? It's not a business anymore. It dies entirely. Lather, rinse, repeat for Amazon. Amazon stops spending so big on AI compute, then maybe that leaves room for Shopify or eBay or somebody else to kind of come in there with more AI stuff and eat away at the retail business. It leaves room for if Google keeps spending on Google Cloud, Google Cloud to take share from Amazon Web Services, Microsoft Azure to take uh market share from Amazon Web Services, etc., etc. Not to mention all the stuff going on in China. Alibaba's got a cloud, right? Baidu's got a cloud. So, all those guys have clouds, too, and they're still spending, too, backed by their own government. So, I just don't think when you look at what these guys are looking at, they give two craps about where the 10-year Treasury yield is. You will need an economic catastrophe, a recession, 20% unemployment, you you buildings on fire for these guys to stop spending. They're just not going to stop spending. And so I think that Wall Street's concerns about oh, now it's debt backed and so now it's rate sensitive. Yeah, sure. 2% rate sensitive. Like the 98% is still going to go through with without a hitch, without a hiccup. And the 2% that is maybe going to get knocked down by this, and we're talking like maybe Oracle stuff. We're talking maybe some Acore weave stuff. We're talking like that lower quality crap. We're not talking Amazon. We're not talking Microsoft. We're not talking Meta. We're not talking the most powerful, highest quality, deepest pocket businesses in the world. No. So, I think that I get why the the AI complex is not rebounded like crazy despite these really, really, really strong results. Yeah, those fears are not sensical. And the market will come to its senses, and we will eventually see AI stocks rebound like crazy. I really just I don't think this trade has changed. The fundamentals haven't changed. Nothing really has changed besides some sentiment. And sentiment, it's wishy-washy. It gets really good, gets really bad, gets really good, gets really bad. But over time, stocks course correct to their fundamentals. And the fundamental trend here is still very positive. So, I think there's a lot of opportunities out there right now to punch long. I think you got to wait for some technical levels to kind of like uh hold or at least be affirmed. But I mean, I I think we're getting close to a back up the truck moment. >> Got it, Luke. All right, so I have to ask two questions. So, this is still with the impression that the the AI thesis is still there. Uh so, two more bearish concerns are the valuations on some of these current AI stocks. Are we just seeing a correction in the prices of these these these stocks? And then also, another concern is the profit from the spend. So, I think a a lot of analysts are wondering where is the profit from all of this CapEx spend going? Or when are we going to see that? Is that something we should be worried about or you know, like you said it are we still looking at a back up the truck moment in the next couple of months? >> No and no. Those are the short answers to your questions. Valuations S&P 500 is trading at about 21 times forward earnings. It's average forward earnings multiples since 2020 so this decade is about 22 times so we're actually below average on valuations. Nasdaq 100 trading at about 24 times forward earnings. This decade's average forward earnings multiple for the Nasdaq 100 is 26 times so we're below average on tech stock valuations. And then the Philadelphia Semiconductor Index SOX SOX that's trading at 25 times forward earnings which is above average but semiconductor stocks are expected to grow earnings by more than 102% this year. They're expected to grow earnings by 42% next year. So you're looking at 25 times forward for 40% plus compounded EPS growth. That's that's not expensive at all. And then when you look at the S&P 500 more broadly you're like I said 21 times forward earnings and you're having I think it's about 26% 25% EPS growth this year and then 14% next year and then another 12 13% expected the year after that so really that you're looking at a really really good profit growth outlook for the next few years. And the valuation multiple you're paying for the that really really good profit growth ramp is not all that absurd. So I don't like the valuation argument. I don't think it makes much sense cuz the multiples aren't that expensive and the growth trajectories are really strong. The better argument is those are estimates right? So maybe those estimates won't come true. That's the better argument but that argument fails when you hear the big spenders are going to keep on spending because we all know that the 16% EPS growth expected in 2027 or the 40% EPS growth expected out of semiconductor 2020 that's all driven by the AI spending, right? That's not driven by anything else. So, if those big spenders step up to the plate and say we're going to keep on spending which two of them already have and again because they're in this race together, they're all you know, two of them are going to step up and say we're going to spend more and the rest say we aren't. Like that's not how races work, right? If two people say we're going to spend more, they all say we're going to spend more. So, they're all going to step up to the plate they're going to hyper 10% or more for the 2026 CapEx guidance and speak directionally positive on 2027, 2028 plans. So, if that spending remains, then the earnings growth estimates look pretty solid. And so, when you kind of couple that all together, I just don't even make any sense the valuation argument at all on on AI stocks or on tech stocks or on the market more broadly. Um, and then the second one with the profit showing up, Google just showed you they're showing up. And again, Google Cloud was a 25 to 35% growth business post COVID. Like you had obviously had the 2020, 2021 kind of weird growth rates because everything shut down and the labs were super easy a lot of y'all had to do, but the 22, 23 normalized post COVID growth rate for Google Cloud was like 25 to 35% and slowing, steadily slowing. Now we're at 82%. We've gone from 30 to 80 50 points of acceleration in a business that is running at a $100 billion revenue annualized. The There is no like clearer cut and dry way to say these this spending is showing up in the profits. Like it it is showing up. The demand is absurd. The backlog is over $500 billion. So, I mean like it's it's very much showing up. I think the valuation argument makes no sense and I think when are the profits going to show up? The Michael Burrys of the world need to be quiet because they are showing up. Like very much so they are showing up. So, I I I get why people are hesitant there, but then again, when you really dig and look at the numbers, I actually don't get it. The The numbers do not support either of those bearish arguments. All right. >> Yeah, understood. I mean, I agree with you. You know, men lie, women lie, numbers don't lie. Um so, my last question here is in our earlier episode in our alpha episode where we talked about our stocks, you said we mentioned Nebius has a great setup. Uh people love names. So, I I'd love to get your opinion on what other stocks you're seeing have some great setups with the uh market conditions as they are right now. >> I think Broadcom looks really good. I think Intel looks really good. I think AMD looks really good. I think going down the market cap chain, uh Amkor, AMKR looks really good for advanced packaging. I think Google's TPU business is really uh starting to I mean, it is starting to come to life, but the commentary is more like this thing is about to come to life in a way way way way bigger way in 2027. And so, I like the plays attached to that. Broadcom is very much attached to that. Uh and then advanced packaging plays like Amkor are very much attached that. So, AMKR. Um I think Comfort Systems FYX looks really good. I think they had a really good earnings report this week. I think that one has a really nice setup. Gevernover, ticker GEV, that one reported earnings and it got hit, but that was a really really good report. I think they are really just crushing it in the natural gas turbine world. Um and that the power bottleneck of AI. So, I think that's a really good play there. Um I like the memory plays. I like Micron. I like SanDisk. I like Seagate. I like Western Digital. I think those all look pretty good here after their very sizable drawdowns. Though they're all still in their long-term uptrends, or at least their AI boom uptrends, I should say. Um I mean, there's there's a lot out there, but off the top of my head, that's kind of like I'm focused on on a lot of names that I just mentioned. >> Excellent. Okay. Yeah, I mean, I think we covered a lot of information here, but do you have any uh closing thoughts before we uh sign off for the week? >> Yeah, I think the closing thought here is that earnings and stock prices go hand in hand. That when earnings go up, stocks go up. And that that's just how it's been forever. Like as long as the financial markets have been around, that's just how it's been. Earnings and stocks go hand in hand. Over the long run. Now, every once in a while, over the course of several weeks or even several months, that relationship can break down. But when that relationship does break down, when there is a divergence between earnings trend and stock price trend, there is always a correction. So, what we have right now is we have earnings trend still moving higher and stock price trends moving lower. When that happens, historically speaking, it resolves in one of two ways. Either stock prices correct sharply higher back to the earnings growth trends, or earnings growth trends correct sharply lower to match the stock price trends. So, we have a divergence right now between earnings and stock prices, and the question is, will stock prices correct higher to match earnings, or will earnings correct lower to match stock prices? And after what I heard from Alphabet and Tesla, I just see no way in hell that earnings trends are going to correct lower to match stock prices. Like these earnings are being powered by big AI spending. The big spenders powering that spending just said they're going to keep spending more than anyone modeled for. So, that means the earnings are going to keep going up. So, the only way this resolves in my view, barring some economic catastrophe, which obviously can happen. You never want to you know, black swans are are a thing. But, barring a black swan, this resolves with stock prices correcting sharply higher to match still robust earnings trends. And so, I just think we're in this sentiment correction that eventually will result in a rapid sentiment reversal towards a fundamental uptrend, which is still intact with earnings. So, I think that's kind of like my closing remark here is when in doubt, follow the earnings. And the earnings are still going up into the right. >> Excellent. All right. Appreciate the the insight there, Luca. And you know, like they say, it's not a loss until you sell. Um that's it for Being Exponential this week. We will see you next week, Tuesday. Take care. >> [music] [music] [music]