- by New Deal democrat
Here is what I have been telling them.
There are two current drivers of the stock market: (1) AI data center related spending, and (2) domestic energy company profits.
Let me tackle the second one first, because it is relative simple and straightforward. As we all know, the Strait of Hormuz, through which most of Middle Eastern oil flows, remains closed. But the Gulf of Mexico is wide open! And that means that countries and companies that need oil are bringing their empty tankers to Gulf Coat ports and loading up. US oil exports have thus hit a new record:
Further, because the price of oil is set globally, they are loading up at that price. Which means that domestic producers like ExxonMobil and Chevron are making out like bandits:
So while consumers may be suffering at the gas pumps, US based producers most certainly are not.
Now let’s turn to AI data center related spending. Below are three components of industrial production that are tied to AI data centers: semiconductors (blue), computer and electronic products (orange), and electric and gas utilities (gold, right scale):
All three have increased much more than industrial production as a whole over the past several years, particularly semiconductor production, which is up over 60%! As I have written before, once you take out AI related spending, manufacturing and production have gone basically nowhere in the past several years.
So, in answer to the first question, these two sectors are what have been driving the stock market higher.
But is it a (sustainable) Boom, or an (unsustainable) Bubble?
To give you my sense of that, I have to get into the weeds on some data I don’t normally concern myself with, which are called “stock market internals.”
Last week I wrote that half of all S&P 500 profits have come from just 5 companies:
That’s not exactly a widespread Boom.
Next, here is an update of a stock market indicator I touched on a few times last year: the advance-decline line. This tells us how many more stocks are increasing in value than decreasing. If the economy is doing well, such increases ought to be widespread. But if only a few companies are advancing, that tells us that the majority of the economy is not doing so well. Here’s what that looked like late last year when I wrote about it:
And here is what it has looked like so far this year:
While compared with last year, there has been an increase in the total number of advances vs. declines, in the past month this number has fallen fairly sharply, back to where it was in February, and only a little better than late last year.
A similar lack of widespread health is shown by the number of new highs vs. new lows in stock prices:
In the recent advance, only a few more stocks made new highs than made new lows.
Finally, let me touch on one other measure of relative health: the stock vs. bond dividend gap. This is the difference between the amount of dividends paid on S&P 500 stocks, vs. the interest rate an investor can get by holding bonds. The higher the gap, the more investors are relying on stocks rising in prices to cover their risks.
And to start with, the S&P 500 is at or near record low dividend payments, at only 1.06% of their price:
Dividends on the S&P 500 have generally drifted lower for decades, but at least during 1981-2020, so did interest rates on bonds.
So here is how the current dividend yield on the S&P 500 compares with the yield on a 10 year Treasury, currently at about 4.5%:
And here is the same comparison with the 2 year Treasury note:
Both of these measures are at their worst levels for stocks since before the Great Recession 20 years ago.
Finally, here are the yields on AAA and BAA investment grade corporate bonds:
These are at levels equivalent to just after the Great Recession. Put another way, you are currently being paid about 3.5% more than S&P 500 stock dividends to own a 10 year Treasury, about 4.5% more to hold an AAA rated corporate bonds, and about 5.0% more to own a BAA investment grade bond. All to bet that the stock market will continue to increase in price in the next year.
This does not tell us in *absolute* terms whether stocks or bonds are a “good” deal. What it does tell us is that in *relative* terms, you are taking more risk than at any point in the past 20 years to gamble on stock price appreciation making up for the puny dividends you are earning on them. Bonds could still be a bad deal at present — but stocks are relatively speaking at far more risk.
The present situation reminds me very much of 1999, when the advances in the stock market were focused on the dotcom issues. But the advance decline line deteriorated for about a year before the dotcom implosion kicked in.
So my conclusion is that, at the moment, the momentum in the AI sector, joined by the windfall profits for domestic oil producers, are more than outweighing the difficulties by most consumers. But that momentum looks extremely risky. Like a bubble.