This edition of Market Factors covers my increasing discomfort with the cozy arrangement dominant AI-related companies are having. We move on to the central question that will determine the near-term returns on global equities, and the diversion describes experiments with cellphone bans in education.
Tech
Intel, Nortel and new AI deals
Nvidia Corp. (NVDA-Q) and Corning Inc. (GLW-N) announced a deepening partnership this week and my brain is aflood (which should be a word if it isn’t already) with unsettling precedents, even as I continue pondering Corning as a potential stock buy.
Corning announced plans for a ten-fold increase in fibre optic cable equipment manufacturing this week which includes new facilities in North Carolina and Texas. The company had previously stated that it would only ramp up production capacity if it received prepayments from customers.
Citi analyst Asiya Merchant believes that Corning’s concurrent announcement that Nvidia would have the option to buy 15 million Corning shares at $180 each, and that the optical equipment would be designed for use with Nvidia chips, strongly implies that Nvidia will help Corning fund their expansion. Another part of the new deal will see Corning basically give three million shares to Nvidia, further supporting Ms. Merchant’s argument. Corning shares closed up 12 per cent on Wednesday after the news.
The ten-fold increase in capacity reminds me of the 1990s in both good and bad ways. Back then, Intel risked everything to expand chip production capacity and was rewarded when eventually they were the only ones capable of feeding the monstrous demand for personal computers. They had enormous pricing power because no other company could guarantee to meet demand.
The collapse of the ‘90s telecom boom was driven in large part by the realization that enough vendor-financed data transmission capacity had been built to handle traffic for the subsequent decade, so demand collapsed. Corning risks doing the same thing, even if some of the expansion will be funded with Nvidia’s money.
The deal also reminds me of the keiretsu of 1980s Japan. The term referred to dense networks of companies with holdings in each others’ stocks. The arrangement eventually paralyzed much of the Japanese economy as strategic consensus and corporate reform was near-impossible. The structure was mutually supportive, allowing poorly performing companies to maintain operation, which eventually led to massive overcapacity and a 35 year bear market in the TOPIX (South Korea had a similar experience with family controlled chaebols and similar difficulty taming them).
The main AI players are getting altogether too cozy. Microsoft’s partnership with OpenAI is longstanding, Amazon and Google have invested billions with Anthropic, Oracle is now tied-in with OpenAI as is Nvidia. Bad things happen when a small group of people think they can lead an economic revolution and go out of their way to limit competition.
The hyperscalers will still buy a lot of equipment for the foreseeable future - that’s why I’m still looking at Corning as a medium-term trade - but longer term I am beginning to worry about the whole thing.
Dado Ruvic/Reuters
Market views
Earnings and AI capex concerns will drive stocks
The medium-term outlook is tied to the resolution of tension between AI-related capital expenditure and earnings growth that is not only strong but historically strong.
Morgan Stanley Wealth Management chief investment officer Lisa Shalett is on the bearish end of this discussion. In her weekly report, The GIC Weekly, Ms. Shalett writes, “most investors appear confident that the GenAI-capex story can compound almost regardless of the macro backdrop, while seemingly dismissing variables experiencing clear trend breakouts (oil, inflation, rates, Fed policy, the US dollar) as transitory noise. We aren’t as sure.”
Ms. Shalett goes on to say that capex booms are “self-undermining” in that spending becomes more volatile as the trend matures. Further, the capital intensive businesses that result from the investment explosion - data centres in this case - become cyclical and expensive to maintain and thus imply lower stock multiples. This is a forward-thinking concept as few investors are considering a world where massive capital-light software companies like Microsoft and Meta Platforms become asset-heavy as the AI buildout continues.
In the very near term, markets look great. Profit momentum for domestic energy stocks is enormous while, according to Scotiabank strategist Hugo Ste-Marie, the ratio of S&P 500 companies reporting earnings above consensus estimates is near a record at 84 per cent. The strategist believes that U.S. earnings fully justify record stock prices, at least for now.
Mike Stewart/The Associated Press
Diversions
Cellphone bans in schools have no benefits, study suggests
I successfully weaned myself off Twitter/X and then Bluesky but Instagram remains an embarrassing time suck. Social media to me seems evidently destructive in terms of discourse, misinformation, unfair standards, medical advice, financial advice and charlatanism of all varieties.
With this as a starting point I was very surprised to hear that experiments with phone-less primary and high school education have shown no verifiable improvement in educational gains. The abstract of a comprehensive study led by Stanford researcher Hunt Allcott was recently published on the Marginal Revolution site.
The study observed students who were instructed to put their phones into pouches in a separate room for the school day and the lack of phone use was verified by GPS data. Standardized testing results were used to measure results.
The students showed an initial increase in disruptive behaviour and a decline in self-reported student well-being, indicating short-term disruption. But these effects eventually subsided. As for academic performance, “average effects on test scores are consistently close to zero.” There were small improvements in high school math ability (my suspicion here is that attention spans marginally improved with less phone use) and a small decline in general primary school academic results.
In hindsight I realize I was looking to listing cellphone usage as a magic bullet to improve education results and reverse the widely reported generational decline in IQ results.
The essentials
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Globe Investor highlights
Mehmet Beceren of Rosenberg Research warns that Big Tech’s capex race will bring big problems when it comes to depreciating assets
Ted Dixon lists three energy stocks with attractive valuations, insider buying and price momentum
Arjun Deiva screens for seven cheap and growing U.S. dividend stocks
Quick hits
I’m tickled by Formula One racing being a top pick at Morgan Stanley. Where else can you buy shares in a best-of-the-best sporting league. The filthy Packers don’t count (I’m a Lions fan, I cannot type the P work without ‘filthy’ first) because the shares provide no rights. The quick investment case for F1 is that the value of the 11 teams is 25 per cent higher than the market cap implied by Liberty Media Formula One (FWONK-Q) stock.
The two stocks I watch to follow the takeover by our new robot overlords are Rockwell Automation (ROK-N) and Japan’s Fanuc (FANUY). In the latter case, ROK’s results this week were so positive that Citi analyst Martin Wilkie believes they have positive read through for Siemens’ Digital Industries division. Fanuc’s most recent results saw strong growth in the factory automation segment, which saw new orders rise 40 per cent year over year. The sector’s global growth momentum is rising for the time being.
Amazon is providing access to its logistics business to anyone willing to pay, not just partners that sell products on Amazon’s site. Amazon Supply Chain Services owns more than 80,000 truck trailers, 24,000 intermodal shipping containers and more than 100 aircraft and also offers warehouse and inventory management. BofA Securities analyst Justin Post describes the move as an extension of Amazon’s tradition of “monetizing core capabilities.” Third party logistics is an estimated US$1.3-trillion business and Amazon is unlikely to get beaten on speed of delivery. Prices in the industry are almost certainly set to decline.
Read this week’s earnings and economic calendar here