“Tech Buyer Beware”

**“Fairly highly valued”. **This is how the Federal Reserve System (FED) chairman, Jerome Powell, described the US stock market during the interview following his September 23^rd speech at the Greater Providence Chamber of Commerce in Warwick, Rhode Island.

There were a few more gems Powell shared with the crowd during the event. For instance:

“The high stock prices contribute to inflation”

“Near term risks to inflation are tilted to the upside and risks to unemployment to the downside”

and the best of all “Two-sided risks mean there is no risk-free path…”

Thank you, Chair Powell, for admitting publicly that money printing to avoid previous recessions amounted to kicking the can down the road, and now the time has arrived where we cannot kick the proverbial can any further. Print more money to juice the labor market when inflation is at 2.7% (PCE) to 2.9% (core PCE) and you get unanchored inflation expectations. Restrict monetary growth to bring inflation down and you may see unemployment jump from the current 4.3% to 5% or 6%, ushering in an economic recession.

For all of us who were really upset the past few years with governments finding cover behind the insane claims of Modern Monetary Theory (MMT) that government borrowing and spending has no limits for governments that can print ever more money to repay the debt, Powell’s admission is a bittersweet victory.

There was nothing “Modern” in MMT. Nations borrowing themselves straight to bankruptcy is as old as recorded history. Of course, a government can print more money, but the more it prints the more the money loses its purchasing power and ends up with high inflation. No nation can print itself into real prosperity because printing money is not the same as producing the products and services to cover people’s needs. At that point, further attempts to fool creditor nations to buy more of the debtor nation’s government debt come empty handed.

According to FED Chair Powell, we are at that point where no easy solutions exist anymore. The interest expense consumes 25% of the federal tax revenues, which is unworkable as it leads to a vicious cycle of more borrowing to pay the interest, thus even higher interest expense. Moreover, the maturing government bonds carry low interest rates (1.5% to 2.0%) but are replaced with new ones carrying the currently prevailing rates of 4% to 5% (depending on maturity). Try cutting borrowing and spending and a recession cannot be far off. Try printing and borrowing to keep the party going and inflation may become completely unhinged. Interest rates follow inflation, thus the interest expense on the government debt will blow up any budget the government may try to put together. You may have noticed how difficult it has become to reach a budgetary deal between the two political parties— thus a looming government shutdown in October.

Despite all that, the US stock market seems detached from economic reality and remains pretty frothy. Examining the 4 components of economic output (Gross Domestic Product) we observe the following conditions:

Consumer spending remains resilient but the recent increases in credit card and car loan delinquencies indicate the lower income quintiles have exhausted their savings and spending power. This is not a surprise as the labor market is at stall speed with an average of only 23,000 new jobs per month for the last three months. The higher income quintiles however, with their frothy investment portfolios feel confident to keep spending. This is good for the stock market, if it continues.

Government spending is in cost-cutting mode since the new administration was sworn in, back in January. Starting with the efforts of Elon Musk at the Department of Government Efficiency (DOGE), spending areas aside from entitlements and defense have been identified for budget cuts. Unfortunately, there is very little appetite for spending cuts in both Congress and Senate, so the spending cuts enacted amount to the equivalent of 12 hours of government operation. Still, civilian jobs at the federal government are now just 1.83% of non-farm payrolls, which is the lowest level since 1939. So, some spending discipline seems to have returned to Washington DC, even if limited to federal jobs. Without a policy reversal we cannot expect that government spending will be much of a factor contributing more to economic output and the stock market.

Trade has gathered the lion’s share of economic news this year. Uncertainty over tariffs has distorted the usually predictable trade patterns. The large imports ahead of the new tariffs’ implementation (July-August) have given their place to much lower imports since then. The Cass Freight Index is at the lowest point since the Great Financial Crisis of 2008, except for the 2020 COVID lockdowns. In other words, transportation of shipments points to struggling trade and an upcoming economic slowdown. That will not be supportive of higher stock prices for several sectors of the market.

Business investment is typically separated into two parts: Housing and Business investment other than housing. Housing has certainly been a drag for the economy this year. The US housing market peaked in 2023 and has been frozen during the past two years. Numbers of building permits as well as mortgage applications are at levels last seen immediately after the Great Financial Crisis of 2008. Unaffordability (high prices) and high interest rates have kept a lot of potential buyers on the sidelines waiting either for prices or for mortgage rates to drop, or both. Without such developments we cannot expect residential construction, building materials, appliances and furniture sales to boost economic activity and stock prices.

The last piece of the puzzle is Business investment other than housing. Admittedly, this has seen the stronger growth among all GDP components. Orders for industrial equipment have been very strong, aided by defense spending due to the ongoing wars in Ukraine and Middle East, as well as the resumption of civilian aircraft deliveries by Boeing. The above have offset the drop in orders for farming equipment. US farmers have lost a lot of sales (mainly soybeans) as China refuses to buy US farming products amidst the trade negotiations with the US government. Lots of farmers are in serious trouble and without government support it will not be long before stories of farm foreclosures start hitting the headlines.

The technology sector has been by far the shiniest star of business investment, with 90% of the capital spending growth focused on the tech sector. Data center construction and energy production to feed the power-hungry data centers to run artificial intelligence (AI) programs have been the areas with the biggest investment announcements this year.

We, however, have concerns regarding these oversized investments. **First, **they have drawn investor funds from all other market sectors into the tech sector, and particularly the largest companies. As a result, the 7 largest companies in the S&P 500 index (Magnificent 7) comprise 34% of market capitalization of the index. The 10 largest companies comprise 40% of the index value. The other 490 companies together are only 60% of the index value. In other words, with such high concentration of funds in just 7 to 10 companies, the movement of their stock prices, up or down, determines the movement of the whole stock market. Investing in index funds for diversification purposes has become a complete joke.

**Second, **it seems the new administration is trying hard to coax domestic investments to boost economic growth. There is nothing wrong with that since business investment is one of the 4 components of economic output, as we discussed above. Companies wanting to be at the new administration’s good graces oblige with big announcements of huge domestic investments to take place sometime in the future and usually in the high-tech sector. Investors seem willing to accept these big tech investments at face value. No-one seems to doubt whether these investments will ever take place, or if they do, they could be much smaller, or too far in the future to have any meaningful economic impact any time soon.

For instance, it seems weird to us that while both Mark Zuckerberg (CEO of META) and Sam Altman (CEO of Open AI and OKLO) proclaimed in interviews this month that the AI sector is a bubble and it is doubtful the sector will ever generate enough earnings to justify the investments, they both announced new big AI related investments. META will spend *“up to” *$600 billion building data centers in the US, while Open AI will spend “up to” $300 billion in Oracle cloud services to run its Chat GPT AI program. Investors rushed to buy more META, Oracle, and Nvidia shares (data centers run mostly on Nvidia processors), making these companies executives even richer. The stock price of Oracle rose 42% and the company’s valuation increased by $700 billion in just one day after the earnings report, despite missing both revenues and earnings expectations, but announcing the $300 billion order from Open AI. Larry Ellison, the Oracle CEO, temporarily became the richest man on the planet, surpassing Elon Musk. Yet, at a closer look, one may wonder how Open AI could even pay $300 billion for Oracle services when it has only booked $3.4 billion in revenues last year???

It is entirely possible that these big investment announcements are simply made to gain the favor of the government, in the form of some tax breaks, or tariff exemptions. There are plenty of past examples of companies pledging to open manufacturing facilities in the US, receiving government incentive grants, while never actually building any facilities nor creating any jobs. Investors should not be taking these announcements as guarantees. They are just plans that can be cancelled at any time and for any reason. Maybe the company couldn’t raise the funds, or raise funds at low cost, or the demand for the product evaporated, or it’s cheaper to make the investment in another country.

Since we cannot know the true intentions of the executives making these big investment announcements at the time the announcements are made, no one can accuse them of market manipulation. Yet, the effect is similar. Investors get excited about the prospects of these companies, buy more shares and subsequently push stock prices higher. When they exhaust their capital, they borrow from their brokers (margin loans) and buy even more shares. Executives and insiders become richer while investors currently carry $1.06 trillion in margin debt. As a percentage of GDP this margin debt is at the same level as it was in 2021, right before the 2022 bear market which saw a 33% decline on the NASDAQ (tech heavy index) and 19.5% decline on the S&P500 index. Margin debt is leverage that magnifies outcomes both upwards and downwards. Excessive leverage risks blowing up bubbles, causing price declines proportional or greater to the prior price increases. (Here at Fierce, we adamantly advise against using margin, as it significantly increases the risk exposure of the portfolio.)

There are plenty more examples we could list, but for the sake of keeping the newsletter to a manageable length we will omit them from this writing. Although, we will add a few more examples in future newsletters.

Our opinion, based on our analysis, suggests that given the current state of the economy, the US budgetary situation, and the FED Chair’s comments, the high-tech sector and the industrial sector at this moment are overhyped, overbought, and overpriced. Here at Fierce, we always aim to be logical, objective, and aware of ever-changing market dynamics. We are not perma-bears, perma-bulls, or market timers. We simply apply critical thinking to the data we analyze, ask uncomfortable questions, and look for sectors and companies offering decent value for our clients’ assets. Currently, we see more value in pharmaceuticals, utilities, energy (other than nuclear which has run up a lot this year) and Treasury bonds. Investors have somewhat neglected these sectors while chasing the shiny high-tech and overhyped companies. That’s why there is still value in the sectors we just mentioned.

Similarly, we wrote at the end of 2024 that we see value in emerging markets and Chinese stocks. At the time, all media stories were calling Chinese companies “un-investable”, despite how cheaply valued they were compared to their US counterparts. For the past 4 years there was a suspiciously unrelenting media blitz smearing the Chinese economy and its companies. We were reminded daily about the “collapsed Chinese real estate market”, the “empty cities”, the “abandoned shopping centers”, the “empty bullet trains”, etc. One after the other, investment companies divested their Chinese holdings, subsequently realizing big losses for their clients. On the other hand, we didn’t fall for the media’s stories and didn’t sell our Chinese holdings. If US consumers were still buying, and the Chinese companies were manufacturing and shipping their products over to the US (as the shipping data were suggesting), how was it possible for the Chinese economy to be “collapsing” but the US one was not?

We talked to people visiting China frequently for business and they verified that business in China was booming, and city centers were full of people and activity. Earlier this month, our own Chris Cercy visited China to verify the economic conditions of key cities for our holdings. He found the cities to be ultra-modern, clean, technologically superior to our cities, robotic servers at hotels and restaurants, attractive domestic electric vehicles, people everywhere, and shopping centers full of shoppers. Not surprisingly, the prices of some Chinese stocks have doubled since January.

We are not writing this to declare victory. Actually, quite the opposite, as investing teaches great humility. The sooner one learns the lesson that perfection doesn’t exist, the lesser the punishment one receives. Chinese stocks can certainly correct at any time, particularly if the US stock market makes a correction too. This writing should not be taken as a recommendation to buy or sell any security, we are simply writing this as an example of our own independent critical thinking process. **We don’t follow the crowd. We follow value. **

Value is currently difficult to find outside of the sectors we mentioned above (again, pharmaceuticals, **utilities, energy, **and Treasury bonds). Moreover, there are several technical indicators exhibiting divergences, which suggest the market is ripe for a correction. Nothing is certain about the future, but we like to take positions when either a good value opportunity becomes available or the odds favor holding long positions. Neither is currently present, so we recommend caution and holding some cash to take advantage of better entry points.

If you feel FOMO (fear of missing out) and want to follow the crowd by chasing pricy overhyped tech stocks, please remember that the crowd is frequently wrong. That’s why markets tend to correct or crash rapidly and dramatically. Our opinion is that individual, critical thinking is better than blindly following the crowd.

You never see statues of crowds. Only of individuals.

Stay Fierce!