'I kind of treat anything out of Washington these days with a grain of salt': Johnson

Key Concepts

• AI Trade Rotation: A market phenomenon where investors shift capital away from Artificial Intelligence-related stocks towards other sectors.
• Algorithmic Sell-off: A market decline driven by automated trading systems selling a basket of stocks in proportion to their market capitalization.
• Valuation Metrics: Measures used to assess the worth of a stock, such as Price-to-Earnings (P/E) ratio and Price-to-Sales (P/S) ratio.
• Productivity Gains: Improvements in efficiency and output resulting from technological advancements like AI.
• Government Shutdown Impact: The effect of a government closure on the availability of economic data and its implications for market analysis.
• Private Data Reliance: An increasing trend for companies and investors to depend on non-governmental data sources for economic insights.

AI Trade Pullback and Market Rotation

The stock market is experiencing a pullback today, following a record high for the Dow Jones on Wednesday. This movement is widely interpreted as a rotation out of the "AI trade" into less speculative assets. Adam Johnson, founder and author of Bullseye Brief, suggests that investors are actively seeking perceived safety in the current market environment.

Johnson draws a parallel to a similar market sentiment approximately six months ago when China announced the development of DeepSeek, an AI alternative to ChatGPT. At that time, there was widespread concern that the AI trade was over. However, after a brief period of selling, the market realized this was not the case, and AI stocks subsequently reached new highs. Johnson believes the current sell-off is "chapter two" of that narrative, with investors questioning the high costs associated with AI and its tangible benefits, as well as the potential for an AI stock bubble.

Key Arguments and Supporting Evidence:

• AI Costs vs. Benefits: While acknowledging that AI is expensive, Johnson argues that the significant productivity gains it promises make it worthwhile.
• AI Stock Valuation: Johnson contends that not all AI stocks are in a bubble. He cites Celestica as being "quite cheap" and Nvidia as potentially undervalued at under 30 times earnings with 75% growth.
• Overvalued Stocks: Conversely, Johnson identifies Palantir as an example of an overvalued AI stock, stating he "wouldn't touch it" due to its high valuation of 300 times sales and 100 times earnings.
• Algorithmic Driven Sell-off: Johnson's primary argument for the current market movement is that it is "algorithmically driven." He observes that several AI stocks are trading down by almost identical percentages, which he believes is characteristic of computer-driven selling of stock baskets rather than individual investor decisions. He contrasts this with individual selling where different stocks might be sold in varying proportions.

Taking Advantage of Market Movements

Johnson suggests that having cash on hand is beneficial during such sell-offs, allowing for opportunistic buying. He admits to deploying his cash over the past week, perhaps a few days too early, but remains confident due to his long-term investment horizon (typically over two years). He views these market movements as natural "ebbs and flows" rather than indicators of an end to the AI trend.

Methodology for Market Exhaustion:

Johnson explains that selling pressure typically exhausts itself. He notes that when stocks decline by 25-30%, selling often ceases because all potential sellers (or algorithms) have completed their predetermined selling targets. This often leads to a rebound within a couple of days as demand returns. He cites the China DeepSeek event and Nvidia's recurring 25-30% pullbacks every 6-7 months as historical examples of this pattern.

Macroeconomic Considerations and Data Reliance

The discussion shifts to macroeconomic factors, specifically inflation and the impact of government shutdowns on data availability.

Inflation and Labor Market Data:

• Inflation: Johnson believes that inflation is intuitively running around 3%, which he considers "a little hot" but consistent with recent trends. He doesn't perceive any significant recent changes that would make prices feel substantially more expensive.
• Labor Market: He points to ADP (Automatic Data Processing) data, which handles about 15% of U.S. payrolls, as an indicator that the labor market is still growing. ADP has reported issuing approximately 50,000 more checks per month for the past six months, suggesting a robust private sector employment trend.
• Government Shutdown Impact on Data: Johnson expresses a preference for information over its absence but doesn't believe the lack of government data due to a shutdown significantly impacts market understanding. He notes that private data sources like ADP provide sufficient insights. He also mentions that even if October data is unavailable, the government will likely focus on forward-looking data once operational.
• Company-Specific Impacts: He acknowledges that some companies, like Delta Airlines, might see a slight impact on their earnings reports due to factors like flight cancellations (e.g., 6% of Delta's flights were cancelled for a week), but this is generally known and not a surprise to the market.

Shift Towards Private Data:

Johnson advocates for a "smaller government is better government" approach and believes that the market has become more creative in its reliance on data. He highlights the increasing role of AI in interpolating information that was previously gathered through manual methods, such as labor department employees making thousands of phone calls. He views this reliance on traditional data collection methods as "old-fashioned" and suggests that market participants are increasingly treating government data with a "grain of salt."

Conclusion

The current market pullback is seen as a temporary rotation out of the AI trade, driven by algorithmic selling rather than widespread investor panic. While some AI stocks are overvalued, others present attractive investment opportunities. The market is expected to recover as selling pressure exhausts itself. Macroeconomic indicators, particularly from private data sources, suggest a stable labor market and manageable inflation, even with potential disruptions from government shutdowns. The increasing sophistication of data analysis, including AI, is enabling a more nuanced understanding of economic trends, potentially reducing reliance on traditional government data.