The bogeyman of AI stocks has been summoned.

In late January, Chinese artificial intelligence company DeepSeek released an open source Large Language Model rivaling OpenAI’s ChatGPT, Google’s Gemini and Meta’s Llama.

The LLM, which was supposedly developed in only a few months with a budget under $6 million, is significantly more efficient than competitors and, consequently, 20 to 50 times cheaper to use than OpenAI’s o1 model.

The stock market’s reaction to the DeepSeek release was immediate, and, for a hot minute, there was blood in the streets on stocks even tangentially related to AI.

Tech darling Nvidia’s (NASDAQ: NVDA) shares plummeted nearly 18%, marking the largest single-day loss in its history and setting a new record for the biggest one-day loss for a single company in U.S. stock market history, erasing approximately $465 billion from Nvidia’s market cap.

The day’s other big losers included Vistra Corp (NYSE: VST), an electricity generation conglomerate with significant nuclear power holdings, and Arista Networks (NYSE: ANET), a purveyor of (among other things) cloud networking services for large AI data centers.

As if that wasn’t enough for the poor, beleaguered markets …

… after a small bounce back, additional volatility hit the market later that week as President Trump announced tariffs on trade with Mexico, Canada and China.

The tariff threat was later rolled back (for now) … but many retail investors are still reeling from the amount of uncertainty injected into the markets in a relatively short period.

So what’s the best way to take advantage of the trend?

3 Ways to Play a Crazy Market

If you’re looking to protect your portfolio while still capturing upside, you have a few options.

1. Defend

When markets get choppy, stable, dividend-paying stocks could help smooth out the ride.

Companies that sell essential products or services like food, beverages, and personal products tend to weather stock-market hurricanes with a reassuring stability.

Johnson & Johnson (NYSE: JNJ) is a classic example. With its mix of pharmaceuticals, medical devices, and consumer health products, JNJ has reliably provided investors with a port in the storm for decades.

Plus, with a 3% dividend yield and a low beta of 0.55, it provides reliable income and lower volatility — an excellent safe harbor in turbulent times.

Another “classic” example would be one of Warren Buffett’s favorite investments — Coca-Cola (NYSE: KO). This beverage behemoth has provided Buffett with stunning returns in the vicinity of 2,437% over the last few decades … while providing up to $700 million in dividends annually.

Neither stock dramatically outperforms the S&P until you zoom your chart out to 30+ years … but then again, the S&P doesn’t pay dividends.

If you are looking for longer-term, reasonably reliable gains while also receiving an income from dividends, playing “defense” could be a good strategy for your portfolio.

2. Parry

In fencing terms, a “parry” is a move that both defends and sets up for an attack … and that might be just the right move for a certain type of investor when the market’s going nuts.

This type of investor might consider using that volatility to their advantage by “buying the dip” when a high performing stock with solid fundamentals suddenly lurches downward.

In the DeepSeek panic noted above, several solid companies plunged more than 15% … but a few days later two of the three had rebounded as much as 20% from trough to peak.

Investors who kept their wits about them during the chaos of trading on January 28 had the opportunity to pick up some well performing, large cap stocks at a pretty decent discount and see an immediate ROI.

This is a more aggressive play, so be cautious as you are doing your due diligence on a potential investment; more than one investor has bled trying to catch a falling knife.

3. Attack

The most aggressive play — the high risk, high reward option — is to lean into the volatility and try to seek out an aggressive growth stock in the sector that’s primed to deliver outsized returns.

For example, President Trump’s outspoken desire to unleash American energy as a tool for American prosperity has the potential to dramatically affect the domestic oil and gas landscape.

His “Drill, baby, drill!” rhetoric hasn’t yet moved the needle for major producers like Chevron (NYSE: CVX), Occidental Petroleum (NASDAQ: OXY) or ExxonMobile (XOM) … but some smaller producers like Prairie Operating Co. (NASDAQ: PROP) have seen dramatic double-digit stock growth over the last month.

The growth isn’t the only thing dramatic about Prairie’s chart. The more observant readers will notice that the swings between company’s peaks and troughs are significantly larger than the bigger producers … but in that volatility lies the potential for what could be explosive growth.

Warning: Math Ahead

As of this writing, the stock is sitting around $8.60 with a $197.38 million market cap. The company released a 2025 EBITDA forecast between $100 million and $140 million and capex estimated at roughly $100 million for 2025. Additionally, the company has relatively low debt.

Based on a valuation formula called the Enterprise Multiple, some back-of-the-napkin math indicates that the company is currently trading at a 1.58x-2.21x multiple.

What does this mean?

It suggests that PROP is potentially undervalued compared to its peers — trading at a relatively low multiple compared to the broader oil and gas industry, which typically sees EV/EBITDA multiples between 4x and 8x.

If the company’s stock starts trading more in line with the industry average, the market cap could shoot up anywhere between $396 million to $1.096 billion.

That’s a huge range … and it’s not guaranteed that Prairie will ever hit those lofty heights.

But with Trump shouting from the rooftops that American energy is going to see a renaissance … this company could potentially be an aggressive investor’s vehicle to fairly significant returns.

The bottom line?

No matter how you choose to play market turmoil — defend, parry or attack — volatility isn’t necessarily something to fear …

… It’s something you could potentially profit from.

Make a plan, do your due diligence, then execute.

It’s a sad commentary on the state of the US economy.

We wrote about it in an earlier post…

Not so long ago, when the US economy was a value-based engine, the stock market could be considered a decent measure of economic activity.

Manufacturing companies who produced and sold more products earned more money. And investors in those companies were rewarded with higher share prices and often dividend payouts.

Everyone’s a winner.

Today we no longer live in a traditional value-based economy. Sure, we have industries that produce stuff that’s sold here and around the world. But more and more that continues to change.

Today, and for the past roughly 50 years, the stock market has turned from a measure of an industrial economy into a tool of financial elites.

A means to make money from money. Period.

The latest chapter appears to have finally hit home.

A Shadow of Its Former Self

Originally formed in 1901, US Steel (X) became the first $1 billion company and was one of the key drivers of the US’ global economic dominance during the era.

Global advances in steel production technology, however, soon saw US Steel’s market dominance fade.

In 1991, X was removed from the Dow Jones Industrial Average after 90 years.

Today the company is only one of four major US steel manufacturers and ranks third in both steel production (as of 2023) and market cap. According to Reuters:

U.S. Steel has reported nine consecutive quarters of falling profits amid a global downturn in the steel industry.

And that has come while protective tariffs from the last two administrations have been in force — an attempt to level the price playing field against none other than China who dominates the steel production industry today.

Over a year ago, however, a major suitor turned up knocking on US Steel’s door. Nippon Steel (NPSCY), Japan’s largest steel producer made an overture to acquire US Steel and in December 2023 a tentative deal was announced.

Nippon Steel bid $14.9 billion for a company that’s only worth $6.9 billion today. They also offered, “a last-ditch gambit to give the U.S. government veto power over changes to output.”

No luck…

Just last week, President Biden officially blocked the acquisition citing national security concerns. (Full disclosure: President-Elect Trump promised to do the same thing.)

US Steel stock dropped 6.5% on the news. Over the past year, the company is down over 36%.

It’s understandable that the US would want to protect one of its key industries from foreign ownership.

The problem (and sad reality) is the steel industry is not so important in the US anymore.

The other reality is that Japan is a close ally of the US, not an adversary.

Over the past decades, the US has seen the vast majority of its steel producing capability offshore itself overseas. (Not unlike the semiconductor industry.)

Another reality is that to reclaim it today, would be a tall, if not impossible, order.

Given the importance of the industry, maybe some form of “ally-shoring” would be a viable solution to rebuild an industry…

The FOMC is closed out 2024 this week.

While humbly bragging that inflation is well under control, they’ve set off in search of more “neutral” interest rate levels to ward off any slowdown in the economy.

Most media will tell you that they have spectacularly engineered the elusive “soft landing.” And that you don’t realize how good you’ve got it!

Others would beg to disagree..

They’ll point out Donald Trump won the White House in pretty amazing fashion based on the fact that Bidenomics and the economy it created both sucked.

Each camp comes to their conclusion based on the measuring stick they use.

And there’s more than one way to measure an inflation monster…

Welcome to “Sticky-ville”

As if there weren’t enough ways to demonstrate how badly the economy is treating you, the Atlanta Fed itself has devised another. It’s called the Sticky-Price CPI.

What is that?

The Atlanta Fed started tinkering with this measure nearly ten years ago. The idea behind it is that some items in the CPI basket change very rapidly in response to economic factors (they’re known as “flexible”) while other items change much more slowly (they’re “sticky”).

The big question on everybody’s mind was whether either of these groups was a better predictor of different drivers of inflation. In other words, was either one a better forecast tool.

After examining the data for a bit, they discovered that half of the categories change their prices every 4.3 months. So they used that as their cut off.

Items with prices that changed more frequently (like, say, tomatoes) were dubbed “flexible” while those that moved less frequently (like coin-operated laundries) fell into the “sticky” basket.

When you plot the two categories, they look pretty much like you’d expect:

But the trillion dollar question was still was either basket a better predictor?

To determine that, they dove into some high-level math. They used something called the root mean squared error (RSME) which is a statistical way to measure how accurate a prediction is.

They compared the RMSE of each basket to the RMSE of the forecast produced from the headline CPI at intervals of one month, three months, 12 months and 24 months out. (We’ll skip the boring math discussion.) What you need to know is that according to the Fed…

A relative RMSE less than 1.0 indicates that the alternative proxy for inflation expectations is more accurate than the headline CPI.

The results were undeniable.

The one month forecasts were all about equal. But, starting with three months out, the sticky and core sticky baskets proved to be better forecasters. And they became even better predictors the further out they went.

Forecasting Trouble

So what are they showing as the FOMC’s year came to a close?

The Atlanta Fed’s sticky-price consumer price index (CPI)—a weighted basket of items that change price relatively slowly—rose 2.4 percent (on an annualized basis) in November, following a 3.6 percent increase in October. On a year-over-year basis, the series is up 3.8 percent.

On a core basis (excluding food and energy), the sticky-price index rose 2.4 percent (annualized) in November, and its 12-month percent change was 3.9 percent.

The year-over-year numbers are double the Fed’s “mandate.”

While their “preferred” inflation gauge, the PCE index, is showing headline inflation around 2.3%, other measures like core CPI which hasn’t been below 3% since April 2021, suggest that things are still not under control.

And considering the Atlanta Fed’s sticky forecasting tool, it may not be for a while.

We suppose that on occasion it may seem like we’re obsessed with predicting Armageddon.

We cite sky-high stock valuations.

We talk about the fact that the strength in the market has largely been driven by a handful of mega-tech/AI stocks.

We point out economic realities (and the Fed interventions they prompt) that don’t support the case for a stampeding bull market.

Our only goal in offering these observations is to make you, our readers, aware of the realities attached to the stock market (and to a larger degree, the economy). It’s important to know these things because we believe that you don’t always get the unvarnished truth (occasionally not even the “varnished” truth) from the mainstream.

For example… A few months ago in August, the Bureau of Labor Statistics released its 2024 preliminary benchmark revision.

Each year, the Current Employment Statistics (CES) survey employment estimates are benchmarked to comprehensive counts of employment for the month of March. These counts are derived from state unemployment insurance (UI) tax records that nearly all employers are required to file. For National CES employment series, the annual benchmark revisions over the last 10 years have averaged plus or minus one-tenth of one percent of total nonfarm employment. The preliminary estimate of the benchmark revision indicates an adjustment to March 2024 total nonfarm employment of -818,000 (-0.5 percent).

In plain English, once a year the BLS adjusts its jobs totals against state unemployment tax records (a more accurate number than their monthly guess). This past March the 12-month jobs number had to be revised down 818,000 jobs. That’s five times the average of the last 10 years.

Things aren’t as rosy as they’ve been letting on.

In the reality of our financialized economy, this is business as usual. But that doesn’t mean you shouldn’t be aware of it.

So we point out the bad stuff. To make sure you have all the facts at your disposal.

But that doesn’t mean we’re looking forward to the doom and gloom. The bigger reality is…

Stocks are a Bullish Phenomenon

The primary direction of the stock market is up!

In fact 80% of the time the market is in a bull trend.

It’s always the corrections (“calamities”) that get the news coverage. But stocks, as a whole, have always come back. Let’s go back 40 years for an example…

In October 1987 the market experienced one of the most spectacular crashes in modern times. After putting in a rebound high on October 2, the market gave up roughly 35% of its value in just 12 days. (Actually, the majority of the crash came in only five days!)

S&P 500 – The October ‘87 Crash

It shook investors’ confidence for months. It led President Reagan to establish a group called the President’s Working Group on Financial Markets (known colloquially as the “Plunge Protection Team”).

But once the shock had worn off, the market started to rebound. And within two years, it had eclipsed its previous all-time high in 1987. (Meaning that those who were buyers during the bottoming period made somewhere around 50% on their money.)

Some declines (and subsequent rebounds) take longer than others.

The tech wreck of 2000 — sparked by the “new paradigm” of paying multiples for companies with zero earnings — took the better part of two years to find its bottom.

But it eventually did.

Today the S&P 500 is 1,700% higher than its high in 1987…

It’s 290% higher than its high in 2000…

It’s even 79% higher than its high in 2020…

Patience is the Thing

There’s a saying about the market that goes, “It’s better to be out when you want to be in, than to be in when you want to be out…”

Bear markets, especially those that happen in a hurry (i.e. crashes), can take their toll on investors’ nerves.

And there’s always the question of how long before it resumes its upward path. (And relative to an investor’s cost basis (the price where you’re in the market) that can try an investor’s patience as well.)

But given time, the market always rises.

Legendary NYSE commentator Art Cashin once said…

“Never bet on the end of the world because that only happens once and something that happens once in infinity is a long shot.”

Our goal is to give you all the unvarnished info out there.

But we’re not betting on the end of the world.

Here’s to a great 2025!

“All the Whos down in Whoville liked Christmas a lot.

But the Grinch, who lived just north of Whoville, did not!”

– Dr. Seuss

The annual holiday classic, that we’ve all seen a million times, tells the story of a nasty green cave dweller who tries to stop Christmas.

Despite the fact he eventually learns the true meaning of Christmas and saves the day, his name has become synonymous with being cynical or mean-spirited.

Well, since the holiday season is at hand, we want to say up front that we really don’t mean to be a Grinch about the markets.

But given we feel it’s our duty to show our readers the unvarnished investing truth, here’s a development you need to know…

Recalling the “Value Master”

A couple weeks back, we took note of the fact that none other than Warren Buffett — mister buy and die — had become a net seller in the stock market.

Buffett, who still actively manages Berkshires’ portfolio, has been a net seller of stocks for the past eight quarters, significantly rearranging his portfolio. …

Add it all up and Buffett has raised Berkshire’s cash position to $320 billion versus just $272 billion in stocks.

We speculated on the reasons for this notable shift in sentiment:

Is the Oracle calling a top? It’s certainly not impossible. Buffett is the king of buying value — great companies fairly priced. If valuations are exceeding what he deems reasonable, he may be building a cash store to take advantage of a major correction.

We also noted that Buffett is not a market timer. So the fact that he’s unloading now doesn’t suggest that anything is imminent. Better to be out when you want to be in instead of in when you want to be out.

But given our speculation, we found a recent analysis of the market’s overall valuation to be worth noting. But first…

A Little Primer On Valuation

When you buy a stock, you’re basically buying a piece of the company’s expected future earnings. And the price you pay today should reflect a discounted value of that. So in basic terms, price should be a fair reflection of value. But that’s not always the case.

Comparing the price of a company’s stock to its earnings (price-earnings or P/E ratio) is the most common way of establishing valuation. Below is an historical chart of the P/E ratio of the S&P 500:

You can see that for over 100 years, valuations basically oscillated around the long-term mean with a dip 50% below indicating undervalued and rise to 50% above indicating overvalued. Then, however, came the tech bubble and valuations became both extreme and extremely volatile.

Another, more smoothed measure, is known as the cyclically-adjusted price-earnings (CAPE) ratio. (It’s also known as the Shiller PE Ratio for the economist Robert Shiller who invented it.) This ratio measures price to earnings except instead of using a single year of earnings, it uses average real earnings over a 10-year period. This smooths out volatility as a result of business cycles.

You can see this measure smoothed things out considerably leaving only two overvaluation spikes: before the crash of 1929 and the bust that followed the tech bubble… until today.

Today valuations according to the Shiller ratio are at their second highest levels in history.

But there’s yet one more level of smoothing that can be done…

It comes from Damien Cleusix of QuantasticWorld and it’s called the margin-adjusted, cyclically-adjusted price-earning ratio (MAPE).

MAPE factors in and adjusts for the level of profit margins embedded in the valuation calculation.
And by this measure the market isn’t just overvalued… It’s insanely overvalued. According to Cleusix “the US stock market is the most overvalued it has ever been.”

Looking at this chart, the sky-high valuations (the level traced in green) are obvious. Further, if you construct a band with boundaries between the 0 and 50 percentiles of historical MAPE, this is what you get:

According to Cleusix:

The S&P 500 is currently almost 400% above the level corresponding to a bottom MAPE and 130% above the 50% percentile MAPE history.

Valuations at the high end of any measure suggest that an investment is “priced for perfection” — that earnings and growth will continue ad infinitum. And that leaves the door open for any kind of disappointment to send prices plummeting back to more “reasonable” valuations.

Like we said, we don’t want to be Grinchy this close to the holidays. But being aware of the potential threats to the market (and the bad news that could result) is the key to actually having a merrier Christmas!

The US consumer is the bedrock of our economy.

If that’s truly the case — (and it is) — then signals are flashing everywhere that the economy is headed for trouble.

Case in point…

The Tylers over at ZeroHedge reported:

Bloomberg Intelligence’s Joel Levington published a new report Monday, citing new data from CarEdge that showed a staggering 39% of vehicles financed since 2022 carry negative equity, including 46% of EVs…

What this basically means is that balances on people’s auto loans are more than the value of the vehicle they’re paying on.

Now falling car values shouldn’t come as a surprise to anyone.

A car is not an asset in any “investment” sense of the word. It’s a means of transportation.

In the world of business, vehicles are recognized as “depreciating assets” (over the “useful life” of the vehicle) on a business’ taxes. They have a tax-reducing effect on their bottom line.

Depreciation refers to the decrease in value of long-term assets over time. Depreciation is spread over the useful life of the asset and is intended to realistically reflect the actual value of the asset and the profit. Furthermore, it is designed to have a tax-reducing effect. Depreciation of vehicles is done on a linear basis, meaning the vehicle’s value is evenly spread over its useful life. The vehicle’s useful life plays a crucial role in this process. The amount of depreciation depends on the purchase price and the vehicle’s useful life.

There’s a maxim that says cars depreciate by over 10% the minute you drive it off the dealer’s lot. So you’re pretty much starting in the hole.

So, again, the fact that the value of American’s cars are falling shouldn’t be any surprise. What is troubling is the fact that consumers still owe so much on their vehicles.

Consumers Are Sinking Fast

The Federal Reserve just reported that the average finance charge for a new car in Q3 2024 was 8.76%! But that’s not the really shocking part. What really catches your attention is that’s the rate being charged for a 72 month loan!

Six years to pay off a car? Not long ago four years was pretty much the financing limit.

The problem stems from a combination of factors.

Back during the pandemic stimulus spree, the extra free money (not to mention the near zero financing cost) at the time made trading in the old car seem like a good idea.

The stampede to the local car dealer (along with the supply fiasco) drove new car prices through the roof.

Source: Federal Reserve Bank of St. Louis

After some 20-plus years of relative price stability in the new car market, prices exploded by over 20% in a span of three years thanks to all the “free” money.

Today, thanks to the sharply higher prices, auto loan balances rose by $18 billion in the last quarter alone, and now stand at $1.64 trillion — the highest category of non-housing debt.

These unaffordable prices are what’s behind the longer and longer financing terms.

Further according to Experian 33% of monthly car payments stand between $500-$700 per month. And, hold on to your hats, over 16% are over $1,000.

This would be fine if everyone could afford it. But 90-plus day delinquency rates on auto loans just upticked again to 4.6%. (Which might not seem bad compared to credit card delinquencies which have reached 11.1%!)

There’s an idea floating around that the economy is doing just fine.

But when you look past the headlines (and you don’t have to look far) you can see the strains building.

It’s a legacy that’ll likely end up being studied in grad school business books for years to come.

But whether it’s a story of success or failure remains to be seen.

In its 50-plus year history, Intel has gone from the world’s dominant semiconductor chip producer to verging on the edge of failure.

Not necessarily a reputation you like to hang your hat on.

In our last post, we said the government tends to make bad decisions when it comes to ~~spending~~ investing your money. Early this year, Intel put in and received the promise of a big chunk of Chips Act money to help build new fabrication and research facilities in Arizona.

If only $20 billion were the solution to all Intel’s problems.

The Big Arizona Bet

By way of a little background, Intel has committed to building two state-of-the-art fabrication plants (known as “fabs”) in Chandler, Arizona that will employ the company’s latest chipmaking process known as “18A.”

That number describes a 1.8 nanometer-class chip that would effectively compete with the 2nm and 3nm chips currently produced by Taiwan Semiconductor Manufacturing (TSM) — the world’s biggest contract fab.

Intel’s plan is to further compete with the likes of TSM by splitting their business into design-side and the manufacturing-side entities. CEO Pat Gelsinger explained In a recent company memo:

A subsidiary structure will unlock important benefits. It provides our external foundry customers and suppliers with clearer separation and independence from the rest of Intel. Importantly, it also gives us future flexibility to evaluate independent sources of funding and optimize the capital structure of each business to maximize growth and shareholder value creation.

Some prospective customers have taken note.

Amazon Web Services recently cut a deal with Intel to co-invest in a custom chip design based on the 18A platform for its servers. The deal was “a multi-year, multi-billion-dollar framework,” according to the press release.

On paper, this all sounds like a step in the right direction. Except the road ahead is anything but smooth. Fortune recently reported:

Meanwhile, costs for Intel’s planned Arizona fabs and two more in Ohio have soared past initial projections. The Arizona plants, which Intel is counting on having online in 2025, have been hit by construction delays.

Which has impacted the availability of $20 billion from the Chips Act:

In March it was awarded $8.5 billion in direct CHIPS funding and $11 billion in loans. But the money is tied to Intel hitting certain construction milestones, and it has yet to receive any funds.

And if that wasn’t enough…

And in September, Reuters reported that Broadcom, which makes networking and radio chips, had tested Intel’s process and concluded it was not yet ready for full production.

According to the WSJ: “Intel’s manufacturing arm is money-losing and hasn’t gained strong traction with customers other than Intel itself since Gelsinger opened the factories to outside chip designers three years ago.”

Completing the business split and getting the new fabs into production are critical for Intel’s future success.

White Knights to the Rescue?

Just two weeks ago, rival chip manufacturer Qualcomm approached Intel to discuss a possible takeover.

Intel’s stock popped. Qualcomm’s took a hit.

That’s because the deal would be a major financial stretch for QCOM.

The deal would be valued significantly above the amount of cash Qualcomm has on its balance sheet and would require taking on significant debt or diluting the company’s shareholders. This deal is viewed as a longshot at best.

Not long after the Qualcomm news broke, Apollo Global Management approached Intel with another offer to support their turnaround efforts:

Bloomberg reported, citing sources familiar with the matter, that Apollo recently proposed an equity-like investment of up to $5 billion to Intel’s management. The people said Intel execs were mulling over the proposal. There were no definite, as the investment could change or fall apart.

And there’s more good news coming from the government…

The Biden-Harris Administration announced today that Intel Corporation has been awarded up to $3 billion in direct funding under the CHIPS and Science Act for the Secure Enclave program. The program is designed to expand the trusted manufacturing of leading-edge semiconductors for the U.S. government.

This is a DoD targeted program that’s separate from the other $20 billion that’s stuck in limbo.

Can They Be the Comeback Kids?

Intel has a history of being on the wrong side of industry trends. (Like when it opted not to provide Apple with chips for its iPhone and ignored its GPU division as Nvidia was making inroads into the AI trend.)

Yet there’s always hope to right the ship.

Meta managed to do it — with a disciplined program of slashing costs and refocusing on its core business — after a disastrous investment in the metaverse that cost them three-quarters of their market cap in a little over a year.

But can Intel?

Given their history in the chip business, they’ll certainly be a stock to watch…

Is the end of AI at hand?

For the past several years, tech heavyweights have been pouring billions into AI development. According to CNBC:

…they’re all racing to integrate generative AI into their vast portfolios of products and features to ensure they don’t fall behind in a market that’s predicted to top $1 trillion in revenue within a decade.

It’s been full steam ahead, and a lot of investors have profited handsomely.

But has the race to dominate that $1 trillion market gotten ahead of itself?

Some analysts are saying yes — and they’re making some reasonable arguments to back them up…

The Case for a Cool Down

Let’s start with Goldman Sachs’ Senior Macro Strategist Allison Nathan. She recently released a client note suggesting the benefits gained from AI weren’t justifying its current costs.

The promise of generative AI technology to transform companies, industries, and societies continues to be touted, leading tech giants, other companies, and utilities to spend an estimated ~$1tn on capex in coming years, including significant investments in data centers, chips, other AI infrastructure, and the power grid. But this spending has little to show for it so far beyond reports of efficiency gains among developers.

Billion dollar solutions… that aren’t saving billions of dollars.

Analyst Brandon Smith…

There is no evidence of a single benefit to AI on a broader social scale. At most, it looks like it will be good at taking jobs away from web developers and McDonald’s drive-thru employees.

And the costs to train AI haven’t slowed.

Researchers at Epoch AI discovered the “cost of the computational power required to train the models is doubling every nine months.”

So has AI overpromised on its future?

In a word… No.

And should investors be concerned about these projections?

That’s a little more complicated. That answer comes in two parts.

Don’t Fade the “Bubble”

Back in the late 1990s, any tech company with even a remote connection to some aspect of the internet was being bought hand over fist. Regardless of whether or not they had produced dollar-one in revenue… or even had a viable business model!

It was the “new paradigm” of investing.

Everyone knows how that ended.

Today, the companies involved in the AI race are all trillion (or near-trillion) dollar companies. Nothing like the “wish and a hope” companies from the 90s.

That makes the AI rally more substantial.

So if you’re invested in AI-related firms and your shares are still headed higher…

Don’t fade the bubble.

It may be a bubble, but bubbles still make people a lot of money.

What’s important is to be aware that it is a bubble. What crushed everyone during the tech bust was the absolute certainty that “this time it’s different.”

It never is.

So that’s number one. The second point, and this is even more important, is to…

Understand the “Long Game”

AI has been a “thing” since the 1950s. But only recently has the technology to actually produce large scale AI applications become available.

That means the industry is just starting to evolve.

Some AI applications will undoubtedly tank. Others, however, that can prove their value will be adopted by the market. And those companies will see exponential growth.

This means that going forward you don’t want to think of AI in general terms. You want to consider it in terms of specific areas of application. Areas where serious ROI could actually be realized.

One area that comes to mind is the healthcare industry.

The healthcare system is plagued by massive inefficiencies: From skyrocketing administrative costs (thanks to a largely broken billing and payment system) to poor patient outcomes that are the result of fragmented treatment and care coordination.

Studies in the National Library of Medicine suggest that if the problems of uncoordinated care, redundant tests, and adverse drug events could be resolved it could save the industry as much as $240 billion.

Other estimates have been bigger:

According to research highlighted by Forbes, a quarter of US healthcare spending — almost $1 trillion — is wasted on inefficient or unnecessary patient care. Operational inefficiencies represent a tremendous opportunity for healthcare organizations to increase their retained earnings while bringing in the same revenue.

A number of huge players understand this and have started investing billions to stake claims in the industry.

One example is none other than Google Health. This division of Alphabet is actively developing AI solutions for medical imaging analysis and diagnostics, predictive modeling and health research.

Another player in the current healthcare market is global conglomerate GE Healthcare. They are now working with AI to develop not only diagnostics systems but also patient monitoring systems and hospital operations management tools.

Cerner Corporation (a subsidiary of Oracle) is developing models for clinical decision/pedictive support. They are also focusing on electronic health record (EHR) solutions, revenue cycle management and other operational efficiencies.

But these are all billion dollar companies (trillions in the case of Google) and returns based on their advances in healthcare AI would be tough to realize. To really get a bang for your investment buck, savvy investors should research solid, smaller-cap companies for whom a breakthrough in the market could be transformative.

Tim Collins, Senior Analyst at Streetlight Confidential, recently wrote about a company that fits that description — Healwell AI.

Healwell AI is a small Canadian company that has developed strategic partnerships with seven medical tech companies all working on AI solutions including:

• Solutions that will allow physicians to rapidly screen and identify patients with rare diseases to facilitate more personalized treatment.

• The development of state-of-the-art EMR or EHR (records management) solutions…

• AI technologies that enable earlier diagnosis and treatment and improved quality of life for the patient

• Applications to target patients that are eligible for specifically approved medications or interventions that can vastly improve patient outcomes…

They’ve also partnered with a leading contract research organization (CRO) specializing in Phase 1 and Phase 2a clinical trials. (Focusing on the field of pharmaceutical development.)

They also have access to one of the most important factors in AI training… data.

The company has partnered with Canada’s largest healthcare provider network, WELL Health, and has exclusive rights to its pool of patient data. WELL Health Technologies Corp. is the largest healthcare technology company in Canada.

All this gives them huge potential throughout the entire healthcare industry.

You can see Tim’s latest research on Healwell AI here.

The bottom line where AI goes is this…

The initial FOMO may be coming to an end. But it won’t be the end of AI.

There is simply too much potential in this technology for it to just fade away.

Instead of just counting on Nvidia to keep selling more and more chips, smart investors will have to start looking for areas where AI will actually pay off!

According to the Guinness book of world records, it’s the most fearless creature in the world.

A ferocious little critter (only about two feet long when you count their tails) that’s impervious to cobra venom, bee stings and just about every other threat that might be lurking in the African plains. (They’ll even throw down with a lion!)

They eat pretty much anything from lizards to rodents to snakes to birds and bee larvae.

We’re talking about the Mellivora Capensis… aka the Honey Badger.

And as the saying goes, “the honey badger don’t give a $#!%…”

Lately, one market has taken on a honey badger attitude.

In mid-September, the Fed decided it was time for rates to start coming down and they began a new easing cycle lowering their Fed Funds target rate by a full 50 basis points. (An aggressive move by any account!)

But like the honey badger, the bond market didn’t give a $#!%.

As the Fed started its easing cycle, yields on the 10-year note, the US’ borrowing benchmark, bottomed. And in the ensuing weeks they have actually risen from roughly 3.6% to nearly 4.25%!

US Treasury 10-Year Yield

What’s Going On?

The US has just closed out its 2024 fiscal year and the results, as expected, were abysmal.

According to Janet Yellen and the Treasury, the budget deficit hit its highest level in history. (That’s not counting the two outlier years during the pandemic stimmy giveaways.)

The total deficit for FY 2024 topped $1.8 trillion.

And while that’s bad enough on its own, in what might be the greatest irony in financial history, the largest contributor to that deficit was… interest on the debt.

If you scroll down the Treasury’s monthly statement it shows they paid out over $84 billion in interest payments in the last month of the fiscal year. That increased last year’s total interest expense by a staggering 29% to $1.13 trillion.

That was more than the government spent on Medicare and the defense budget.

Needless to say, the exploding interest cost is a serious problem.

When it comes to government debt, nothing gets retired. The Treasury simply rolls its debt over, refinancing the securities that come due. Which simply adds to the total amount of debt — increasing the interest expense they have to pay.

Now interest on the debt will soon become the biggest contributor to the debt itself.

Think about it. This year alone has added over $1 trillion to the annual base borrowing needs of the country. Before we pay for anything else. In that same 2024 fiscal year, the country took in $4.92 trillion in income. The interest cost ate up 23% of that.

This, of course, increases the amount of debt that has to be issued every year. And higher yields make that cost go up exponentially. (You don’t need to be a financial genius to know borrowing at 1% is better than 5%.)

This situation is one of the main (albeit unspoken) reasons the Fed is scrambling to lower rates — to ease the ever-expanding interest burden the spendthrifts in the government keep racking up.

The only problem with the Fed’s plan is that the funds rate is an overnight borrowing rate between banks that no longer have to maintain any reserve requirements.

So it’s basically just just for show.

It would appear the bond market (the folks who actually buy our debt and finance our deficits) knows this — and it doesn’t give a $#!%…

Election issues may be factoring into this rise in yields, but we don’t think it’s to any significant degree.

More likely the market may be reacting to what it knows is going to be an ever increasing supply of bonds they’re going to need to buy. (More supply = lower bond prices = higher bond yields.)

And this could easily force yields, as one Fed chairman once noted, to stay higher for longer. We’ll see as the week’s progress. But should the market take out previous yield highs of 5%, 6.5% could be within reach.

For now understand that when it comes to the Fed… the bond market don’t give a $#!%!

AI explosion creates monster investment opportunity

The government’s on a roll…

The Treasury Department just issued its Monthly Treasury Report and indicated that the government overspent by $296 billion in February.

So far this year they’ve shelled out $593 billion for social security, $369 billion on health care, $363 billion on defense, $350 billion in interest payments, $324 billion for Medicare and on and on it goes. All this deficit spending is finding its way into the economy (and adding to that net interest payment) and giving it the appearance of above average growth. (Perpetual debt isn’t growth… or at least it shouldn’t be.)

But last week the economy actually got some bona fide good news…

PMI is Back in the Headlines

We’ve talked about the Purchasing Managers Index and why it’s an underrated but important indicator.

First is because purchasing managers are in the know about nearly everything that’s going on in their companies.

The second reason is it’s an incredibly straightforward calculation. A net score above 50 is good. A net score below 50 indicates trouble.

The third reason is because it’s as close to a real time indicator that you can get. (It’s not subject to months of revisions like so many other indicators.)

And if you want to add a fourth, it’s a forward-looking indicator. It’s what purchasing managers see coming.

PMI reports (issued by the Institute for Supply Management (ISM) and S&P Global) are reported for both manufacturing and service businesses. Services, which have been the foundations of our economy for some time, had been keeping things afloat over the past couple years.

But in the most recent reports for March, manufacturing readings in both indexes rose back above 50.

And that’s a good sign for the sector.

A Boom in Manufacturing?

A boom in manufacturing would be an honest-to-goodness good thing for the economy.

According to the US census, manufacturing is the fifth largest employment sector in the economy…

The manufacturing sector is responsible for the largest dollar amount of exports in the US…

According to McKinsey:

The country currently meets 71 percent of its final demand with regional goods, trailing Germany (with 83 percent), Japan (86 percent), and China (89 percent).

manufacturing means greater supply chain resilience…

They’ve created a graphic that sums up all the benefits of a healthy manufacturing sector…

So this developmenet is actually osme pretty good news for the economy.

And if the trend persist…

Now Comes the Bad News

Stocks have long been anticipating the Fed to cut rates. Cheap money means “risk on.” And the market’s been risk on since at least November 2023. (If not October 2022.)

An actual boost in manufacturing PMI is probably the worst news they could get.

An actual growth spurt in the economy, one that has come with a funds rate of 5.5%, means easing should be out of the question. (PMI manufacturing prices paid dumped gas all over that fire jumping way above estimates as well.)

Higher for longer carries all kinds of risks for other parts of the financial system. The Treasury has trillions in maturing debt to refinance and regional banks are holding hundreds of billions of CRE debt their books that will need to be refinanced soon as well.

We’ve previously suggested a strategy the Fed might use in the future to justify cuts. It’s still on the table

Tomorrow, however, we’ll get more clarity when official inflation numbers come out.