DAILY STRATEGY: The most frequently asked question in investor meetings is what catalyst would cause non-AI cyclicals (Retail, Airlines, Transports, Banks) to re-rate higher. The near-term catalyst remains some resolution on the Strait of Hormuz. The longer term outlook for input cost, and inflation expectations would decline. 10yr yields would be biased lower. At the same time, economic growth is likely to trend at ~2% real.
Recall, <4.5% on 10yr yields should support non-AI Cyclicals. Along with all Cyclicals and Fundamental factors (HERE). Unfortunately, the SOH resolution catalyst keeps being pushed back. Polymarket odds of traffic “returning to normal” by end of June are down to 15%. The potential asymmetric returns for non-AI related Cyclicals if there is a SOH resolution remains interesting. But the situation is volatile and it’s an open question if a resolution can be reached without significant demand destruction first. i.e. oil prices increase to $120+ before something gives in the negotiations. We have been recommending options to hedge against event risk when volatility cheapens (HERE).
Company Margin Outlook Follow Up – Yesterday went over some investor concerns that AI adoption is correlated with, not the cause of, margin improvements in 1Q. And how companies could be using AI to save time on specific tasks, but not monetizing the productivity improvements (full explainer HERE). This concern might be true, but right now, 66% of AI Using companies have above average forward-looking margin sentiment. The companies that have quantified AI are guiding to ~80bps of margin improvement. The practical implication is IF firms are overspending on AI, now is NOT the time to position for it. Position for it when the spread between margin and cost sentiment narrows.
FYI, Gerard had a similar point about the economic effects from AI spending. The AI buildout might be tracking bubble dynamics LONGER TERM. But so far, the pace of activity does not look extended, based on the relatively tame increases in capital stock growth rates (HERE).
We attempt to apply investor concerns about AI costs and margins at a micro level today. To be clear, this is an initial filter. We would not trade this group as a basket. We look at this group as a place for analysts to do some digging into the names highlighted. Hopefully laying out our framework is informative. Anyway, we list companies that are using AI but have deteriorating margin and cost sentiment. This group of companies COULD be overspending on AI relative to the productivity benefits. Or maybe the benefits of AI just haven’t shown up yet and they will going forward. That could be positive. List below.
Charts…
The companies in the S&P 1500 who have detailed specific use cases of AI but worse forward-looking margin and cost sentiment are below. These are companies to risk manage around.
Yesterday we showed how the level of forward-looking margin sentiment is associated with strong levels of margins (HERE). The level of forward-looking margin sentiment is also indicative of margin expansion QoQ. The fit isn’t particularly strong, but sentiment at these levels has almost never resulted in margin compression QoQ. Now is not the time to position for AI overextension.
Source: Amenity Analytics, 22V Research
Odds that the Strait of Hormuz traffic returns to normal by the end of June are dropping. This tail risk is weighing non-AI Cyclicals (retail, transports, airlines, banks).
From Gerard on the economic side of the AI buildout… “the rate of growth of the equipment capital stock is no longer depressed – as it was at the last time I did this update a couple years ago. But nor does it compare with that of the 1990s boom. The structures capital stock is growing at a depressed rate, which I assume is known. And the intellectual property capital stock, dominated by software and the output of corporate R&D, is at the top of the historical range, although not well above it. The sum of these three times, shown in the chart below, is growing at a moderately slow pace, although it is no longer fair to say it is depressed.”
