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On CPUs, Oil & Securing Rare Earths
Agentic AI is proliferating, and to run AI agents requires way more CPU semiconductor chips than running chat boxes. Demand for CPUs is expected to skyrocket as a result, shifting the architecture of data centers. Today, Jackie examines the players and recent industry developments, including NVIDIA’s foray into the stand-alone CPU space. … Also: Oil prices have dropped on hopes that the US and Iran are nearing an agreement that will reopen the Strait of Hormuz. But if it doesn’t reopen soon, oil markets will be in dire straits. … And: Weaning America from dependence on rare earth minerals from China.
What Could Possibly Go Wrong?
The bull case for the stock market remains intact. The S&P 500 rose to yet another record high today. The economy and the labor market remain resilient. Consumers are spending. The AI boom is boosting capital spending. Corporate earnings are soaring on strong revenues growth and higher profit margins. The odds of a recession in 2026 fell to 19% today, the lowest reading of the year (chart). Stock prices are rising on FEMO (fabulous earnings momentum) rather than FOMO. We have been steadfastly bullish during the first seven years of our Roaring 2020s thesis. We still project the S&P 500 will rise over the final three years of the decade to 10,000. The fundamentals continue to support our stance. But a disciplined bull monitors the risks. Here are the ones we're watching: (1) Elevated valuation. The S&P 500 forward P/E is 21.2, and the forward P/S is 3.30 (chart). They are very high historically. That increases the downside potential of the S&P 500 in the event of a recession, which would clobber both earnings and the valuation of those earnings. We continue to bet on the resilience of the economy and earnings. All bets are off if a recession occurs. (2) Earnings exuberance. Analysts' consensus long-term earnings growth (LTEG) expectations for the S&P 500 is currently 22.4%, nearly double the 12.7% average of this measure since 1985 (chart). This is the highest reading on record, excluding the pandemic period. This suggests that earnings growth expectations are irrationally exuberant. This increases the likelihood of a meltup/meltdown scenario in the stock market. But unlike the Tech boom-and-bust of the late 1990s and early 2000s, we expect the economy to continue to grow, and that any sell-off will be yet another buying opportunity. (3) Bond Vigilantes and hawkish Fed. The Bond Vigilantes pushed bond yields higher earlier this month on concerns that the Fed wasn't being sufficiently vigilant about mounting inflationary pressures resulting from the spike in energy prices (chart). The hawkish April FOMC minutes released last week temporarily calmed the financial markets. The FOMC is likely to drop its easing bias and adopt a tightening bias at its June meeting. An unexpected rate hike at the July meeting (which we are expecting) could unsettle the stock market. (4) The war and oil prices. The latest Gulf War isn't over. Oil prices rose today after fresh US "defensive" strikes in Iran, renewing concerns about disruptions to commercial shipping through the Strait of Hormuz. If the shooting war starts again, oil prices might soar well above $100 per barrel. This would increase the risk of a 1970s-style stagflation scenario (chart). We expect that the US will maintain the blockade of Iran, forcing Iran to accept US peace terms. We could be wrong. (5) Concentration. Micron alone accounts for a staggering 51% of S&P 500 EPS growth revisions since February 27. On Monday evening, UBS raised its 12-month price target from $535 to $1,625, pushing the stock to $928.41, nearly three times its 200-day moving average of $319.34 (chart). Parabolic increases in stock prices tend to be reversed, which can take the entire stock market down if they account for an unusually large share of the market's capitalization. This time, the rapidly rising earnings shares of the high-flyers justify their astonishing price rallies. The SPMO momentum ETF, as a ratio of the S&P 500, stands at 1.99, at an all-time high, with momentum strategies as crowded as they have ever been (chart). Crowded trades tend to increase the risk of crowded panic sell-offs. (6) Mixed sentiment. The Investors' Intelligence Bull/Bear ratio was 2.00 this past week, just above its 1.93 long-run average (chart). So it is neither too bullish nor too bearish. Yet 54.8% of consumers expect stock prices to be higher in 12 months, well above the long-run average of 35.5%. That's the most bullish reading on equities outside of the recent highs (chart). From a contrarian perspective, that's bearish. With household wealth increasingly tied to equity portfolios, a market sell-off would trigger a negative wealth effect more quickly and sharply than in prior cycles. That could cause consumers to retrench, resulting in a recession. (7) Funky private credit. Private credit ETFs have been in a clear downtrend since 2021 (chart). Major private credit managers, including BlackRock, Apollo, and Ares, have enforced 5% quarterly redemption caps as withdrawal requests swell. Investors wanting out are being queued. Illiquid loans inside semi-liquid vehicles are a risk worth watching. In the past, credit crunches have caused most recessions. (8) Monster IPOs. SpaceX is expected to price the largest IPO in history around June 12, with the company valued at north of $1.75 trillion. Further, the company cited a total addressable market of $28.5 trillion, larger than the entire US economy, in its S-1. Of that, $22.7 trillion is attributed to AI enterprise applications. The deal's 4.29% float is deliberately small, generating an estimated $42 billion shortfall between index demand and available float as SpaceX seeks fast-track index inclusion. Passive and active managers benchmarked to the S&P 500 would need to sell existing large-cap holdings to make room for that deal and for the gigantic IPOs of OpenAI and Anthropic. (9) AI is too expensive. Last but not least, there is the possibility that AI is a bubble that will burst. Our main concern currently is that agentic AI is a budget buster. Microsoft recently decided to pull Claude Code licenses from thousands of its engineers, highlighting a massive, looming economic challenge for large-scale enterprise AI adoption: the raw cost of token-based billing. Unlike traditional corporate software—where a seat license costs the same whether an employee uses it for an hour or a week—advanced generative AI operates like a metered utility. Every line of code analyzed, debugged, or rewritten consumes tokens. Because adoption skyrocketed, Microsoft reportedly burned through its entire annual AI pilot budget for that division in just a few months. AI is supposed to cut labor costs, increase productivity, and boost profit margins. There is another side to this story. Stay tuned and stay nimble.
On AI’s Complex Pricing, South Korea’s Good Fortune, And S&P 500 NERIs
Pricing for AI services is becoming increasingly complex as AI becomes increasingly agentic. That takes much more computational power than fetching answers. Melissa discusses how AI pricing works, surmising that the winning AI providers won’t be those with the smartest models but those that use “tokens” the most cost effectively. … Also: William discusses the vulnerability of the South Korean stock market and economy. They’ve been soaring on the wings of AI with little underlying broad support. … And: Joe shares his takeaways from updates of our Net Earnings Revisions Index and Net Revenues Revisions Index.
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