Eric Lascelles - Managing Director, Chief Economist and Head of Investment Strategy Research

Hello and welcome to our latest video #MacroMemo. As always, there's quite a lot to cover off. We'll start with some macro developments, including higher energy prices in the context of Iran and some tariff threats and some other recent developments.

We'll also dig into some more thematic type issues. One will be just the trend of mega IPOs, with SpaceX in particular focus and what that means for the market. And perhaps more broadly, we'll spend a moment on economic growth without help from housing – which is indeed the case in a number of markets right now – and how unusual that is.

We'll talk about AI, as we almost always do, but in this context: really falling token prices as a challenge to some of the cutting-edge models out there.

We'll do a quick midterms preview. It feels awfully early, but the whole point here is to get ahead of things and to be thinking about it before the market is thinking about it. Then we'll finish with a little examination of the U.S. stock market, and why we talk about it so much. And actually, there are some awfully strong arguments as to why it's not just thought about so much, but why it's a pretty large fraction of investors’ portfolios.

Okay, let's start at the top and we'll talk about macro developments. The first one is artificial intelligence concerns. We've seen markets much choppier in recent weeks. And we’re seeing clear proof that the AI trade, as it's called, is no longer uni-directional. There have been some clear declines as well.

That's not to say it's all down from here by any means, but there are some concerns – in particular about cheap open-source models, as I'll talk about in a bit more detail later. Some souring public attitudes toward data centres, including a New York state moratorium on data centres, is making that more challenging. And then some questions about just whether prior stock market gains were unsustainable, particularly when you look at some of the memory chip makers. And so very much a choppier space right now. And again, some real questions being asked. And so there’s no longer a reliable tailwind every day of the week.

Let's talk as well about Iran and the war. And of course, there had been that tentative peace deal with 60 days set out to nail down the details – and the details really are not being nailed down at this point. Yes, they are still talking. But as we warned in the last #MacroMemo, it's far from certain this peace accord sticks.

And we have seen indeed quite a resumption of fighting. Oil prices were up from, at one point, the high 60s, or about $70 a barrel and into, at this juncture, the low 80s. And so of course that’s not as good for the inflation outlook, not as good in terms of the Federal Reserve implication. We wouldn't want to overreact.

Actually, I think the right way to interpret this is that we spent a month with surprisingly low oil prices, and we had never really fully revised our forecasts down to reflect that. So I don't think we're off track per se. But ultimately it's not looking quite as favorable as it did a few weeks ago. And this conflict could just drag on. And so oil prices may well remain somewhat problematic for a longer period of time.

And then on tariffs, we don't talk as much about tariffs as we once did. And I was personally quite pleased about that. But I'm afraid to say we have to be back and discussing them fairly seriously. And so there was just a threat to apply a new 50% tariff to Canada.

It is selective, I should say. It only affects about 5% of Canadian exports. It explicitly excludes energy and potash and other major things. It does not sit on top of other products that are already being tariffed, like steel and aluminum and autos. And so I guess 5% of the export pool isn't a disaster, but it's certainly unwelcome.

And of course, it does suggest a somewhat weaker Canadian economy and a weaker U.S. economy. And it does add a little bit to U.S. inflation. And so none of that is exactly ideal. I will note as well that there are other elements of the tariff story starting to play out as well.

Some of the temporary tariffs the U.S. had implemented on much of the world in the spring are due to expire in the next few days. And the thinking is we will see potentially some more enduring replacements proposed. So do brace yourself for some more tariff talk. And we will see whether this Canadian tariff threat goes through. It is scheduled to do so in about a month. And so there is room for some backtracking before then, potentially.

Okay. On to the more thematic topics. The first one is just mega IPOs. Of course we've had this massive space IPO recently. There are others planned, OpenAI and Anthropic. And this is raising three concerns or three types of concerns.

So let's speak to those. The first one is just can the market absorb this? This is a lot of capital that investors need to drum up and find under their mattresses and deploy. And so is it going to take away from the rest of the stock market or other stocks and so on?

We would say we think the market can absorb it. Of the IPO's at least of those three large companies, only about 0.3%, so one third of 1% of the U.S. market cap. And so that's not likely to be too problematic for the broader market. I will note that some does grow over time as the shares of employees are unlocked and that kind of thing. So it becomes maybe a bit more consequential.

It's fair to say that we've gone from a period of contraction in the stock market with buybacks dominating to one in which there is a bit of net issuance. So not completely trivial, but equally not cause for concern in the sense of creating outright trouble for the stock market.

I think maybe the second question is just how attractive are IPOs, or perhaps even these IPOs?

I won't pretend to be a security level analyst. But I can say a couple of very general things. One is that historically IPOs underperform the market, in some cases rather significantly.

That's not always true. But on average, that is true. The valuations of these particular stocks are quite expensive relative to revenues or sales. They do of course have very impressive earnings growth. And so that's the tricky calculus investors are making. And so very expensive. But the potential for growth would probably be a little bit more focused on the challenging valuations and a fairly poor history of expensive IPOs over the subsequent three-year periods.

But ultimately, I guess it is still an open question. And certainly AI is an extremely exciting technology and indeed space economics is very exciting as well. Something we actually talked about in this call last week and indeed wrote about in the last #MacroMemo as well.

The third concern or question I think is just to what extent do all of these IPOs parallel the dot.com boom?

And so here you are again with a bunch of issuance. And there's a big exciting tech theme. And markets have soared. And so you know there are some linkages certainly. And we did see a lot of issuance across the 1990s. I would emphasize the issuance today is much, much less. We're running at, you know, at most half, maybe even a third sort of the level of issuance that's happened in an average year in the 1990s.

And so I don't think it's nearly as frenzied. And there is maybe more of a sound basis of economic outlook on this. But equally, it does suggest there's some heat in the stock market. We would concede that point doesn't necessarily mean the whole thing is coming to an end, though.

Okay, onward from there. Let's talk about economic growth without housing.

So, you know, the housing markets are weak across much of the world. We're focusing here on the U.S. and China, but certainly weak in Canada and parts of Europe and indeed beyond. And so housing weakness and housing does matter. Officially in the U.S., residential investments are 5% of GDP, it's officially about 8% in China.

But actually, if you take a more expansive definition and you include furniture purchases and real estate lawyers and all those sorts of things and wealth effects when home prices are rising, it can actually be more like 20% plus. So, it's a pretty important part of GDP. It's quite unusual for economies to be moving forward well – the U.S. is, China is at least moving forward – without housing markets actively supporting.

Housing is usually very pro cyclical. It's often the problem when you have a recession, it's often a driver of growth when you get recoveries. The correlation between economic growth and housing growth in the U.S. is a pretty significant 0.52. In China it's a massive 0.76. And yet we are getting economic growth. And so how is that happening?

It's because other special things of course, are going on. And so in the U.S., CapEx in the AI space and productivity gains and so on are seemingly filling in that gap for the moment. In China, you've got a little bit of consumer support, though consumers are hardly strong. Maybe you would say more that export growth has been strong.

So there's been a pivot away from the U.S. towards other Asian and developing markets. And the Chinese economy has managed to keep moving forward without that usual housing helping hand. I wouldn't say we're predicting housing immediately revives. But it is worth appreciating on both sides. If you were to lose the AI support for the U.S., you might have a problem without housing.

If you were to lose the export support for China, you might have a problem. But conversely, of course, if housing did start to revive, as it usually does when economies are growing, we think that might be a little bit further off. But that is not unusual. You could actually have very strong economic growth, indeed maybe to a problematic degree in the U.S., to the extent we're already a bit concerned about the prospect of overheating.

Nevertheless, this is sort of a weird, unusual cycle without housing along for the ride.

Okay, AI token prices. So tokens are really a unit of measurement for just the output of artificial intelligence models. The prices received are going down quite a bit. In fact, it's down about 20% in the last two months.

There has been quite intense competition. You have new open models in particular being released, including China's Moonshot AI, which has attracted a lot of attention in the last week or so. To be clear, premium models are still getting a premium price in terms of what people are willing to pay. But increasingly, it is clear that the open models, the cheaper models, can compete and are notably cheaper and aren't that much worse in their capabilities.

And so, as we argued a few months ago and we'll re-argue it now, it's not clear this will be a winner-take-all outcome. In fact, it's increasingly likely that it will be a competitive marketplace with a range of offerings and multiple models and so on. Many users don't require cutting edge models. Certain businesses and certain activities do require the absolute smartest intelligence on the planet.

Some do not require that. Some are quite regular tasks and they can get by with far, far cheaper, more pedestrian models. And some companies that are using AI are getting wise to this and shifting their usage and allocating appropriately. And so, that's an opportunity for businesses. It represents a distinct challenge, though, for the AI model makers.

You can argue maybe a good thing in a purely economic and productivity sense. But of course, I wouldn't want to underestimate the extent to which this whole AI infrastructure has been built up on this frenzied race to be the first to some sort of undefined finish line. And maybe that's a little bit less important than previously imagined.

So that does change things somewhat.

Okay, two more things for me. A quick U.S. midterms preview. So the U.S. midterms, less than four months away, I think I'm allowed to talk about them now. Really the default expectation – we’re not off consensus on this – is that the House of Representatives probably flips from the Republicans to the Democrats. They'll lose the Republican sweep.

A divided Congress is therefore likely. And so we would argue – and critically this is not likely to be the dominant market driver – there are plenty of other important things going on. But we would say all else equal, that kind of political shift might be slightly stock market negative, slightly inclined towards lower yields, slightly inclined towards a weaker U.S. dollar.

You know, it's harder to pass budgets. To be sure, we would think maybe a little bit less fiscal stimulus with the divided Congress. That's normally what happens. The Democrats do seem to be a bit less business-friendly these days. And so the deregulation push might weaken. As an example, you could see more pressure on pharmaceutical companies and oil and gas in particular as well.

Sort of hard to read the AI implications. I think the talking point is that both parties are pro AI, but you might imagine the Democrats being more concerned about labour market disruptions or more concerned about data centre and electricity issues. And so perhaps a little bit less support there.

I do think you have to stop well short of being concerned if you're a business owner about tax hikes, because you require really both parties to support that.

And so I think those concerns are overblown. Unlike with prior tax cuts – and recall, there were some big tax cuts last year – those last year tax cuts are largely permanent, not temporary. So there is not the need to find a solution in the next few years to extend those. And so that takes some pressure off, as well.

And maybe on the positive side, you could say – and this is maybe a silly thing to say – in a week when new tariffs have been proposed, but you could imagine perhaps slightly fewer tariff pressures to the extent that there's now another party with some part of control in Congress. And in Washington right now, equally, a lot is being done via executive orders.

But as an example, if the USMCA were to be seriously revisited and changed in a material way, that would require, in theory, legislation, and you might imagine the Democrats being less supportive of that. So it does maybe limit a little bit of the tariff action. Again, I don't think the midterms are going to be a central market driver, but worth paying attention to. And indeed, that's what we're doing right now.

I'll finish with this: the U.S. stock market, which of course we talk so much about and so just trying to understand why do we talk so much about it? And of course, it is the bellwether. It happens to have some pretty exciting stocks and industries right now, but it is a bit more than that.

One would be, why is it that equity allocations tend to be higher toward the U.S. than the simple size of the U.S. economy would seemingly justify? And there's a couple of answers.

One is just that the stock market in the U.S. is huge. And so 51% of the value of global stocks is in the U.S.

And so if you want to be just sort of evenly distributed around the world, you end up significantly in that U.S. market. Similarly, and I think more subtly, there is a big international exposure. And so U.S. companies, this is S&P 500 companies, 42% of their revenue is generated elsewhere. So when you're buying these U.S. stocks, you're not actually buying the U.S. economy.

You're buying to an extent the global economy. And just to give you an example, 70% of Intel's revenues are international. For Visa, it's 61%. For Apple, it's 57. Meta is also 57. Alphabet 52.

That's all mostly non-U.S. Caterpillar's 46%, Johnson and Johnson is 43. So, you know, when you're buying those U.S. stocks, you’re not really buying the U.S. economy. You're, if anything, diversifying to some extent.

Of course, the U.S. market does have some special charms. And I'm not talking about its outperformance over the last 15 years. So those might be a result of this. But a very strong shareholder return culture and strong rule of law and property rights and a very entrepreneurial and risk-taking oriented system.

And then maybe the other thought is just the U.S. stock market has some unique or at least unusual sector exposures.

You know, it, it is just about the only place you can get that kind of AI exposure and has a very special entertainment sector and a defence sector that's huge. And biotech and pharma similarly. This isn't an argument to overweight the U.S. or to underweight the U.S. It's really just more of an observation if you've ever wondered why is it that the U.S. is so central in my portfolio?

The answer is it's a big, big market, way bigger than the economy itself would suggest, though the economy is big. And actually there's a lot of international exposure, so there's less concentration risk than you might initially think.

All right. I'll stop there. And so thanks very much for sticking with me. I hope you found that interesting and useful.

I wish you well with your investing. And please tune in again next time.