'This year the focus is going to move more to what's the return of investment on AI': Aul

Key Concepts

• Federal Reserve (The Fed) Policy: Current interest rate levels and potential for rate cuts.
• Bond Yields: US vs. Japan & China, yield as an income play and portfolio insurance.
• Artificial Intelligence (AI) Investment: Market expectations for ROI on AI spending by tech companies.
• Small-Cap Performance: Russell 2000, broadening market participation, and recent lagging performance.
• Economic Outlook: Assessment of US economic strength and potential for deterioration.

US Economic & Market Analysis with Chad Owl – Davos Discussion Breakdown

I. US Debt Yields & Federal Reserve Policy

The discussion began with President Trump’s observation regarding the disparity in US debt yields compared to those of Japan and China. Trump highlighted that the US ten-year yield is “north of 4%” while Japan’s is around 2.5% and China’s is under 2%. This prompted a question about whether the Federal Reserve (The Fed) is maintaining rates “too high,” as suggested by David Malpass, former Under Secretary of the Treasury under President Trump and advisor to multiple Republican presidents (Reagan, George H.W. Bush).

Chad Owl, Chief Investment Officer at SLGI Asset Management, agreed that the Fed has “a little bit of time” before needing to aggressively cut rates. He characterized the recent Fed meeting as a “textbook neutral pause,” noting that concerns about the labor market have seemingly eased, with the jobless rate appearing to have stabilized. While acknowledging that inflation remains “at the higher end of an acceptable range,” Owl believes a pause is justified, and the market anticipates rate cuts in the latter half of the year.

II. Bond Market Strategy – US & Canada (5-Year Horizon)

Owl detailed SLGI’s bond allocation strategy, emphasizing that US and Canadian bonds constitute a significant portion of their core bond holdings. He positioned bonds as a strong “income play” given the currently “pretty high yields,” a situation not typical of the past five years.

However, he stressed the dual benefit of high yields: not only providing income but also offering “portfolio insurance.” The elevated yields create “room for yields to fall,” leading to capital appreciation if the economy weakens unexpectedly. This makes bonds a crucial “strategic holding” for mitigating risk within a broader portfolio.

III. AI Investment & Tech Earnings – Return on Investment is Key

The conversation shifted to the recent tech earnings reports, particularly focusing on companies like Meta and Microsoft. Owl identified a key takeaway: the market is willing to accept substantial capital expenditure (capex) on Artificial Intelligence (AI) provided that these investments begin to demonstrate a tangible return on investment (ROI).

He described AI as a “multi-year…beyond the cycle” theme, but emphasized that the focus is now shifting to profitability. Companies like Meta, showing positive sales growth alongside AI investment, are being rewarded by the market. Conversely, Microsoft, with increasing spending but slower sales growth, is facing market punishment.

Owl stated, “The market will discern between um those that are driving that return on investment uh for for their AI their AI investments,” and believes this discernment is “a good thing” for the sustainability of the AI theme, preventing a potential “bubble.” He noted the hyperscalers are planning to increase AI spending even further.

IV. Small-Cap Performance & Market Breadth

The discussion concluded with an assessment of small-cap performance, specifically referencing the Russell 2000. Owl acknowledged an initial “broadening out” in early 2024, with small-cap companies catching up to their large-cap counterparts, driven by a stronger-than-expected economic outlook. This was accompanied by increased participation from sectors like resources, consumer staples, and industrials.

However, he noted a recent trend of small caps “lagging” large caps, coinciding with the focus on tech earnings. Despite this, Owl views the broadening market participation as “very healthy,” but reiterated that the AI theme and mega-cap tech stocks remain dominant. He stated, “It just is a reminder that you know while there's a there's a broadening out I think it's very healthy for the market. Uh that AI theme around around those mega cap stocks it's it's not going away.”

V. Notable Quotes

• Chad Owl: “Bonds are still a very important strategic holding…think about the income but also understand that you can get some insurance because the income is so high there's room for the yields to fall and get that price appreciation if the economy begins to derail.”
• Chad Owl: “The market will discern between um those that are driving that return on investment uh for for their AI their AI investments and I think that's actually a good thing for the theme for particularly for those that are concerned that we're entering bubble territory here uh on the AI theme.”

VI. Technical Terms & Concepts

• Capex (Capital Expenditure): Spending by a company on fixed assets, such as property, plant, and equipment.
• Hyperscalers: Companies that operate large-scale, distributed computing infrastructure (e.g., Amazon, Microsoft, Google).
• ROI (Return on Investment): A measure of the profitability of an investment.
• Russell 2000: A stock market index measuring the performance of approximately 2000 small-cap companies in the United States.
• Textbook Neutral Pause: A monetary policy decision by a central bank to hold interest rates steady, signaling a lack of immediate concern about inflation or economic growth.

Conclusion

The discussion with Chad Owl paints a picture of a cautiously optimistic economic outlook. While the Fed has room to pause rate hikes, the market is closely monitoring inflation and economic data. Bonds offer a compelling income opportunity with built-in downside protection. The AI theme remains strong, but investors are demanding demonstrable ROI. Finally, while market breadth has improved, large-cap tech stocks, particularly those driving AI innovation, continue to dominate the landscape. The key takeaway is a focus on quality, return on investment, and strategic portfolio diversification.