Morning Call Sheet: Markets hold near highs on earnings and AI bets

Key Concepts

• Magnificent Seven (Mag-7): A group of seven high-performing US technology stocks (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) that are major drivers of market performance.
• Hyperscalers: Large cloud computing providers (e.g., Microsoft, Google, Amazon) that are the primary drivers of AI infrastructure spending.
• Aspirational Spend: Capital expenditure on emerging technologies (like AI) where the return on investment (ROI) is projected for the future rather than currently realized.
• Immediate Expensing: A tax provision allowing businesses to deduct the full cost of certain investments (depreciation) in the year they are made, acting as a stimulus.
• Strait of Hormuz: A critical maritime chokepoint for global oil supply; geopolitical tensions here create market volatility.

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Market Outlook and Justification

The panel agrees that current market highs are justified despite geopolitical noise, specifically citing the conflict in Iran and potential blockades in the Strait of Hormuz.

• Earnings Power: The primary driver for the market is the robust earnings growth, particularly within the tech sector.
• Growth Statistics: Sylvia Jablonski notes an expected 13.2% growth rate for the current earnings season, with 88% of the 10% of companies that have reported so far beating expectations. The Mag-7 is projected to deliver 22.8% year-over-year growth.
• Retail Mitigation: Steve Grasso argues that while inflation has increased costs for retail investors, government tax policies—specifically tax refunds and immediate expensing/depreciation—have helped mitigate these new expenses, keeping the consumer economy resilient.

The Tech Divergence: Software vs. Infrastructure

A notable trend is the divergence in how the market reacts to tech earnings:

• Software Struggles: Companies like IBM have faced negative reactions, particularly in their consulting and software segments.
• Infrastructure Strength: Conversely, companies like Texas Instruments and GE Vernova are showing strength. This is attributed to high demand for power infrastructure, automation, and electric vehicle (EV) components.
• The AI Runway: The panel suggests that while software might face a challenging quarter, the "runway" for AI-related hardware and power infrastructure remains strong due to persistent supply shortages and high demand.

Investor Positioning and ETF Flows

Dave Masa highlights a shift in investor behavior regarding thematic ETFs:

• Flow Dynamics: Significant outflows occurred during the market decline, but inflows returned in size as the market bottomed out around March 30th.
• Pre-positioning: Investors are currently positioning themselves ahead of the "Super Bowl of Earnings" (the week of the 29th), where four major hyperscalers report on the same day, followed by Apple.

Critical Analysis of AI Spending

A central debate is the market's growing frustration with "aspirational spend."

• The ROI Question: Steve Grasso points out the disparity between massive capital expenditure (e.g., Microsoft spending $150 billion) and the relatively smaller projected AI revenues ($25 billion).
• Monetization: The market is increasingly demanding evidence that the $650 billion in total AI spending by the Mag-7 will lead to tangible monetization. Investors are shifting their focus from the promise of AI to the real return on that investment.

Synthesis and Conclusion

The market is currently in a "show me" phase. While the broader economy appears healthy—supported by strong corporate earnings and resilient consumer spending—the tech sector is undergoing a transition. The market is moving past the initial hype of AI and is now scrutinizing the efficiency of capital allocation. The upcoming earnings reports from the hyperscalers are viewed as the definitive catalyst that will determine the next leg of the market's direction. Investors are advised to watch for clear signs of AI monetization to justify the high valuations of the Magnificent Seven.