Not just AI input trade, its more about broader tech sector: HSBC's Rasco

Key Concepts

• AI Trade: Investment strategy focused on companies involved in artificial intelligence.
• Generative AI: AI capable of generating new content (text, images, etc.).
• Mag-7: The seven largest tech companies (e.g., Apple, Microsoft, etc.) that have driven much of the recent market growth.
• Forgotten 493: The remaining companies in the S&P 500, excluding the Mag-7.
• Growth vs. Value: Investment styles focusing on high-growth companies versus undervalued companies.
• Recalibration of Equities: A shift in market leadership from growth stocks to value stocks.
• FOMC: Federal Open Market Committee, the policy-making body of the Federal Reserve System.
• SEP: Summary of Economic Projections, the FOMC's forecast for key economic variables.
• Easing Cycle: A period when the Federal Reserve lowers interest rates to stimulate economic growth.
• Secular Deflation: Long-term downward pressure on prices, often driven by technological advancements.
• FDI: Foreign Direct Investment, investments made by foreign entities into a country's businesses.

1. AI Trade and its Evolution

• Initial Phase: The current state of generative AI is compared to the early days of the internet, specifically "putting the phone, the modem together with the computer."
• Future Potential: The future of the AI trade lies in working directly with industries and clients through joint ventures to enhance productivity.
• Broader Impact: The AI trade is not just about AI inputs but about the broader tech sector and its impact on the overall economy, potentially creating a broader market rally.

2. Market Dynamics and Recalibration

• Growth vs. Value: The market has been dominated by growth stocks, particularly the Mag-7, but a recalibration towards value stocks is anticipated.
• Earnings Slowdown: Earnings growth for the Mag-7 is expected to slow from 23% to 15% from Q3 of the current year through the end of the fourth quarter of the next year.
• Forgotten 493 Opportunity: The "forgotten 493" companies are expected to benefit from the adoption of generative AI and have easier comparisons, leading to potential earnings growth from 4% in Q3 of this year to 15% in the fourth quarter of next year.

3. Economic Factors and Fed Policy

• Economic Strength: The bet on the "forgotten 493" hinges on the economy remaining strong or at least avoiding a recession.
• Fed Easing: The Federal Reserve has begun a new easing cycle and is expected to ease two more times in Q4, specifically in October and December.
• Labor Market Cooling: The labor market has cooled enough to allow the Fed to ease monetary policy.
• Inflation Dynamics: The Fed is battling higher year-over-year inflation, but month-over-month numbers are tamer, providing some room for easing.
• Secular Deflation from Tech: The secular deflationary forces from technology have not yet fully kicked in.
• Inflation Target Challenges: Achieving the Fed's 2% symmetric inflation target may be challenging due to factors like significant FDI inflows into the US.
• FDI Impact: The US is the number one recipient of FDI, leading to "too many dollars chasing the same goods," which could make it harder to lower inflation.

4. Market Concerns and Examples

• Oracle and Apollo: Examples of companies facing challenges in the AI narrative, with Oracle stock down for a fourth straight day and Apollo stock falling nearly 20% this week.
• Nvidia and OpenAI: Jen-Hsun Huang and Sam Altman announced a potential $100 billion investment from Nvidia into OpenAI, highlighting the promise of future breakthroughs.
• Priced-In Expectations: Concerns that the market may have already priced in too much of the future potential of AI, leaving little room for error.
• Government Shutdown: The potential for a government shutdown next week could contribute to a recalibration in terms of growth versus value stocks.

5. Conclusion

The market is at the beginning of a recalibration, shifting from growth stocks (Mag-7) to value stocks (Forgotten 493). This shift is predicated on the broader adoption of AI, the Fed's easing cycle, and the ability of the "forgotten 493" to capitalize on easier comparisons and AI integration. While the Fed faces challenges in achieving its 2% inflation target due to factors like high FDI, the expectation is that a broader market rally will emerge, driven by the earnings potential of companies outside the Mag-7.