The AI Bubble: Why Being Right About the Tech Means Being Wrong About the Stock

Welcome to Trading Trends. This is Ilia Spivac, head of global macro here at Tasty Live with a very special guest, publisher of the Macro Tourrist, co-host of the Market Huddle podcast, our returning champion, Kevin Mure, is here. Kevin, >> good to be with you, Ilia. Looking forward to this. >> Pleasure to have you here. I wanted to uh pick up something you've said recently because uh wanted to kind of make some heads explode here. Um, I think that that's a good description for where we're going to go here. You've said that the more transformative you believe the AI boom to be, the more gamechanging this technology, the more convinced you are in those merits, the more you should be thinking it is a poor investment. Explain. Yeah. So a lot of times when I tell people that I'm bearish on the stock market or specifically AI, they start telling me, "No, no, you don't understand. You don't get, you know, how transformative and how important this will be for for the economy and how much it's going to change the world." And at that point I s I tell them you know the reality is that the more that a technology is viewed as transformational like the more important and the more that society views this as like something that is truly going to change the world that means that there's going to be the more investment. And by its very nature, the fact is that when you get too much investment, it makes it a poor, you know, riskreward as a as a as a kind of somewhere to put your money. So, one of the things that I think is ironic is the more you believe that AI will change the world, the less you probably should be invested because the reality is if you go back and look over time at all of the really transformational technologies, they were terrible investments. Go look at the railroads. Go look at electricity. Go look at the dot bubble. Like, yeah, they changed the world. No doubt about that. I'm not disputing that. I'm not going to sit there and argue with that. But I'm going to say the more convinced you are of that, the worse investment it is. So, if we're setting it up in the sense to say, okay, well, this is a transformative technology like railroads, like telecoms, frankly, like the US itself. I mean, we had a a warrants blow up uh uh to show us that uh that this kind of hype generates invariably overinvestment, overallocation of capital that eventually blows up. What do you do with that information as you look at AI and you go, "Okay, well, do I short this? Do I try to get in front of it and try to take the pain of being wrong until I'm right? How do you approach this? Do do you just not participate in that part of the market and go, you know what, I'm going to go some place else and do something great and it depends on who you are. One of the things that I, you know, uh, I get asked all the time is, you know, you know, I I come from the institutional world. I come a lot of my friends are you know working for institutions whether the sell side buy side and a lot of retail thinks oh you guys have it so easy you have all the information you have all the flows you know it all and I always tell them no you don't understand you actually as a retail investor have the greatest advantage out there and what that advantage is is just the ability to not play you just you can go and walk away from something you don't need to be invested. Having said that, if you're sitting there and you're managing money for Fidelity or CAP or somebody like that and you say, "I'm really bearish AI. I don't think this is going to work in the long run." You go, you watch the AI continue to go up and you lose all your assets. You can't take the pain as a professional investor that you can take as a retail investor. And ultimately, if we go look at some of the greatest investors out there, people like Warren Buffett and Howard Marx, the thing that they were able to do is is to not participate and to make sure that they have dry powder when the stuff actually, you know, comes unglued and the true opportunities are there. Now, in the meantime, it's easier said than done because, you know, there's nothing more disturbing than watching your dumb neighbor get rich, you know, owning three times socks SMH, uh, you know, ETFs and that is what you're struggling with. But when you ask me what do you do? Yeah, you can go short it if you want. If you're a real professional investor and you want to take that pain, but most people shouldn't. They don't like that. They don't like shorting. They should just go do something else. Wait. Now, speaking of people who are betting against uh this thing, I think something you've mentioned recently is that the people that know AI best are not buyers, they're sellers. >> Yeah. Explain to the folks what you mean there. So, if you go look at the tech stock story over the past two decades, uh it's been kind of centered around the fact that these things are cash generating machines. And if you go look at Google and Amazon and all, well, not Amazon, that actually wasn't as much, but Google, Microsoft, all these different meta, they were cash generating machines. And one of the things that everyone was excited about was that they were continually buying back stock. It was just something that was just you go pull up Microsoft stock, the number of shares outstanding. Look at it. Same with Google. It's just collapses the number of shares outstanding. And that was just this huge tailwind at your back. right? Like the the reality was that these the the supply of stock in these tech stocks was diminishing, you know, and that's why the prices were going up. Fast forward to today, it's the exact opposite story. Google, who hasn't issued a single share since they came public in whatever it was, I can't remember ' 05 or whatever the number was, they have it, they did the largest secondary in history. So, one of the things that I I kind of push back on when when everyone tells me, you know, this time is different. All these stocks, all these AI stocks are are great investments. They're trading cheap. They're earning money. And I'm like, okay, I get it. They are cheap on a PE basis, but if you go look at the earnings, the earnings have exploded higher. And we can talk about why they've exploded higher. But more importantly is that for a while, they were free cash flow machines. And everyone then for the kind of the narrative for a bit was don't worry, they're funding this out of their free cash flow. So there's no debt. There's nothing to worry about. So now all of a sudden they're no longer funding it out of their free cash flow. They're they're going and they're borrowing tons of stock money to to build all these uh data centers. So we have this situation where free cash flow is actually going negative, right? That in itself is already concerning. But then it's even more concerning when not only are they borrowing to go and do this, they're now hitting a point where they're saying the borrowing costs have gone up. Not only that, our equity is really expensive. So let's issue equity. And so we have some of the largest equity issuances in history. And it's not just like secondaries, it's also stuff like SpaceX. Like one of the biggest bull, you know, bull reasons, the narratives of why this was such a um a sustained and easy bull market was that the supply of stock was not expanding. And for the first time in years and maybe decades, we're seeing a huge supply of stock come on the market. Well, so one of the biggest sort of stories out there around all of this that nobody seems to talk about very much is and and we just got data on this this week. So I thought what a perfect time and you're the perfect person to ask because you would be in these granular details. We just got data out of China this week, inflation data and um the trade balance report and it showed once again that here's the world's second largest economy. It hasn't had domestic demand since before they scrapped COVID lockdowns. The only engine of growth here seems to be this AI buildout boom and this roaring export engine that feeds it. If AI were to not break, but just slow and the buying of that stuff would slow. Does China still have an economy? And what does that mean? >> Okay. So I I I'm actually more worried about the US if if if we have a situation where the AI spending slows, right? Let's let's stop and think about what's really driving the US stock. I mean, sorry, the US economy. It's it's the stock market. This is a bubble that is fueled by private asset wealth. And if you go look at like actual jobs being created, it's almost zero. And what they are is basically all education and and mostly health care, right? There's been no return of the manufacturing. Um we go we have a situation where um there's the average stock in the US is underperforming and it's just more and more driven by this very concentrated bubble. But let's bring it back to China because I think you you kind of hit the nail on the head when you said they haven't done well and they haven't stimulated their domestic like there's been no domestic spending and like why is that right? Like let's ask ourselves the the China Bears will tell you they're stuck. They're in a hard you know they're between a rock and a hard place. They can't spend. I I call BS on that. Like I'm just not a believer in that. And I just all you have to do is ask yourself who has the capital. Like it's it's we go and look at who has the savings and it and it's not the US. It's actually China. So China has the money. But but you are correct to point out that they're not spending it. They're purposely running their economy uh you know slow. Right. The US is purposely running their economy as fast as they can. the you China is purposely running their economy slow and you might ask yourself why and actually this is my buddy Louis Vincav you know articulated this much better than I ever did he says like if you're sitting there in your China and you're seeing the oil price going through the roof like why would you run your economy hot into that like you don't want a situation that exacerbates this this energy shock already so his argument argument and I'm very, you know, um, sympathetic to this argument is that they're purposely running their economy slow and that when we finally roll over as a global economy because of the higher interest rates, because of the higher oil, then they will be able to stimulate and they will be able to to to get things going again. So, no, I don't worry about China. I I worry a lot more about the US and it comes down to that I I believe that running the largest deficit that we've ever seen in a period that the economy is already running hot um is is going to ultimately be very dangerous. And I also am just very concerned because I look at the what's kind of driving this economy and it's all this bubble and and I'm worried there's nothing left if the bubble rolls over. And I do believe it's a bubble. Like no doubt about it. And I I'll say it here and I'll say it time and time again. This is a bubble of dot proportions. And and I know all the arguments against it and I'll just push back on that and let's go back to the earnings because a lot of people will say, "But Kev, like Nvidia is only trading I don't know what the number is these days, 10 times earnings, 12 times earnings or whatever it is." And I go, "I know, but go look at the actual earnings." And part of the reason that the earnings have gone so stratospheric is because if you stop and think about what happens when a hyperscaler goes out and takes a hundred billion loan. They go out they take a hundred billion dollar loan. Microsoft goes borrows a hundred billion from the market. They go and they build an a data center. They immediately take a third of it and buy chips. They take a third of it and build a plan. They take a third of it and and do the cooling or whatever. All those companies on that side, they immediately register the benefit from it, right? They're that is earnings today, right? And there it's earnings today and margins that are just completely and utterly through the roof, [music] right? But the trouble about it is that's earnings today for for that side. But on the other side, Microsoft goes and advertises that over the next seven years. So the larger that we've built this bubble, the more that we've taken earnings up front and then had all this risk on the other side. And that's fine if we have a situation where the AI ends up generating as enough revenue to just sustain that. But I'm skeptical that that's the case. Right? To me, this feels like the Uber moment. you know, when Uber was free and they were trying to get everyone to use it and so you used to be able to take Uber rides and and I I've heard crazy stuff in China where they were they they had a couple of companies uh competing for this and you could literally order stuff for free and they would just deliver because they were trying to get you to download their app and do stuff. To me, it feels like that like if you go and look at your Claude and I'm a big user of Claude. I love it in terms of for programming. It's been a lifesaver for me and it's and it's Yeah, it's exactly it's fantastic. But having said that, when I go and I look at what I use in terms of token cost, right, like I I figured it out, me and my son, my son's an engineer and we were doing some programming. We had a couple projects that we were doing this summer and I sat down. I was like, how many tokens did we use? We were paying the $200 a month or whatever. The reality was I figured out the token use and it was like five, four or five grand, right? Like so so the actual cost of that was much different and I don't know if I'd use it as much if it was four or five grand. And sure, it's great. there's all this demand when it's really cheap, put it to the proper price, then it's much different. And I know I understand the bulls will come back and say, but token costs are falling and stuff. It it it's going to be tight, but I still contend that it's going to be way way way overbuilt. And just going back to my idea that any bubble attracts too much capital, and that's what it is. Um but but when we go and we think about all this situation bringing it back to China US when this thing finally comes unglued I'm much more worried about the US stock market and the US economy than the rest than the rest of the world. Well, talking about things getting unglued, um, one of the interesting things I think that we've seen even just over the past, let's call it, week or two, we got a little bit of a scare with Open AI last week where, god forbid, they made 20 billion less than the market thought they should. >> Yep. And one of the one of the most interesting things happened, bonds went up at the long end after this relentless surge in yields. >> Yeah. >> And the conversation sort of naturally goes, well, wait a second. is this surge in yield that we've been watching especially like the long end relentlessness of it because we've seen at the front end oil goes up oil goes down there's a conversation about rate hikes there's a conversation about uh what this will mean for the Fed two hikes one obviously we got a hot CPI report it all started to respond again the dollar strengthened so there's all this stuff happening at the front end but at the long end it's been relentless and you sort of naturally gravitate to the question of well wait a second an a minor AI rounding error of a disappointment maybe gets the bonds to rally and today they're not really going away on a hotter C CPI number they're not really backfilling all that much are we looking then maybe at a process that's already in the in a devolving kind of situation because what's happening at the long end starts to look not so much like oil or even tariffs or even uh the demographics of the labor market but just competition for loanable funds where the hyperscalers as you say are now borrowing handover fist to hypers scale at the same time governments are trying to finance these enormous deficits with no desire apparently to actually shrink the [laughter] def deficits in any kind of way only just to finance the more short term. And so if AI slips are we then already seeing that the squeeze of rates is having the effect people are retrenching and the bond market becomes the interesting place to be. >> Great question. Um and yes, yes is the answer to your your question that that is ultimately where people will gravitate when we get a situation where the AI tree comes unglued. The real question is timing and you and you highlighted how we have this situation where the supply has been overwhelming the market, right? So we have not only do we have the US government issuing record amounts of of stuff. We have all these AI companies also issuing. And then there's a third one that not enough people are talking about. And I and this is something that I've been focusing on. Love them or hate them. And you can probably guess as a Canadian which side I come on. Trump has changing the world. And one of the things that he's changing the world on is that all of a sudden the rest of the countries that relied on the US to do all the spending and to do all the defending and to to be the the uh kind of demand of last resort are saying, "Hey, wait. We can't rely on them anymore." And I'll just talk about Canada, for example, um because I'm a Canadian. We had when you guys the last year of the Biden administration, you guys had an 8% deficit to GDP. If you'd asked a lot of, you know, market participants, you know, if if the US is eight, what's Canada? They probably would have gone, oh, those guys are socialists. It's going to be 10% of deficit to GDP. And the reality is it's not. We were running a 2% deficit to GDP. We were trying to balance the books. We were we weren't spending. And that was everywhere. like Japan was running a two and a half or something. Europe was running a three. Now all of a sudden with Trump, we have a situation where everyone is forced to spend. Like we're forced to go build pipelines to sell to other people because we're no longer feel like we, you know, we can rely on you guys. We're forced to go and cut taxes because we need to create our own stuff. We're forced to spend on the defense. Same with Germany. Germany finally abandoned their debt break. So we have this situation where for the first time in like years maybe decades not only is the US running a hot fiscal everyone is running a hot fiscal and that is part of the reason that we've seen bonds backing up in yields as you point out and one of the interesting things about it as well is it's been moving up in real terms meaning that inflation expectations over the long run have not been moving very much. It's actually just been wider and wider real um rates. So, you can actually go buy a 30-year tip that's like meaning that you get um a CPI plus um a yield and that yield is now 3% or something like that for the next 30 years. There was a time that that was was zero or even minus 100 basis points. So, the real yields like what you can earn after inflation has exploded higher. I have this buddy He's on Twitter. His name is Efficient Market Hype. And he has this great line that he says. >> Yeah. He says, "Don't make me tap the sign." And the sign is bonds breaking will break equities until equities breaking saves bonds. What he's saying there is that we're in this period where bonds rising in yield that that pressure that that tightening of the monetary policy will eventually cause a problem in the stock market. And when that problem in the stock market occurs, that'll finally be the time to buy bonds. And I've been sitting here and I for those who don't know I have been like one of the biggest bond bears for the past decade out there. I kind of made my name being a bond bear. I am no longer as bearish. Um I I I have taken stabs on the long side. Recently I wrote this piece where I said, you know, I'm going to wait. I still think there's going to be a better time to buy bonds because everyone I know, every smart guy I know is trying to buy bonds. And one of the things that I found in the markets these days is that you often get to extremes. Trends are taken to levels that are absolutely insane. And the example I use is silver. Like I was bullish silver. I owned it at 30, went to 50. I was like, "Oh jeez, I'm a genius." Sold it at 60, then watched it go to 70, 80, 90, 90. I'm like, "This is unsustainable." Maybe I even tried shorting some. I can't remember. Then it goes to 100, 120, 110, 120. My point is that this is the way of of the modern market. So I've been of the opinion that that we're going to get like a final puke in bonds. Having said that, you rightfully point out today is an interesting day, right? We're taping this on Wednesday. We just had a terrible CPI number. Bonds immediately gapped lower. Okay, stocks were kind of bunched. Since the open, we've had a situation where stocks have been sold aggressively and yet bonds are rallying. And one of the things that we've seen is that going back to my thing, bonds breaking will break equities until equities breaking saves bonds. We're looking for that negative correlation to return, meaning that we finally see people selling equities to buy bonds. And maybe, just maybe, we're there. And Ilia, I'll say the other thing about this. Did you see what was on the cover of The Economist the other day? >> I did. I did. And so one of the things that I've been um motivated by to add into my exploratory um longs in TLT uh was I saw The Economist cover because I'm a religious subscriber for the past 18 years. Uh and so every week cover to cover. And so I saw it and said, "Oh, well, I'm not nearly big enough in these [laughter] ET call verticals. >> I didn't double this position immediately." [laughter] >> For those who don't know, it was a bearish bond piece. And generally, that's kind of when it makes magazine cover, you know, the trade might be getting late. So, listen, I'm sympathetic to that. One of the other things that people should think about as well is that if you go look at I can't remember what the name of the index, it's like it starts with a P. There's an index that measures how fully funded pension funds are and you can go and you can find it on the Bloomberg. I can't remember what the name of it is but if you go look for the first time in a long long time the pensions are 100% fully funded in the US. So if you were a a pension that was trying having to manage for a bunch of people you should actually be selling your equities and just immunizing it by buying bonds. And so far we haven't seen that. But I think that if we get a situation where stocks stop going up that there will be that will be the catalyst for a big move. I I think the more difficult question though to ask yourself and and if you want to go and you're just a retail guy and doesn't want to use leverage, then you go own the TLT because the long end gives you more leverage. But if you're a sophisticated player that can use leverage, the real question is what is the yield curve going to do? How bad is it going to be? Are we going to get a situation where the the we get a financial accident and rates are going to be cut to 1% or whatever the number is at the front end and what will be the reaction to the long end at that point? Will we get a steepening like we've never seen before? And I am actually sympathetic to that idea and worried about that cuz ultimately in my heart of hearts I'm a bond bear. Um so one of the things that I've been, you know, contemplating is do I want to own 30s? Do I want to own tens? Do I want to own fives? Do I even just want to like pick like sofur out a years from a year from now and just bet on that? And that is a much more difficult question. >> Yeah. Yeah, I mean especially when you get a hot CPI number and the markets are already 50 basis points apart from the Fed for next year and you kind of figure okay this is the kind of number that lets that disconnect continue at least at least for now. And so uh to your point, you look at uh how the front end looks and how the stock market outside tech looks. And since mid August, it's a very clean, very textbook story. Front end yields going up, dollar going up, Russell is down, equal weighted S&P is down, S&P excluding tech is down. It's all downing except the headline indexes. I mean, everything works the way it's supposed to work except the bubble. >> But but in the old days, I remember when the it used to be the long rates going up in terms of a yield was bad for tech because it was a long duration asset. >> Yeah. >> And now to your point though, like I look I was I was gone out of the country for for September and I came back and I was absolutely flabbergasted. If you look at the return since uh Fed Chair Worsh's Jackson Hole speech at the end of August, if you go look at that, I think the S&P 500 was up one or 100 basis points or 150 basis points or whatever. NASDAQ was up 4 and a half five. Um MAG 7 was up six. Equal weight S&P equal weight was down 350 and the Russell 2000 is down like six. So the difference between like NASDAQ and Russell is 10%. That is a monster monster move. And I think it just goes to show you how the higher rates are choking off the real economy. And the only thing that's really surviving is the bubble. And ironically, as investors and sophisticated investors see this, they sell their smalls and they go and they they rush in because they need to be long something. They rush into Mag 7. So, it only makes the bubble worse. Like, listen, this it's it's crazy. It's wild times. >> It is. It is indeed. By the way, I think that index you were talking about is the Millimman pension funding in index. And an interesting tidbit there, just to close the the loop on that, is the last time that pensions were this wellunded was on the eve of the GFC, the global financial [laughter] crisis. And uh the time before that was on the eve of the dot bust. >> There you go. >> So uh just just some points of information to have. Uh folks, uh Kevin Mureer is with us. Uh Kevin, let the folks know where they can get more from you. >> Uh they can go to the macroouour.com. You can send me an email, kevin Kevinthero.com. I'm happy to send you some uh recent samples. And listen, it's great being with you. I really appreciate the opportunity to chat with you. >> Always a pleasure, Kevin. We'll hope you be you'll be back with us soon.