A Turnaround for Tech? | With Jim Welsh
Audio Brief
Show transcript
This episode covers Jim Welsh and Maggie Lake discussing the growing disconnect between massive AI capital expenditures and recent stock performance, along with the specific economic supports keeping the recession narrative at bay.
There are four key takeaways from their conversation.
First, investors should monitor the shrinking capacity for stock buybacks among tech giants. There is a structural shift occurring where massive AI capital expenditures are absorbing a greater share of free cash flow. Historically, this cash flow funded stock buybacks that provided a floor for share prices. As hyperscalers prioritize infrastructure spending over returning capital to shareholders, this critical support mechanism for the stock market is beginning to vanish.
Second, the US economy remains resilient primarily due to the wealth effect. The top ten percent of earners now account for fifty percent of consumer spending, meaning high stock and housing prices are directly fueling economic activity. While this keeps the economy afloat for now, it creates a fragility where any significant drop in asset prices would likely trigger a deeper and longer recession than usual.
Third, high valuations alone are not a catalyst for a market sell-off. Welsh argues that markets require a specific reason to sell, such as a labor market shock or an external threat, to drive prices down. Without a clear trigger, even historically overvalued markets can continue to drift higher or sideways, fueled by the buy the dip mentality.
Finally, technical indicators suggest a counter-trend move for both the US Dollar and Gold. Despite mainstream narratives predicting the demise of the dollar, sentiment has become too crowded, signaling a potential base and intermediate rally for the currency. Conversely, Gold has made a parabolic move and is due for a necessary cooling-off period or consolidation before its next major leg up.
In summary, investors should prepare for a potential rotation in market leadership as AI spending crowds out buybacks and currency trends look set to reverse.
Episode Overview
- Jim Welsh and Maggie Lake discuss the current state of the stock market, specifically addressing the disconnect between massive AI capital expenditures and recent stock performance ahead of Nvidia's earnings.
- The conversation challenges the recession narrative, outlining specific economic supports—such as the "wealth effect" and government deficits—that are keeping the US economy resilient for now.
- Welsh provides technical analysis on the US Dollar and Gold, predicting a counter-trend rally for the Dollar and a necessary cooling-off period for Gold after its recent parabolic move.
Key Concepts
- The AI Spending "Valley": There is a growing divergence between the massive capital expenditure (Capex) by hyperscalers (like Amazon and Google) and their stock performance. Investors are beginning to demand a Return on Invested Capital (ROIC) which hasn't materialized yet, creating a "valley" where costs are high but profits haven't caught up.
- Cash Flow Crowding Out Buybacks: Historically, tech giants used free cash flow to fund massive stock buybacks, providing a floor for stock prices. As AI Capex absorbs more of that cash flow (and some companies even turn to debt), the capital available for buybacks is shrinking, removing a critical support mechanism for the stock market.
- Valuation is Not a Catalyst: While market valuations are historically high, Welsh argues that high valuation alone never causes a sell-off. A market requires a specific "reason to sell"—usually a recession or a labor market shock—to trigger a decline. Without that trigger, overvalued markets can drift higher or sideways.
- The Wealth Effect Dependency: The US economy is currently heavily reliant on asset prices. With the top 10% of earners accounting for 50% of consumer spending, high stock and housing prices are directly fueling economic activity. Conversely, a significant drop in asset prices would likely trigger a deeper recession than usual due to this dependency.
- Sentiment as a Contra-Indicator: Welsh highlights "magazine cover indicators" (specifically a Barron's cover predicting the death of the Dollar) as a sign that a trend has become too crowded. When a narrative hits mainstream covers, it often signals the trend is exhausted and ready to reverse.
Quotes
- At 6:11 - "Valuation isn't a reason to sell. And the market doesn't go down unless there is a reason to sell... in order to get people to pull back from that behavior [buying dips], something has to threaten them." - Explaining why high P/E ratios alone won't crash the market without an external economic shock.
- At 9:00 - "The spending has reached a level that it's absorbing a greater and greater share of cash flow... that cash flow not only funded the AI spending but it also funded... an enormous amount of stock buybacks. So as that cash flow starts to dwindle, one of the big supports under the market... is shrinking." - Identifying a structural shift in market mechanics where AI costs reduce the capacity for stock buybacks.
- At 11:42 - "The top 10% represent 50% of consumer spending... As long as the market stays healthy, that's not going away." - Clarifying why the economy remains robust despite struggles in the lower 50% of income earners.
- At 14:45 - "We have this dependence on asset values to sustain spending... if and when we see a meaningful pullback in housing values... that's going to make a recession deeper and last longer." - Highlighting the long-term risk of an economy built on asset appreciation rather than organic wage growth.
- At 19:43 - "Any time you see a cover on a magazine you have to take a step back and say whoa, there's a yellow light flashing here and it's time to pay more attention as to whether or not the trend... is ready to reverse." - Teaching how to use extreme sentiment and mainstream media headlines as a signal to look for market reversals.
Takeaways
- Monitor the "Buyback Window": Be cautious with big tech stocks over the next 12-18 months; as companies prioritize AI infrastructure spending over stock buybacks, a major source of buying pressure will vanish. Watch cash flow statements to see if buybacks are being sacrificed for Capex.
- Prepare for a Dollar Bounce: Despite the "death of the dollar" narrative, technicals and sentiment suggest the US Dollar is forming a base and is poised for an intermediate rally. Adjust portfolios to account for a stronger dollar, which typically acts as a headwind for commodities and international equities.
- Wait for Gold Consolidation: Avoid chasing Gold at current highs. The recent parabolic move suggests it needs to enter a corrective phase (Wave 4) or a long period of sideways consolidation before the next major leg up. Use this time to identify entry points lower rather than buying the peak.
