The U.S. Industrial Renaissance Will Create Winners Beyond Tech
Equity markets continued their upward climb last week with all three major indices advancing roughly 1.5%. It’s been a terrific start to the year with the averages registering weekly gains in six of the eight weeks so far in 2024. I remain of the view that the setup is ripe for consolidation at best and/or a correction at worst with both the Nasdaq and S&P 500 trading nearly 5.0% above their 50-day trendlines. This level of extension has marked the outer boundaries of the trading range in recent history. Don’t get overly concerned, as I’m not in the camp that something more dire is in the offering, but a good cleansing of the excesses in sentiment, positioning, and valuation would improve long-term return potential.
It is worth pointing out that with all the craze about the Mag7 and Tech crushing everything, the Nasdaq Composite is only up +1.5% from its January 24 highs. A classic case of ‘perception being better than reality’.
As for sentiment, the latest readings don’t leave much room in the bull camp for investors to get even more excited. The CNN Fear-Greed index is at 77 and near the highs it’s seen over the past twelve months.
The Investors Intelligence poll has the bulls up to 57% vs the bears down at a lowly 16% - gaps in this spread of 40% or higher are typically as extreme as it gets. Lastly, we have the Market Vane sentiment index with bullish sentiment up to 63% which is right where it was back in January 2022 at the prior all-time highs. Bottomline, all these sentiment gauges are telling the same story – stock prices have done well and as a result a lot of good news is priced in. Likewise, positioning whether you look at hedge funds, vol-control strategies, risk-parity, and CTA funds are all at or near max long exposure. None of this means a correction is certain. It just means that there is a lot of selling pressure that could be unwound if one occurs.
As for valuations, the P/E multiple on the S&P 500 is pushing back up against 21x on forward earnings estimates (close to 23x on trailing earnings) and for the white-hot tech sector it’s just shy of 30x. I know, I know valuation is a terrible timing tool, but like sentiment it does provide the context for which investors can evaluate the height at which they will fall from if they slip. These lofty valuations make the 1.47% dividend yield on the S&P 500 look more and more puny with each passing day. Moreover, the yield differential between bonds and cash relative to the S&P 500 dividend yield is on par with what we saw at the peak of the last prolonged tightening cycle in October 2007. Little did we know at the time that this would be the last time for the next fifteen years that investors would have the opportunity to sacrifice upside potential in equities to lock in 5-6% returns on Treasuries and Investment grade credit. Something to keep in mind for all the investors getting caught up in the FOMO of today. Gosh, I remember conversations not too long ago where clients would have done back flips to get a secure 5% and not have to worry about a thing! The emotions of fear and greed are undefeated in this craft we call investing.
One area that looks and trades downright awful lately is commodities. The Bloomberg Commodities index is at its lowest level since 2021. It’s a bit of headscratcher for commodities to be acting as badly as they are with U.S. economic growth as strong as it is and green shots emerging around the rest of the globe. This is just a huge disconnect and one that has me a bit confused at the moment (more thoughts on this below).
I tend to keep things bigger picture in this weekly missive with a focus on the major asset classes and macro drivers, but it would be professionally irresponsible if I didn’t touch on the results out of Nvidia last week. Afterall, it has pretty much garnered the status of being its own macro variable with what it has accomplished.
Once again, its quarterly results topped expectations and its forward guidance continues to raise the bar, which helps to explain its nearly 20% rally since reporting less than three trading days ago. But it’s these numbers that I’m about to rattle off that illustrate why Nvidia is clearly in a league of its own at this time. We’re talking about a company worth nearly $2 trillion posting revenue growth of 265% over the past twelve months and is guiding for year-over-year revenue growth to be around 234% next quarter.
Without question this company is demonstrating the transformative potential of generative A.I. and while operating in a very competitive industry they remain several years ahead of their peers. Its market cap has doubled from $1 trillion last June to over $2 trillion today (can you believe its market cap was $100 billion five years ago and half the size of Intel). The power and durability of this A.I. craze is formidable and shouldn’t be viewed through the same lens as fiber optics was at the peak of the tech bubble. Sure, there are commonalities and without question it will lead to excesses and extremes in market pricing, but the results this company is putting up are on another level. The entire semiconductor complex has a tailwind at its back that benefits many companies, but Nvidia’s perch at the top of the industry is fairly secure for some time to come.
Relative to industry peers its valuation at a 34x P/E multiple is not overly excessive and nearly 20% below its average over the past three and half years. In a nutshell there is no precedent for the level of growth this company is putting up – especially at its size. You want to know the real kicker; I missed it and outside of having exposure to it in some ETF holdings in client portfolios it is not a company we own on an individual basis – ‘what a knucklehead’. But that’s investing. You win some, you lose some. Those that are successful over the long-term win more than they lose, what’s important is that you continue to look forward and not focus on the ones that got away.
In the spirit of looking forward I wanted to highlight the following article published in Politico about the ongoing shift in U.S. industrial policy. I encourage you to put aside any political bias and do your best to contextualize it for what it is actually saying rather than who deserves the credit/blame. This is one of those things where the “what” is more important than the “why” and the “what” is that policy in the U.S. has and continues to make a monumental pivot from where it was eight years ago. I took the liberty of republishing the majority of the article because I know all too well how easy it is to skip over the links imbedded in a piece of research and never look at them. Now you know I’ve intentionally made this difficult for you to ignore:
One of the party’s leaders, Jake Sullivan, was about to challenge long-held beliefs and lay out a road map for the nation’s ideological future. The times were changing, and America had to change with them.
Brookings is a legendary place, among the most famous think tanks in the world. It’s the kind of institution presidents visited to give great speeches and senior officials went to for outside policy counsel, and where the capital’s elite waited out an opposing party’s administration while itching to serve with a like-minded team. Now it would serve as the birthplace of a quiet revolution.
For weeks, Jake Sullivan and his team crafted an address that was nominally about the administration’s views on economics. But it would really serve as a critique of orthodoxy in America’s capital, a bludgeon to U.S. foreign policy thinking that was so prominent in the gilded halls of Brookings and among Washington’s well-heeled.
The speech reflected the journey Sullivan himself had been on for six years. Down and out after Trump’s victory over Hillary Clinton, he sought to understand why the modern-day traditions of U.S. foreign policy weren’t resonating with the kind of people he grew up with in Minnesota. He helped craft a new vision that took root among Democrats and formed the backbone of the Biden administration’s thinking about the world after the scarring scenes of Jan. 6, 2021.
And buoyed by the success of Washington’s support for Kyiv amid Russia’s invasion, he now had confidence to offer a different vision for U.S. policy at home and abroad. It was Bidenism, fully embraced by the president, but a brainchild of the national security adviser who, due to his young age, could serve as an ideological leader within the Democratic Party for decades to come.
The Bidenism that Sullivan helped define has infused every corner of this administration’s foreign policy. A focus on the home front was one reason Biden chose to withdraw from Afghanistan. A rock-ribbed belief in keeping U.S. forces out of the Russia-Ukraine conflict has helped shape America’s response. And China’s decades of cheating in global economics led Team Biden to adopt some elements of Donald Trump’s trade war. The elements of Trumpism that Biden and Sullivan adopted — though they would probably prefer the term “populism” — could help Biden fend off Trump’s ideological challenges to his foreign policy heading into the 2024 election.
To arrive at this new outlook, Sullivan first had to dismantle establishment orthodoxies within himself — the same orthodoxies he now sought to undo at Brookings: That globalization and free trade were an unalloyed good, growing economies and improving people’s lives in the process. What was good for the stock market, in effect, was great for everybody. Given enough time, swelling wallets would produce a steady middle class, one that demands its political and human rights from its government. Even the most repressive regimes, the thinking went, would eventually crumble under the weight of inflowing capital. Consistent pressure via greenbacks did the most good for the most people.
Those theories had decades to prove themselves right after World War II. At Brookings, where that thinking took hold and was championed for years, Sullivan was about to assert that it was time to move on.
…
As he strode up to the think tank, perched prominently on Massachusetts Avenue in downtown Washington, D.C., flanked by other prestigious institutions and embassies, Sullivan looked like any U.S. official at the upper echelons of power. His straw hair was matted down, swept to the right. He wore a typical dark-blue suit and a bright white shirt, muted by a gray tie. The national security adviser looked like he was about to give a speech like any other, like thousands before it by D.C.’s elite. Not this time.
“After the Second World War, the United States led a fragmented world to build a new international economic order. It lifted hundreds of millions of people out of poverty. It sustained thrilling technological revolutions. And it helped the United States and many other nations around the world achieve new levels of prosperity. But the last few decades revealed cracks in those foundations,” Sullivan said to a crowd of journalists, government officials and well-known experts. In other words, the Marshall Plan and the tech boom during the 1990s were products of their time and place. They wouldn’t necessarily have the desired effects in a modern context.
“A shifting global economy left many working Americans and their communities behind. A financial crisis shook the middle class. A pandemic exposed the fragility of our supply chains. A changing climate threatened lives and livelihoods. Russia’s invasion of Ukraine underscored the risks of overdependence.”
That was the problem. What was the solution? Instead of rampant globalization, Sullivan’s pitch was that a reenergized American economy made the country stronger. It was time to remake the Rust Belt into a Cobalt Corridor, to establish industries that led not only to blue-collar work but to azure-collared careers. If that was done right, a strengthened America could act more capably around the globe.
“This moment demands that we forge a new consensus. That’s why the United States, under President Biden, is pursuing a modern industrial and innovation strategy — both at home and with partners around the world,” he said.
Sullivan would go on to list why America needed to take this new path. Manufacturing in the United States had lost out to cheaper labor abroad. Growth for growth’s sake was inherently unequal, not benefiting everyone. The economic rise of other countries and their integration into the world economy didn’t automatically make them more democratic — some, namely China, simultaneously grew more powerful and despotic. And the free market at home and globalization’s effects wrought havoc on the climate while failing to incentivize greener means of production and industries.
Implicitly, Sullivan said the main assumptions undergirding America’s foreign and economic policy had been wrong for decades. China, and the Washington belief that liberalized markets would eventually lead to democracy within the halls of power in Beijing, was the most glaring example.
“By the time President Biden came into office, we had to contend with the reality that a large non-market economy had been integrated into the international economic order in a way that posed considerable challenges,” he said, citing China’s large-scale subsidization of multiple sectors that crushed America’s competitiveness across industries. Making matters worse, Sullivan continued, “economic integration didn’t stop China from expanding its military ambitions.” It also didn’t stop countries like Russia from invading their neighbors.
Sullivan, the accomplished debater, was dismantling, point by point, the dominant worldview that Biden held for decades and that the national security adviser grew up believing until Trump won the election in November 2016. He was, wittingly or not, offering a mea culpa for once being an acolyte of the foreign policy establishment. Now, cloaked in power, he was trying to right his perceived wrongs.
Standing in front of the esteemed audience, Sullivan was telling them he didn’t want to be caught flat-footed as the global economy reshaped around them. The U.S. government would be proactive, prepared and proud in search of an industrial strategy to undergird American power. Without saying the words, he was offering a plan to make America great again.
The speech served as the grandest example of the significant rethink that occurred in the Biden administration’s first half of the first term. A self-proclaimed “A-Team” came together to move beyond the Trump era, but in some ways they embraced elements of it. Not the nativist demagoguery, but the need to return to fundamentals: a healthy middle class powered by a humming industrial base, a humility about what the U.S. military alone can accomplish, a solid cadre of allies, attention to the most existential threats and a refresh of the tenets that sustain American democracy. Sullivan proposed an old road map to a new future.
“This strategy will take resolve — it will take a dedicated commitment to overcoming the barriers that have kept this country and our partners from building rapidly, efficiently, and fairly as we were able to do in the past,” Sullivan said at Brookings. “But it is the surest path to restoring the middle class, to producing a just and effective clean-energy transition, to securing critical supply chains, and, through all of this, to repairing faith in democracy itself.”
This article is one of the better articulated summaries of where U.S. industrial policy used to be, is now, and where it’s going. Focus if you must on the politics of it being a Red or Blue initiative, a Trump or Biden policy, but doing so risks you missing the point. This is happening and it’s actionable from an investment standpoint. Furthermore, it doesn’t look like this policy initiative is going to change no matter who wins the 2024 election. The horse is out of the barn and we’re not putting her back in.
Keep in mind, this is not the type of investment that plays out over weeks or months, but rather years and decades. What’s important is to understand that it is underway. To my eyes we are seeing the early beneficiaries being rewarded in the Tech space and this shift just so happens to coincide with the A.I revolution. The ‘Chips Act’ was part of this industrial policy pivot. So were aspects of the Inflation Reduction Act. Legislators are writing bills that incentivize the implementation of this shift in industrial policy.
What I think is being overlooked by markets at this juncture is the amount of real assets, energy, and commodities that will need to be procured and protected to make this a success. I highlighted the unprecedented results from Nvidia earlier in this missive, but what’s getting overlooked (in my opinion) is the amount of energy and electricity needed to operate these revolutionary chips. Data centers are one of Nvidia’s fastest growing markets and in the U.S. market alone, demand (measured by power consumption to reflect the number of servers a data center can house) is expected to reach 35 gigawatts by 2030, up from 17 GW in 2022 (McKinsey). That’s a doubling in energy needs in the next five years!
Climate change, the EV revolution, A.I., and the shift in U.S. industrial policy is going to require an enormous amount of energy. Yet as we sit here today, we see that the market cap of the entire energy sector pales in comparison to Technology. We’re talking about a roughly 4% weighting in the S&P 500 compared to a 30% weighting for Tech.
Will they ever flip flop positions? I doubt it, and please understand that I’m not suggesting they will. But I do think the divide between the two is irrational and will mean revert over time. When? I don’t know that either, but I do think this is where the puck is going and the opportunity to position for this gradual mean revision is today. Commodities have been all but forgotten as an asset class given the success of investing in Tech over the last fifteen years. Over the next fifteen years I think investors will be rewarded for owning both. Copper, cobalt, nickel, lithium, rare earth metals, and silver (to name a few) are all metals that will see demand increase dramatically in the future with the implementation of these policy initiatives. Taking advantage of it as an investor may not bring immediate gratification and definitely requires a time horizon that extends beyond one’s nose, but the time to start building this exposure out is now. This shift also benefits industrial companies, robotics, power generation, storage, and transport infrastructure companies.
Ask yourself this; who will keep the power running for the “picks and shovels” of the A.I. revolution? What about the computing needs of the crypto industry if it is to ever become more widely adopted? Or the infastructure for building out a cleaner more efficient energy grid? Not to mention the everyday needs of existing infrastructure and projected global growth.
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