3Fourteen's Warren Pies: AI having an impact on labor, 'it is absolutely a big deal' for markets

Key Concepts

• AI Exposure: Categorization of industries based on their susceptibility to disruption and automation by Artificial Intelligence.
• AI-Resistant Industries: Industries less likely to be significantly impacted by AI-driven automation.
• BLS Data: Data from the U.S. Bureau of Labor Statistics, used to analyze job trends.
• Macro Outlook: The overall assessment of the economic environment and its potential future direction.
• Cyclical Support: Economic factors that contribute to a specific phase of the economic cycle (e.g., disinflation).
• Credit Spreads: The difference in yield between a corporate bond and a comparable government bond, indicating credit risk.
• High Yield Index: A benchmark for tracking the performance of bonds with lower credit ratings (higher risk, higher potential return).

AI’s Impact on the Macroeconomic Outlook and Equity Markets

The discussion centers on the emerging impact of Artificial Intelligence (AI) on the labor market, macroeconomic conditions, and equity valuations. Warren Paes from 314 Research argues that AI’s influence is becoming increasingly apparent and has prompted a downgrade of his firm’s outlook on equities, coupled with an upgrade on bonds.

Analyzing Job Market Trends Through AI Exposure

Paes details a methodology used to assess AI’s impact: categorizing the 30 most “AI-exposed” industries versus the 30 most “AI-resistant” industries based on the potential for automation. This categorization was applied to data from the Bureau of Labor Statistics (BLS). The analysis excluded 2020 and 2021 due to anomalous hiring patterns during the pandemic. The key finding is a discernible trend: AI-exposed industries are experiencing slower job creation compared to their pre-COVID trends, signaling a nascent but clear impact from AI.

He notes a progression in AI’s effect: first a slowing of hiring rates, now transitioning into sporadic layoffs. He acknowledges the value of anecdotal evidence alongside data, stating, “You want to have data to back it up, but the anecdotes are pointing towards the next phase, which is going to be some sporadic layoffs.” Recent layoffs at companies like Google and Pinterest are cited as examples of this trend.

Market Signals and the Rates Market

Paes highlights that the market is already reacting to this AI-driven shift. He points to the software industry’s equity prices as an obvious indicator, but also notes a more subtle signal in the overnight rates market. This market is now pricing in more interest rate cuts, extending them further into 2027, which is subsequently pushing down the ten-year Treasury yield. He states, “If you’re really pushing against this and saying this is all AI psychosis, you should be arguing with the software market.” This shift in the rates market was a primary driver behind 314 Research’s decision to downgrade stocks and upgrade bonds.

GDP Growth, Jobs, and AI’s Influence

The conversation addresses the possibility of a scenario where GDP growth continues while jobs are negatively impacted by AI. Paes doesn’t foresee a “doomsday” scenario of widespread job losses and economic depression. Instead, he views AI as a “modest headwind” to the labor market. He explains that the initial cyclical support for disinflation (falling inflation) came from factors like contained oil prices and issues in residential construction. AI adds another headwind by potentially hollowing out white-collar jobs and replacing them with AI investment.

He emphasizes the potential for productivity increases, stating, “This technology is transformational. And that’s part of like anyone who touches it in reality in their business feels the power.” He believes the market is collectively recognizing this transformative potential.

Credit Risks and Market Corrections

The discussion then turns to credit risks, noting widening credit spreads and falling yields. Paes maintains a base case that these risks will remain contained. He details an analysis of the high yield index, finding that the widening of spreads is largely concentrated in the financial and technology sectors. While acknowledging the significance of these sectors, he suggests the distress is currently contained.

He also believes some of the market’s recent moves are “a little overdone,” particularly in the software sector, which he considers to have been overvalued prior to the current correction. He views the recent correction as a necessary process, and notes the market’s resilience in maintaining a trading range as a sign of strength. As Paes states, “We’ve corrected the overvaluation at least.” He also points to the market’s effective handling of negative sentiment within the current range as a positive indicator.

Notable Quotes

• “You want to have data to back it up, but the anecdotes are pointing towards the next phase, which is going to be some sporadic layoffs.” – Warren Paes, emphasizing the importance of both quantitative and qualitative evidence.
• “If you’re really pushing against this and saying this is all AI psychosis, you should be arguing with the software market.” – Warren Paes, highlighting the market’s clear reaction to AI’s impact.
• “This technology is transformational. And that’s part of like anyone who touches it in reality in their business feels the power.” – Warren Paes, underscoring the tangible benefits of AI.

Conclusion

The core takeaway is that AI is no longer a future concern but an active force shaping the macroeconomic landscape and financial markets. While not predicting a catastrophic outcome, Warren Paes argues that AI represents a significant headwind to the labor market and a key factor driving the shift from equities to bonds. The market is already pricing in this reality, and investors should be prepared for continued adjustments as AI’s impact unfolds. The analysis emphasizes the importance of data-driven insights, combined with an awareness of anecdotal evidence and market signals, to navigate this evolving environment.