What really keeps Wall St. up at night: it's not AI or inflation

Key Concepts

• Due Diligence: The process of researching and analyzing an investment before committing capital.
• Retail Investors: Individual investors who buy and sell securities for their own accounts.
• Wall Street: The financial district of New York City, representing the U.S. financial industry.
• MAG7 (Magnificent Seven): A group of seven large-cap technology companies that have significantly driven market performance.
• Pick and Shovel Play: An investment strategy that focuses on companies providing essential tools or services to a growing industry, rather than the industry itself.
• S&P 500 Equal Weight Index: An index where all constituents have the same weight, unlike the market-cap-weighted S&P 500.
• Small Modular Reactors (SMRs): Smaller, factory-built nuclear reactors designed for easier deployment.
• Hindenburg Omen: A technical indicator that suggests potential market volatility.
• Consumer Spending: The total money spent on goods and services by households.
• Stuffed Baby Pumpkins with Butternut and Squash Pumpkin Risotto: A culinary dish discussed in the video.

Due Diligence: The Investor's Compass

Kenny Pulcari, broadcasting from Yahoo Finance headquarters in New York City, emphasizes the critical importance of due diligence for investors. He contrasts the disciplined approach of professionals with the speculative behavior of many retail investors who are swayed by headlines, tweets, or hearsay. Pulcari asserts that "gamblers lose to researchers every single time" on Wall Street, highlighting that true success lies in thorough research.

He outlines a six-step framework for conducting effective due diligence:

1. Know the Business: Investors must be able to articulate a company's core business in a single sentence. Examples provided include Apple (selling devices and ecosystem), Coca-Cola (selling sugar and brand nostalgia), and Nvidia (selling "shovels in the AI gold rush").
2. Follow the Money: This involves analyzing the income statement and cash flow to assess revenue growth, profit quality (distinguishing real profits from accounting tricks), and debt levels. Trends over time are more important than single-quarter results.
3. Listen to the People Running It: Management's honesty and transparency are crucial. Investors should review quarterly letters and earnings call transcripts, looking for candid discussions of challenges rather than mere hype. A CEO who dodges questions is a "red flag."
4. Check the Price Tag: Even a great company can be a poor investment if overvalued. Comparing the Price-to-Earnings (PE) ratio to competitors and questioning significant premiums (e.g., 40x earnings vs. 20x for peers) is essential. The focus should be on buying "value," not "hype."
5. Spot the Risks Before They Bite: Identifying potential risks such as regulation, competition, supply chain issues, or poor leadership is vital. Investors must be prepared to "stomach the downside."
6. Play Your Own Game: Defining an investment time frame (long-term vs. trading) and adhering to it is key. Long-term investors should avoid hourly price checks, while traders must set and respect stop-loss orders. Professionals have a clear "horizon and they have a clear exit plan."

Pulcari concludes this section by stating that due diligence "separates investors from speculators" and provides the "conviction when the market tests you." He urges investors to "read, question, verify, and own your decisions," as "hope doesn't really pay the bills."

Earnings Season Insights and Market Opportunities with Lou Bassin

Kenny Pulcari welcomes back Lou Bassin, Executive Vice President of Market Strategy at Prairie Operating Company and founder of the Big Skinny.com research platform. Bassin, a seasoned Wall Street veteran with over 25 years of experience, offers his perspective on the current earnings season and market opportunities.

US Corporate Health and Earnings Trends

Bassin notes that approximately 65% of S&P companies have reported earnings, with an 83% beat rate on the top line and 76% on the bottom line. He describes the situation as "more of the same and it's all good." Contrary to concerns about a divergence between MAG7 growth and the rest of the market, Bassin observes that the gap is closing, with overall earnings growing by 10% for the third consecutive quarter. He believes analysts are "woefully underestimating how strong earnings growth is."

Identifying Value in a Tech-Dominated Market

While acknowledging the AI fervor, Bassin emphasizes that value can be found in other market segments. He points to the energy sector as a "screaming screaming buy" due to its low weighting in the S&P 500 (below 3%). Although oil prices may decline in the short term, he suggests that for long-term investors, dividend-paying, low-priced energy companies trading at around 15 times earnings present an opportunity.

Healthcare is another area of interest. Bassin highlights Halozymes, a company he personally owns, as a "pick and shovel play." Halozymes develops technology to convert infusion-based drugs into subcutaneous injections, partnering with pharmaceutical giants like Pfizer. The company trades at approximately nine times forward earnings, representing a compelling opportunity in a market many perceive as overstretched.

The AI Revolution: Not a Dot-Com Bubble

Bassin strongly refutes comparisons between the current AI boom and the dot-com bubble of 2000. He cites two key data points:

1. Nvidia vs. Cisco: While Cisco's stock chart during the dot-com era showed a disconnect from its earnings growth, Nvidia's parabolic rise is mirrored by its substantial earnings growth.
2. Infrastructure: In the dot-com era, over 95% of fiber optic infrastructure was "dark." Today, data centers are consuming immense amounts of power, indicating a real demand and infrastructure build-out.

This power demand itself creates opportunities. Bassin suggests looking at companies involved in natural gas, small modular reactors (SMRs), and Bitcoin miners pivoting to AI compute. He mentions Cipher Mining and Iron, which have announced significant deals with Microsoft and Amazon Web Services, as examples of "pick and shovel plays" in this trend.

Further down the supply chain, Bassin suggests exploring companies involved in building new power plants and data centers, such as "Williams construction type names" and even Caterpillar and John Deere, as their equipment is essential for infrastructure development and increasingly utilizes AI. He reiterates the idea that "every company is a tech company" and "every company is turning into an AI company."

Bassin believes the current AI wave is in its "very, very, very early part," comparing it to "1995, 1996" in the dot-com era, with potentially "two, three years" of runway. The key will be whether this spending translates into profitable earnings.

Market Leadership and Tactical Allocation

The discussion shifts to market leadership and rotation. Pulcari points out that in October, the S&P 500 was up 2.7%, but the equal-weight S&P 500 was down 0.7%. This underperformance of the equal-weight index suggests that the market is "stretched on the AI side," but not necessarily "bubbly."

Bassin agrees that there are "other places to look," such as energy, healthcare, and basic materials. He notes that the tech sector is driving the S&P 500's earnings growth (26% vs. 20% expected), which will likely sustain momentum. However, he advocates for a balanced approach: staying in momentum names while tactically reallocating profits into undervalued sectors like healthcare, energy, and biotech.

Bassin suggests a personal strategy of using new money to invest in underperforming sectors like consumer staples and basic materials, rather than selling existing positions in well-researched tech stocks. He also emphasizes the use of trailing stops to let winners run.

Policy Signals and Market Impact

The conversation turns to the potential impact of new policy signals, particularly those associated with a potential Trump administration. Bassin acknowledges that Trump has a history of making "deal after deal after deal." He recalls the "Anything but the USA" trade from earlier in the year and believes that clarity on tax rates, deductions, and trade policies can reduce uncertainty for corporate America.

He highlights the recent shift in China's stance on export tariffs as a positive development, driven by side deals made with other countries for rare earth materials. While acknowledging that replacing all supply chains from China will take years, Bassin sees a path towards greater competitiveness and reduced reliance on China, which became evident during the COVID-19 pandemic.

The Labor Market and Job Creation

A key concern for Bassin is the labor market, which he sees as cooling. However, he balances this with the job creation potential of new data centers, which require thousands of skilled workers. He believes this growth will help restore balance to the labor market.

Both Pulcari and Bassin agree that while AI may displace some jobs, it will also create new ones requiring different skill sets. They draw parallels to the Industrial Revolution, where technological advancements ultimately led to net job growth. Bassin believes that within 12 to 18 months of a major tech revolution, new jobs are unlocked, and the total number of jobs in the U.S. continues to rise.

Consumer Spending and Business Models

Regarding consumer spending, Pulcari questions Chipotle's recent results, wondering if it signals a weakening consumer or a failed business model. Bassin leans towards the latter, noting that while interest rates should eventually provide relief to consumer spending, he "doesn't bet against the consumer." He points out that demand is strong in other restaurants, suggesting that specific business models may be the issue.

Energy Demand and Infrastructure Opportunities

The discussion returns to the power surge driven by data centers. Bassin sees opportunities across industrials, basic materials, and building equipment. He outlines a progression:

1. Chips: The initial leg of the AI trend.
2. Power: The current bottleneck, with data centers needing more energy.
3. Energy Infrastructure: Including SMRs and transmission lines.
4. Services: Companies that will service the newly built data centers.

He uses the example of HVAC (heating, ventilation, and air conditioning) as a potentially profitable business due to the immense cooling needs of data centers.

Small Modular Reactors (SMRs) Timeline

Bassin provides insights into SMRs, noting that they are unlikely to have a significant impact before 2032. The primary challenges include the need for 99.999% uptime for data centers, requiring redundant SMRs, and the inherent difficulties in building and integrating the first units. He believes many SMR-related companies will trade on potential future revenues.

Market Divergences and Forward-Looking Nature of Stocks

Pulcari raises the apparent mismatch between rising markets and some concerning macro data, including high bullish sentiment (a potential contrarian indicator) and the Hindenburg Omen. Bassin dismisses "ominous sounding omens" as useless, comparing them to vague predictions of market corrections.

He reiterates that "the stock market is not the economy" and is "forward-looking." If the market sees a path of clarity through potential downturns, it will respond positively. He attributes this to positive developments in trade deals and tax policy.

Real Estate and Interest Rates

Bassin identifies real estate as an area needing resolution. He disagrees with the notion that interest rates are the sole factor, emphasizing the lack of supply. He warns that aggressively lowering interest rates could lead to price increases. He also notes that current mortgage rates (around 6%) are not historically out of line, recalling paying 15.5% in 1985.

Stuffed Baby Pumpkins with Butternut and Squash Pumpkin Risotto: A Culinary Celebration

Kenny Pulcari concludes the discussion by sharing the story behind his dish: Stuffed Baby Pumpkins with Butternut and Squash Pumpkin Risotto. He explains that the dish embodies the tradition of using all harvested ingredients, a practice that became popular when pumpkins arrived in Europe from the New World in the 1500s. Italian cooks embraced pumpkins, combining them with their creamy risottos.

The dish involves roasting baby pumpkins until tender, scooping out the flesh, and mixing it with a rich butternut and pumpkin risotto. The risotto is then spooned back into the pumpkin shell, topped with the pumpkin lid, creating a "beautiful presentation" and a "perfect marriage of flavor." Pulcari describes it as a dish with "rustic roots" and a "refined spirit" that naturally brings people together, especially during Thanksgiving. He encourages viewers to scan a QR code for the full recipe.

The episode ends with a reminder to subscribe to Trader Talk on various podcast platforms and to email trader [email protected] with questions or topic suggestions. Pulcari signs off with advice to "stay sharp, stay disciplined, and stay in touch." A disclaimer is provided stating that the content is not financial advice.