TOO GOOD TO BE TRUE?: Stocks exceeding expectations in typically rough season

Key Concepts

• Fiscal Stimulus: Government actions to increase spending or cut taxes to boost economic activity.
• Monetary Stimulus: Central bank actions to increase the money supply and lower interest rates to encourage borrowing and spending.
• Russell 2000: A stock market index that represents approximately 2,000 small-cap U.S. companies.
• Consumer Price Index (CPI): A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
• Rate Cut: A reduction in a central bank's benchmark interest rate.
• Tariffs: Taxes imposed on imported goods.
• Taiwan Semiconductor Manufacturing Company (TSMC): A global leader in semiconductor manufacturing.
• Artificial Intelligence (AI): The simulation of human intelligence processes by machines, especially computer systems.
• Irrational Exuberance: A term coined by Alan Greenspan to describe a speculative market boom that is not supported by underlying economic fundamentals.
• Circularity (in investment): A situation where companies invest in each other, creating a closed loop of investment and product purchasing.
• Dot-com Bubble (late 1990s): A period of rapid growth in internet-based companies followed by a sharp decline.

Market Performance and Driving Factors

The market is currently experiencing broad gains, with "all the flags flying in the right direction." This positive performance is attributed to a confluence of factors that have been building for months:

• Fiscal Stimulus: Government initiatives are providing economic support.
• Monetary Stimulus: The Federal Reserve's actions are injecting liquidity into the market.
• Exceeding Earnings Expectations: Companies are consistently performing better than anticipated. The Russell 2000, a small-cap index, is up 2.6% on the week, described as "unbelievable" given earlier doubts about its recovery. This surge is supported by earnings that are "not tough" as feared, but rather "looking great" this quarter.

Inflation and Federal Reserve Policy

Despite positive market sentiment, some investors are anxious, viewing the current situation as "too good to be true." The recent Consumer Price Index (CPI) report, which came in lighter than expected both month-over-month and year-over-year, is a key data point.

• Benign Inflation: The CPI report is characterized as "benign," meaning it shows mild inflation.
• Market Expectation for Rate Cut: Despite the benign inflation, the market still anticipates another rate cut from the Fed next week.
• Fed's Focus on Employment: The Federal Reserve is clearly focused on a "weakening employment situation," which they have been signaling.
• Tariff Impact: Fears that tariffs would spark a new wave of inflation have not materialized at the consumer level. Evidence suggests companies are absorbing these additional tariff costs rather than passing them on to consumers.

Key Stock Performances and Investment Thesis

The discussion highlights specific company performances and an investment thesis for a particular stock:

• AMD and Broadcom: Both companies are mentioned as performing well, with Broadcom "spiking."
• Taiwan Semiconductor Manufacturing Company (TSMC): This company is identified as a stock that Mark Mallick "absolutely loves."
  • Thesis: Beyond its role as a chip manufacturer for other designers, TSMC has a "history of perfect execution."
  • Risks Associated with TSMC:
    • Concentration: "Everyone is using TSMC," creating a single point of failure.
    • Geopolitical Risk: TSMC is located "within spitting distance of mainland China," raising concerns about potential Chinese intervention. This has been an industry risk for some time, and efforts are underway to diversify manufacturing locations.
  • Upside Potential: Despite risks, there is "so much potential upside" due to the company's strong execution and significant investments in the U.S., which will aid in geographical diversification.

Artificial Intelligence (AI) and Market Exuberance

The conversation shifts to the Artificial Intelligence (AI) sector, which some perceive as a "bubble" but is described by Mallick as "exuberance."

• AI Exuberance: Mallick argues that there is "good reason for exuberance" in AI, and it is not "irrational." While there are "corners of the market" that might be overextended, the overall market still offers many great stocks.
• Overbought Stocks: Many stocks are "overbought," but "stocks that are overbought and rich can stay that way for quite some time."
• Google's AI Deal: Google's parent company, Alphabet, has reached a record high after striking a deal with Anthropic. This deal signifies Google's entry into the chip business, as they will be using Anthropic's processing units.
• Concerns about Circularity: The trend of companies investing in each other, leading to a situation of "circularity" where both sides buy each other's products, is a noted concern and a risk to watch.
  • Historical Parallel: This situation is compared to the "dot-com bubble of the late 1990s," where excessive investment in fiber optic infrastructure led to overcapacity.
  • Capital Inflow: More and more capital is flowing into the AI market, raising questions about whether it is "too much." This trend requires careful monitoring.

Conclusion

The market is currently driven by a combination of fiscal and monetary stimulus, coupled with strong corporate earnings that are exceeding expectations. While inflation remains a concern, the recent CPI report was benign, and the market anticipates further Fed rate cuts, likely due to a weakening employment situation. Geopolitical risks and concentration in key manufacturing sectors, such as TSMC, are present. The AI sector is experiencing significant exuberance, which is seen as rational by some, but the increasing trend of "circularity" in investments and the massive capital inflow warrant careful observation to avoid a potential oversupply or bubble.