Bubble bursts in 2027, Nvidia earnings preview, Materials sector set-up, AirBnB takes flight

The Compound and Friends

This episode of 'The Compound and Friends' explores market dynamics around AI spending, upcoming earnings previews, sector outlooks, and investor psychology.

Key takeaways

• Stock markets are anticipatory—pricing future expectations more than current conditions.
• High AI-related capital expenditure is already priced into stocks; recent earnings don't drive price movements if they're expected.

Main topics

• Anticipatory nature of stock markets
• AI spending and capital expenditure trends

Notable quotes

Stocks behave based on the outlook more so than bonds.

The current conditions are not as important as we all think—they're already priced in.

Conclusion

The episode underscores that successful investing requires understanding market

Transcript preview

Speaker 2 (0:15) Yeah, we're back. Speaker 2 (0:18) It's going to be a big show, Michael. What do you think? Loaded. You look at all the stuff that we're going to do? Speaker 1 (0:24) No, I haven't looked at it. All right, so Speaker 2 (0:27) everyone's talking about Dolly Parton in the chat. You have Speaker 1 (0:31) thoughts? Speaker 2 (0:32) Iconic, right? Yeah, Jolene. What a legend. Speaker 1 (0:37) A little bit before my time, so I'm vaguely familiar with her music, but probably not as much as you are. Speaker 2 (0:41) We will never see or hear anything like Dolly Parton ever again. I have to tell you. Why? She's just like, she was just so, like, I keep saying iconic, but really and truly and could do it all. Acting, singing. She started an amusement park where she grew up in Pigeon Forge, Tennessee. She's like a Hall of Fame, like everything, you name it. Grammys. Speaker 2 (1:16) What's called the country music, Hall of Fame or like when I was in Nashville and I did all the tours. She's just everywhere. She's just she's it. She's the thing. So, you know, what's cool. She did live long enough. Beyonce paid homage to her. Beyonce did a country record a couple of years ago and had Dolly on it. And she kind of got her flowers from like the younger youngest generation. And that was kind of that was kind of cool to say. Anyway, RIP Dolly. You know what else they're saying in the chat? Speaker 2 (1:48) They're saying, am I going to address the Live Nation settlement? Yeah, all right, I'll address it. I'm a shareholder. So I am pro Live Nation settling its issue with the government. Seems to happen every three or four years. Somebody decides to sue them. And they always come out of it unscathed because in the end, they are the best operator of concert venues in the world. And people really like the combination of the ticketing. being connected to the venue. And sure. I love it. Speaker 1 (2:23) What's the alternative? We don't need to get into that right now. Speaker 2 (2:26) Okay. Anyway, that's my comment. And by the way, this was settled in March. It only came to light now. But it's news, but it's not actually new. It's not a new thing that just happened. It happened six months ago. Get over it. Anything Speaker 1 (2:41) else you would like to comment on? Or they would like you to comment on? I Speaker 2 (2:44) got Speaker 1 (2:44) one more thing. Speaker 2 (2:47) I want to let people know that we are going to be throwing a major event later this year. I cannot get into the details. However, I strongly advise you to go to thecompoundnews.com and subscribe. And become a compound insider. Because the people who are compound insiders are going to get the heads up before everybody else. Will there be Speaker 1 (3:16) PFPs for the giveaway? Speaker 2 (3:19) What is it? Oh, PRP. We will have doctors on site performing the platelet-rich plasma procedure. You should do it on Speaker 1 (3:31) stage. That'd be great. Speaker 2 (3:32) Well, I don't need to anymore because look what I have going on. All right. So anyway, guys, super excited about this event later this year. I can't say more. I'm not at liberty. You cannot, Josh. Go to thecompoundnews.com and subscribe. Become a Compound Insider. We regularly send you guys the heads up on stuff before everybody else knows about it. So this is your opportunity. We have a sponsor tonight. Michael's going to tell us all about it. We Speaker 1 (3:57) do. The sponsor is FM Invest. And I just want to say a big, big congratulations to the entire FM Invest team, Alex Morris and squad. They just got bought by T. Rowe Price, a little asset management company. Maybe you've heard of them. And it's been a pleasure working with them. Just great people over there. All right. So. This podcast, as I said, is sponsored by FM Investments and SGVA, the FM accumulator, ultra short treasury ETF. Most ultra short treasury ETFs pay out monthly cash distributions that investors don't need and don't want. Those distributions come as taxable income that must be reinvested after taxes. Well, here's an ETF built to solve that problem. It's the FM accumulator ultra short treasury ETF ticker SGVA. SGVA is structured to avoid unwanted taxable distributions and harness the power of compounding inside the ETF. So instead of monthly distributions, you stay invested in ultra short treasuries and you choose when to redeem based on your personal cash needs. SGVA built to grow, not distribute. To learn more about SGVA, visit fminvest.com slash SGVA. Speaker 2 (5:11) What a great story. We like this guy, Alex Morris. Big fan. Good Speaker 1 (5:14) dude. Speaker 2 (5:15) And I like when good things happen to good people. So really happy to hear that. And thank you guys for sponsoring the show, of course. All right. I think we're starting with peak AI spend. And the message that I wanted to get across here is one of the most important things to understand about stock markets are that they are anticipatory. Bonds are different. I mean, There is an anticipatory component to bonds and how they trade. But the investors in bonds are mostly there to get their money back plus interest. And they're not looking for surprises, upside surprises. They're not looking to substantially grow their investment. It's more about return of capital. And equities are about return on capital. And so stocks behave based on the outlook more so than bonds. The current conditions are not as important as we all think. So we're all looking at economic reports and we're all listening to earnings reports that are talking about 90 days ago. And we're all looking at what's going on right now and how do you play it, how do you invest based on it. But the reality is the preponderance of people in the market and the dollars at play are investing based on how things might be going six months from now. a year from now, depending on the stock. Do you think what I'm saying is accurate so far? Facts only. Where are you going with this? Okay. Where I'm going with this is this year. is an absolutely incredible year for CapEx and technology and spending and investment. And it's like, it's almost, I don't want to say it's never been better, but in our lifetimes, it might not ever have been better than it is right now. But the stock market doesn't care about how good things are right now. They have already started to price in how good things would be today. In January, in February. So what the stock market is principally concerned with at this stage in the game is the coming winter and the coming spring. And that's why you have gigantic chip companies like Broadcom, for example, in deep drawdowns off of a tie. You have Marvell in a drawdown. Both of those companies have just been reporting some of the greatest news and contracts and earnings. any of us will ever see. But that was already priced in six months prior. Now, those stocks are looking to the future. And people that don't understand this, they would intuitively look at the share price and conclude either the stock market is wrong or I don't understand what's happening. And neither of those has to be true. Stock market could be right and you could perfectly understand what's happening. But it's the future. That matters to the share price today, not today's current conditions. And I bring that up because there was a really shocking op-ed at Bloomberg by Bill Dudley. Bill Dudley was the chairman of the New York Fed, I believe. Yeah. All right. So it's not often that you will get a former chairman of any of the Federal Reserve banks come out and literally call his shot. Point to the bleachers like Babe Ruth and tell you where the ball's going. But he has an op-ed last week, basically five reasons the bubble will burst by the end of 2027. So he's not just saying it's a bubble. He's saying it's going to burst. And he's not just saying it's going to burst. He's telling you the time horizon. And I thought it was really interesting and the timing was interesting. So he is now a Bloomberg columnist. in his private life, no longer at the Fed, but still was at the Fed recently. And this is a remarkable piece. So I wanted to go through it with you. Just to set the table, put up the first chart. So I'll quote him. Speaker 2 (9:32) He's setting the table by telling you that stocks are expensive, which I think we all sort of understand. He's citing three things. The Shiller cyclically adjusted price earnings ratio or CAPE, which has not been helpful, obviously, for short term market timing. But a lot of the old heads really do care about this. It's 10 years. It's a multiple on 10 years worth of earnings, which is meant to smooth out the business cycle, which I don't think we have one of those anymore. But he's saying the long run average is 17. Now it's 41. In December of 1999, very close to the peak for stocks, it was 44. Dude, Speaker 1 (10:08) I'm Speaker 2 (10:09) sorry. What? Come on. He's not using this to time the burst of the bubble. He's just giving us the landscape. He's also citing the equity risk premium, which we'll get to in a second. Hold Speaker 1 (10:19) on. Number one, that's an erroneous landscape. I understand the concept of the CAPE ratio. You smooth out earnings to extend the business cycle, to look over a longer period of time. You inflation adjust it and you compare it to history. I understand what it's doing. But, and I'm not saying that stocks are cheap, so that's not what I'm saying. But when you are looking at today's earnings and they're being bundled with earnings from 2017, it's a different world. Speaker 2 (10:47) Okay, agreed. And, but can we also say, if there were to be some sort of a bubble in technology bursting, but it happened from a substantially lower valuation, probably the damage would be less. Speaker 1 (11:06) If there was lower valuations, we wouldn't even be using the B word. And I know you're going to get to Nvidia, but that's trading at what? 20 something times forward earnings? Meta is trading at 15 times forward earnings. So I reject that. Are the earnings Speaker 2 (11:18) definitely coming? So that's what he's asking. So he... He throws in the real equity risk premium, which is the expected pickup of return holding stocks versus inflation index treasury bonds. We're going to get to that one second. And he throws in the Buffett indicator, which is no longer really in use by anyone, probably not even by Buffett. But that's market cap to GDP ratio. Bill Speaker 1 (11:40) Dudley, you got to do better, sir. Speaker 2 (11:42) I would point out, though, it's not a little bit high. It's 240 percent. U.S. market cap of all stocks versus GDP. The stock market is selling 240 % of the GDP, the annual GDP of the country. So he's just setting the table that we're in a position right now where stocks are historically at a high valuation. I'm not saying – he's not saying sell because of that. He's just giving you the backdrop. Here's the meat. Speaker 1 (12:15) Okay, good. Speaker 2 (12:16) And he walks us through. Number one, the favorable impact of the AI investment boom on economic activity and earnings will likely diminish significantly in 2027. That's because what's relevant for growth is how much the investment is increasing, not its level. He is not saying the level of investment will fall apart. He's saying the increase in 26 over 25 is a much faster increase than what we're going to have next year. And I think that gets back to what I was saying about the anticipatory nature of how we price stocks. Can I ask – Speaker 1 (12:51) wait. Hold on. Can I ask a question about this part of it? I would love to. I think everybody knows that the percentage growth rate that we're seeing across the board is not sustainable. Earnings are not going to grow 20 % every single year. It's just not going to happen. So therefore, I think that that is not going to shock the market. I think that is very well baked into the pie at this point. Speaker 2 (13:17) Okay. What do you think? Not everybody has to agree with that. No, I'm Speaker 1 (13:21) asking your opinion. What do you think? Speaker 2 (13:22) I think that people get disappointed when growth rates slow down. Even if they see it coming while it's actually happening, they don't enjoy it. That's my personal opinion. Two, as the growth of investment spending slows, the growth in earnings of the hyperscaler suppliers will falter. Profit expectations will diminish. And as a result, PE ratios will shrink. See, this is the problem. Speaker 2 (13:51) The growth rate slows. The earnings growth slows. And then simultaneously, the multiple compresses. So you get hit twice. And that's without the bubble bursting. That's not earnings falling. That's just like earnings aren't as good. And also because people are less enthusiastic, people pay less for those earnings. I Speaker 1 (14:10) just think, not Speaker 2 (14:10) to Speaker 1 (14:10) nitpick every point that he's making, everything that you've said so far, I think is very much consensus, which is why. We've repeatedly spoken about the forward PE coming way in, even as earnings surge. Everybody is expecting this to happen. So Speaker 2 (14:25) what happens next? Speaker 1 (14:26) I don't Speaker 2 (14:27) know. I can't Speaker 1 (14:28) wait Speaker 2 (14:28) to find out. So his opinion is it's not good what happens next. So this is number three. As the investment cycle matures, the focus shifts, and now it becomes about the returns that the hyperscalers are expected to earn. on their massive investments everybody's getting the benefit of the doubt and not almost everybody's getting the benefit of the doubt right now with a few notable exceptions meta oracle okay um he says quote i suspect it will be difficult for the hyperscalers to generate sufficient revenue which he defines as two trillion dollars or more per year to generate the returns needed to justify an ai capital base that is likely to reach five trillion Reasonable? Not reasonable? Speaker 1 (15:11) I agree with everything he's saying. Will $2 Speaker 2 (15:14) trillion be good enough on $5 trillion? Josh, the max seven are up 2 % this year. Okay. He's talking about the suppliers more so than just the hyperscalers. But your point is well taken. Fourth, the supply of U.S. equities will increase due to the sharp rise in IPOs and the sale of equities by corporate insiders as lockup periods end. This should weigh on valuations. Okay. You could say it's consensus, but also it's true. Fifth, last point. The macroeconomic environment is likely to become more challenging. Speaker 1 (15:46) This is a former Fed chair. Speaker 2 (15:49) So we'll take his word that he's saying this honestly in his opinion, but he can't know this for sure. But this is his point. Real and nominal long-term rates have increased significantly this year. Yields on 30-year Treasury bonds are at the highest level since 07. The rise in yields puts increased strain on equity market valuations. The risks are tilted toward a further rise in yields given the lack of political will and progress to address the debt trajectory. Here's a chart. Here's the too much risk point. He's showing you the earnings yield in stocks, basically the earnings of the stocks, but like in the form of a yield relative to price. Like you would look at a dividend that's in black, and he's showing you the tips yield almost on its way toward meeting or possibly eclipsing that level. Last thing on this, and then I'll take your full comment. We'll give Bill Dudley the last word. In its early stages, the bubble's growth is self-reinforcing. The demand from the boom supports rapid profit growth, wider margins, and higher valuations. But on the downside, the feedback loop runs powerfully in reverse. Collapse in demand leads to a drop in cash flow and a re-evaluation of the risks of lending to support the bubble's further expansion. I expect AI will follow. the broad trajectory of the other great technology booms and busts like the railroad and the internet, AI will have a significant impact on productivity and growth. There will also be an inevitable glut of overcapacity that will weigh on profits and stocks. And this is the final chart. Speaker 1 (17:38) What he's showing here is Speaker 2 (17:40) interesting. This is the Wilshire 5000 index market cap. So let's just say this is the complete stock market, every category, unmoored from reality versus gross domestic product. It's not that – I guess the point here is we have never seen these two things this divorced from each other. It is a tremendous distance. between the growth in the market cap in dollar terms, which you see