'I do think, at least in the near term, there is scope for more investment': Peta on AI rally

Key Concepts

• AI Stock Valuations: Concerns about the current high valuations of companies associated with artificial intelligence.
• Dotcom Boom Analogy: Comparison of the current AI stock market rally's concentration to the final stages of the dotcom bubble in the late 1990s.
• Hyperscalers: The five largest investors in AI data center buildouts: Amazon, Google, Microsoft, Oracle, and Meta.
• Capex (Capital Expenditures): Spending by companies on acquiring or upgrading physical assets such as property, buildings, and equipment.
• Final Decile: The last 10% of a period, often used in market analysis to describe the final stages of a bull or bear market.
• K-Shaped Economy: An economic recovery or trend where different segments of the population experience vastly different outcomes, with some improving significantly (the upper leg of the K) while others decline or stagnate (the lower leg of the K).
• Non-Farm Payrolls: A key economic indicator that measures the number of jobs added or lost in the economy, excluding farm workers, private household employees, and non-profit organization employees.

AI Narrative and Market Concentration

Doug Peta, Chief US Investment Strategist at BCA Research, believes that despite current concerns about AI stock valuations, the AI narrative still has room for growth. He notes that the concentration of performance within the AI equity sector is beginning to resemble the final stages of the dotcom boom.

Evidence of Concentration

Peta draws a parallel between the current market and the dotcom bust of 2000.

• Dotcom Era (1990-2000): During the final decile of the 1990s bull market (April 16, 1999, to March 24, 2000), only the Information Technology sector managed to outperform the S&P 500. Six other sectors – Energy, Utilities, Financials, Materials, Healthcare, and Consumer Staples – actually lost ground in absolute terms. The strong performance of tech stocks was instrumental in driving the S&P 500's 17% gain over those 11 months.
• Current Market: A similar pattern is emerging today. In the provisional final decile of the current bull market (as of last week), four out of eleven sectors were showing negative performance in absolute terms, with Financials near the zero line. The rally has been primarily powered by Technology (third from the left) and Telecommunication Services (second from the left), which includes companies like Google, Meta, and Netflix. Peta suggests that Healthcare's performance might be a one-off recovery rather than part of this concentration trend. This increasing concentration is seen as very similar to the conditions preceding the 1990s bull market's end.

Potential for Near-Term Growth

Despite the concentration concerns, Peta sees potential for continued investment and stock rallies in the near term.

• Hyperscaler Investment: He points to the projected capital expenditures (capex) of the five largest AI data center investors (Amazon, Google, Microsoft, Oracle, and Meta) for 2026. Peta suggests that these stated plans should be considered a minimum level of investment, as their projections for AI capex have consistently been revised upward each quarter. This indicates ongoing and potentially increasing investment in AI infrastructure.

Economic Concerns: The K-Shaped Consumer

Beyond the AI stock market, Peta expresses concern about the broader economy, particularly the impact of a K-shaped consumer economy, citing disappointing earnings from Home Depot as an example.

Characteristics of the K-Shaped Economy

Peta outlines two key points regarding the bifurcation among consumers:

1. Swelling Lower Leg: The bottom segment of the K is expanding, with stresses on American households spreading from the lowest income and wealth distributions to at least the middle of these distributions.
2. Importance of the Lower Leg: Peta argues that the lower half of the income distribution is more critical for the business cycle than the upper half. He refutes the notion that wealthy households' continued spending, fueled by rising stock prices, can sustain an economic expansion indefinitely.

Path to Economic Revival

Peta suggests that a turnaround in the labor market is crucial to alter the trajectory of the K-shaped economy.

• Tepid Job Creation: Recent data on US net non-farm payrolls growth (through August) has been between 25,000 and 30,000 on average over the last four months. Peta describes this as "tepid" and insufficient to prevent the lower leg of the K from swelling.
• Diminished Capacity and Willingness to Spend: This tepid job growth leads to a reduced capacity and willingness to consume among a significant portion of American households.
• Revival Requirements: For the economic expansion to revive, growth to accelerate, and for it to continue robustly, there needs to be a reversal of this weakening willingness and diminished capacity to spend. This likely requires more meaningful job creation.

Conclusion

Doug Peta acknowledges the potential for continued near-term growth in AI-related stocks, driven by significant investment from hyperscalers. However, he cautions that the increasing concentration of market performance within this sector mirrors the late stages of the dotcom boom. Simultaneously, Peta highlights growing concerns about the K-shaped economy, where the struggles of the lower and middle-income households are expanding. He emphasizes that a robust economic revival hinges on a stronger labor market and increased job creation, which would bolster the spending capacity and willingness of a larger segment of the consumer base.