Top of the Morning: CIO Strategy Snapshot - Investment goes boom
Per the full note source, AI-related investment in the US is booming while the rest of private sector investment lags. The desk frames this as a net positive for the macro outlook, supporting the recent equity rally despite unresolved geopolitics. Markets have shrugged off US-Iran tensions, focusing instead on strong earnings and steady economic data. This desk view aligns with a constructive risk environment, but caution is warranted given the duopoly of AI versus non-AI investment.
What the desk is arguing
The desk argues that AI investment in the US is acting as a powerful macro support, even as other private sector investment remains subdued. Per the full note source, this bifurcation is still a net positive for growth, as it reinforces productivity gains and capex momentum in a key sector. The market has rewarded this narrative with five consecutive weekly gains in the S&P 500 and the best month since October 2020.
Supporting evidence includes strong Q1 earnings and resilient economic data, which have allowed markets to overlook the lack of progress on a US-Iran ceasefire. The desk notes that oil has not spiked despite the de facto blockade, further reducing geopolitical risk premiums.
The alternative read—that AI investment alone cannot sustain the broader economy—is implicitly rejected by the desk. The view is that AI capex is sufficiently large to drive aggregate demand and boost sentiment across sectors.
Key takeaways
01AI-related investment in the US is booming, supporting macro outlook despite weak private sector investment elsewhere.
02Markets have ignored ongoing US-Iran tensions, focusing on earnings and data.
03S&P 500 rallied five consecutive weeks; April was the best month since Oct 2020.
04Desk sees glass-half-full perspective as justified given fundamental strength.
Market implications
Watch for continued equity upside if AI data and earnings remain robust. Oil and USD could become more sensitive if geopolitical tensions escalate. A break of S&P 500 resistance near 4200 would confirm the bullish thesis.
Risks to this view
An escalation of US-Iran conflict that disrupts oil supply would challenge the glass-half-full view. A material slowdown in non-AI investment could weaken the macro picture and trigger risk-off positioning.
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Hi everyone, this is Brian Contreras and welcome back to Top of the Morning on the UBS Market News Podcast channel. Last week was the fifth positive week in a row for the S&P 500 and the best month since October of 2020. So investors seemed to like what they saw in the news last week from quarter one earnings to the FOMC meeting and Kevin Walsh's testimony and didn't pay much attention to the U.S.
Iran war. Here to discuss all this is Jason Drejo, head of Asset Allocation Americas. Jason, let's start with the markets, which I said keep grinding higher.
Why is that happening and especially with no progress on a U.S. Iran ceasefire? Well, you gave a couple of stats that kind of speak to what the markets have been doing.
Fifth straight week where the S&P is up, it was for the month of April up about 10.5%. The best month since October of 2020. The end of the month, that might have been, certainly would have predicted that because the conflict was still going on.
The catalyst for the rally was the ceasefire and that certainly provided strong momentum. But as we move forward and there's not a lot of progress on resolving what's called a blockade, the markets have been able to kind of shrug this off. It does seem like the markets are taking a glass-half-full perspective, focusing on the ceasefire, just like less kinetic activity and less worried about the fact that oil has not really kind of picked up in terms of the flow through the straight-forward moves.
The blockade is still de facto in effect and as we speak on Monday morning, the situation is fluid regarding whether ships to the U.S. would provide support for ships to go through. Iran's saying no. There's reports of some military strikes.
So again, a fluid situation. The markets by and large have sort of shrugged this off. I think in part because the economy, the economic data, we'll get into that, has been holding up relatively well.
Earnings have been holding up relatively well. So the fundamental story has given investors some comfort. I think the economic consequences of higher oil prices are not yet material.
It's certainly not evident in the data, but that will likely happen. So there's a sort of runway where this can sort of be sort of status quo. If things don't start to kind of clearly improve by the end of the month and oil can start to kind of pick up and flow by the end of the quarter, then that starts to cause kind of more real economic pain.
But for the moment, I think investors are willing to look through that. And even if it would take, I think, a significantly more escalation for investors to really think that for the markets to pull back, I think dips would be bought and ultimately the longer term story is kind of relatively constructive. But it is a tail risk at this point in time that the markets are pretty much fairly sanguine about overall.
Last week was Jay Powell's final meeting as the chair of the FOMC. As expected, the Fed made no changes to interest rates. Kevin Warsh, the nominee to be the next Fed chair, also testified before the Senate Banking Committee.
Based on these events, what's the takeaway for the Fed policy outlook? So the Fed made no changes. That was almost certainly the case.
So the real focus was on the press conference for Jay Powell, but also the statement, the FOMC statement. And there was actually a little maybe more changes than investors were expecting. So one committee member, Stephen Myron, dissented.
He wanted a rate cut. But the notable thing is three people actually dissented to the easing bias in the statement itself. They weren't advocating for a cut or hike, but they thought the statement still contains a bias towards easing.
The language, you have to be kind of, you know, read Fed speak to understand all this. But basically, the wording is sort of additional adjustment, i.e. the Fed will continue to cut rates. They basically wanted that statement to be dropped with the idea that the Fed is now in a situation where the policy rate outlook should be more balanced, that the next move could be a hike or a cut.
And one of the dissenters, Lori Logan, the president of the Dallas Fed, gave a speech at the end of the week, basically reiterating that a rate hike is a possibility. What that really suggests is that there is a divided committee, and when Kevin Warsh takes over, and it's very, very likely he will be in place by the mid-June meeting, that he will have a committee that there's a lot of people who don't want to be proceeding with a cut. And I think this was a part of their attempt to kind of like, kind of publicly state this is kind of what their overall view is.
You know, Warsh, during his testimony, kind of, you know, reiterated things that were well known already, that, you know, the Fed's balance sheet is too large, that the Fed communication should change. Again, the notable thing he said from a policy perspective is that he'd focus on trimmed inflation, as maybe a good indicator of where inflation trends are. What trimmed inflation is, you basically take off, let's say, the top, you know, 15% of inflation, you know, components, and the bottom 15%, with the idea that every month there'll be outliers.
Something will jump from a one-off. That's not an indication of the underlying inflation trends. So you don't want to, you know, focus on that too much.
Now, that's one of different ways to look at it. Core inflation sort of does some of this as well. Now it is convenient at the moment that some of the trimmed inflation measures, like the Dallas Fed is widely followed, has a trimmed inflation measure, is something like about 2.3%.
Core inflation is closer to 3. So if you want to make a case for inflation as being somewhat contained, allows you to cut, that is, you know, kind of probably the lowest measure you can kind of point to. There's certainly issues with it.
You know, one would argue that, you know, the trimmed inflation is more of a guide for future inflation rather than sort of current inflation, that it's, you know, only one of many data points, and it is the most optimistic on inflation right now. So if you rely on that, you can get a false sense of where inflation is overall. So this will speak to some of the debates that the FOMC will have going forward.
Ultimately, it's kind of why we think that the Fed is still biased towards easing, because you have a chair who's kind of pushing for that. Other committee members could change, you know, the composition could change, you know, more dovish members. But as it stands, you know, the case for the Fed to cut, you're right, at this moment, it's not there.
Inflation is still too high. We need to see signs of oil prices stabilizing and heading lower for that, you know, to be comfortable, I think, for the Fed. For goods, inflation needs to trend lower.
And with the tariff component of inflation likely kind of rolling off by the summer, that should be in place by the fall. And we also need to see signs of, you know, weaker growth, which we think will sort of maybe more materialize more in the second half of the year, which is why we're sticking with two cuts, September, December. But given where inflation is, given the resiliency of the economy, the risk is certainly that gets kind of pushed out.
But that's the bottom line is, after all of the Fed news last week, I think the story has changed at the margin, but not significantly so. So Jason, in your most recent blog titled Investment Goes Boom, you discuss how investment is surging and contributing a lot to economic growth. You say that this is a positive for the investment outlook.
Why do you think that? So there's two ways I want you to look at the data from last week. One is the, you know, during earnings season, some of the big mega cap hyperscalers can have reported earnings, you know, good earnings results.
But just focusing on the investment coming into this earnings season. So let's say as of March 31st, April 1st, the consensus expectation is that the five big hyperscalers would spend about $650 billion this year on AI CapEx, like data centers. Post last week, now the consensus is at $750 billion, so up a small $100 billion here and there you find out of the pillow every now and then.
The guidance for next year suggests it could be upwards of $900 billion. So these are massive numbers. And to put it into context, you know, roughly $650, you know, $700 billion is about 2% of GDP.
If we get to $900 billion, we're talking getting closer to like 2.5% of GDP. That moves the needle significantly. It's also flowing kind of downstream, so a lot of other companies are benefiting from it.
So if you're building data centers, you need construction, you need electricity, energy, all that kind of thing. So you can see it sort of flowing through, you know, profitability across the board. In terms of, you know, broader investment for the economy, we also got Q1 GDP numbers.
GDP grew 2%, a little less than expected. But if you kind of break down the components, you know, investment was a key driver, specifically private sort of non-residential, so takeout housing, investment accounted for about 30% of that 2% GDP. So let's say 60 basis points of that, you know, 2% growth.
Investment in computers and peripheral equipment rose 98% annualized. So on a quarter-over-quarter basis, you annualize it, basically 100% growth. You can see a lot of that is tied to this whole AI trade or theme.
That alone contributed about 30 basis points of the 2% growth. So like you can see like just people buying computers, semiconductors, that's driving a lot of what's kind of going on. Now there's a broader capex cycle, you know, that's sort of also taking place.
But at a more modest scale, it's kind of tied to a theme that's out there in the marketplace called high assets, low obsolescence. So you can't obsolete, you know, like physical plants, you know, halo is a terminology that people use. And that contributed about 5.5% increase in industrial equipment investment.
So it's positive, but really it is sort of an AI kind of related theme. There doesn't seem to be any kind of real sort of let up in insight. Now there's a concern for investors, you know, that, you know, these companies are investing massive amount of money.
Where are we going to get a return on investment? You know, is it justified? And you've seen at a stock by stock level, the markets are willing to differentiate between investment they think will actually be rewarded by the companies and those I think, well, where are you going to get that investment?
There's definitely sort of differentiation at a more micro stock level. At a macro level, you know, thinking overall for the economy, it's hard to sort of think this is a bad thing, at least in the near term. These are significant investments helping contribute to growth overall kind of gave some of the numbers there.
If you think about longer term, ultimately, this investment should help lead to higher productivity. You know, there's a, the general economic relationship is the more you invest, the more capital you build, you sort of deepen kind of capital or the capital deepening, which just means the capital to labor ratio and the economy goes up. That typically precedes higher growth in labor productivity, because workers have more tools effectively at their disposal.
So that should lead to higher productivity long term. That's the goal, higher productivity growth is leads to higher growth that's not inflationary. There's also concerns about, you know, could there be too much investment overall, if you take aggregate investment, you know, it fluctuates, it's pretty volatile over the business cycle, much more so than consumption.
But since 1950, it's averaged about 17 and a half percent investment of a sort of GDP. Right now, it's after the first quarter was like 17.7%. So kind of long in line with long term averages, typically, you get sort of investment booms where it caps at around 20% at the end of a cycle right before recession.
So we're not there yet, we're kind of at an average level, because you exclude AEI, the rest of investment is not that strong overall. So again, it doesn't suggest there's excesses in the economy that would make it vulnerable to some sort of correction. So the investment story continues, it should lead to stronger growth, all is equal, stronger productivity growth down the line.
To me, it's a net positive. Now the winners of that on a stock level, that's to be determined, but I think for the macro perspective, I think it's a positive overall. And just to follow up with that, I'd like to end on some investment recommendations.
Could you remind us of CIO's views and how the latest developments fit into them? Well, we just sort of take away from last week, our expectation for the earnings season would be about 17% earnings growth in Q1, 11% for the year to date. We're tracking on line with that, if not even sort of above, depends on how you want to measure certain things.
There's a lot of one offs in some of the companies that reported that would boost quarter over quarter growth to over 20%, but maybe not sustainable. So you can strip that out, it's still a very good number. And then the estimates and guidance would suggest we're probably a little too conservative on our 11% growth for the year.
So the fundamental story on earnings is there. On the macro side, we got 2% earnings growth. Our view for the year is 2% GDP growth roughly this year.
So the fundamental story is still very much kind of in track, and that's critical. We talked about the Fed and central bank policy still biased, I think, ultimately towards easing. So you have macro conditions that should be supportive for risk assets overall.
In the near term, the other risks we've already touched on that is the Strait of Hormuz doesn't really open up. So oil doesn't flow, oil prices start to go higher, that would be a near term risk. More medium term is that all this investment we're talking about, it is lifting growth.
If that sort of starts to slow down, that'll be obviously a drag not only on growth, but also the financial market. So it's a medium term risks. These are also reasons why when we think about the equity outlook constructive based on fundamentals, but also I think there's a lot of things out there that would warrant sort of taking a much more broad diversified approach, and not just being sort of concentrated too much into US large cap, you know, AI oriented stocks at this point in time.
And a couple of things, if you look at commodity performance, it's benefiting from oil prices, but also all that investment requires actual physical material goods. So there's also seen like industrial metals would benefit. So tied to this investment theme, it should benefit given the geopolitical uncertainties, there's just kind of, you know, that provides another tailwind.
So commodities overall, we also like gold more as a kind of portfolio diversifier for other reasons. So that's another attractive asset class right now. Thank you, Jason, for joining me on top of the morning today to keep our listeners informed on CAO's thinking.
You're welcome. Have a great week. Thank you for tuning in.
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