Big Tech earnings preview, plus the impact of the US-China trade war

Key Concepts

• AI Spending Boom vs. AI Bubble: Distinguishing between legitimate investment driven by demand and speculative investment funded by debt.
• Capital Expenditures (CapEx): Investments made by a company to acquire, upgrade, and maintain physical assets such as property, buildings, and equipment.
• Special Purpose Vehicles (SPVs): Entities created for a specific, limited purpose, often used to isolate financial risk.
• Related Party Transactions: Business dealings between entities that are connected by common ownership or control.
• Digital Advertising Market: The market for advertising on digital platforms, including search engines and social media.
• iPhone Upgrade Cycle: The period during which consumers purchase new iPhone models.
• US-China Trade Tensions: Geopolitical and economic friction between the United States and China, impacting global trade and supply chains.
• Decoupling: The process of reducing economic interdependence between countries.

Big Tech Earnings: AI Spending and Valuations

The upcoming earnings reports from Microsoft, Alphabet, Meta (on Wednesday), and Apple and Amazon (on Thursday) are crucial for setting the market's tone heading into the end of the year. A primary focus for investors is the "AI boom" and whether it represents a sustainable investment or an "AI bubble."

AI Boom vs. AI Bubble:

• Argument: Gil Laura, Head of Technology Research at DA Davidson, argues that for the major reporting companies (Microsoft, Amazon, Google, Meta), their AI spending is not indicative of a bubble.
• Supporting Evidence: These companies are increasing Capital Expenditures (CapEx) to meet existing customer demand for AI compute capacity. Customers are committing to long-term contracts, justifying the expansion.
• "Bubbleicious" Aspects: The speculative elements are emerging from companies leveraging other entities' capacity, such as Oracle or Coreweave, through off-balance-sheet Special Purpose Vehicles (SPVs). Meta is noted as engaging in this practice.
• Prudent Investment: The core companies' investments are described as "prudent," driven by high demand and a savvy approach to deploying capital for AI, which can also reduce their own CapEx and borrowing needs.

Circular Web of Investments and Unhealthy Behavior:

• Concern: A circular investment pattern, where Nvidia invests in OpenAI, and OpenAI then commits to buying Nvidia's chips, raises concerns.
• Unhealthy Behavior: Laura identifies this as an "unhealthy part of the behavior." Nvidia is seen as trying to expand the market beyond its core customers by creating related party transactions with entities like OpenAI, Oracle, Coreweave, and Stargate.
• Funding Mechanism: This expansion is often funded by debt with high leverage.
• Data Points: Oracle is discussing an additional $38 billion, Meta $27 billion, and OpenAI aims to raise $400 billion in debt for data center construction.
• Speculative Nature: Despite the excitement around AI, these investments are in assets with short lifespans. Nvidia's chips, while currently phenomenal, may not yield the same returns in three to four years.
• Conclusion: While the large companies are making healthy investments, significant "unhealthy behavior" is occurring around the periphery, often debt-funded.

Digital Advertising and Search Market Health

Laura provides insights into the health of the advertising and search markets, particularly concerning Meta and Alphabet.

• Performance: Both Meta and Google are performing well. In the last quarter, Meta grew 22%, while Google grew 12%.
• Future Outlook: This growth gap is expected to narrow slightly due to comparisons with election-related spending in the previous year. Meta's growth may decelerate, while Google is anticipated to maintain its performance.
• OpenAI as a Disruptor: The "elephant in the room" is OpenAI, which has not yet launched advertising. As one of the largest digital advertising platforms (alongside Meta, Google, and ByteDance's TikTok), OpenAI's future entry into the ad market is expected to take share, primarily from Google. This is not anticipated for the current quarter but is a significant factor for the coming year.

Apple's iPhone Cycle and Valuation

The discussion shifts to Apple, with recent positive headlines surrounding the company.

• iPhone Cycle Uncertainty: Laura expresses uncertainty about the strength of the current iPhone upgrade cycle, stating that clarity may not emerge even after Apple's earnings report.
• Holiday Season Impact: The true health of the cycle will only be known after the holiday season.
• Product Compellingness: Initial product examination did not suggest a compelling enough reason for a large upgrade cycle, despite data points pointing towards it, which has driven the stock's performance.
• Valuation Concern: Apple is currently the most expensive among the discussed group based on earnings, even with potentially lower growth even in a strong upgrade cycle.
• Risk of Pullback: Any disappointing news next week could lead to a stock pullback due to the built-in excitement.

US-China Trade Tensions

The geopolitical landscape, specifically US-China trade tensions, is also a key consideration.

• Priced In for Nvidia: For Nvidia, these tensions are largely priced in, as the company has minimal sales to China currently.
• Volatility for Apple: For Apple, trade tensions add significant volatility, though this is also largely embedded in the stock price.
• Decoupling Trend: Regardless of negotiation outcomes, a slow process of decoupling from China is underway. Apple is shifting production out of China, and Nvidia is moving production out of Asia. This trend is expected to continue.
• Potential Relief: A constructive outcome from the upcoming Trump-G meeting could provide relief, but a significant positive shift is not realistically expected.