RHP Market Talk
Complicated economic topics distilled into digestible and palatable investing principles.
Hosted by Natalie Picha, Partner and CXO of RHP Wealth Management.
RHP Market Talk
What Is AI Hiding?
While the markets keep buzzing about AI, we look at what's happening and ask the question: What are sky-high AI returns hiding?
Natalie Picha, CXO, sits down with our CIO, Glenn Royal, CFP® to separate signal from noise as mega-cap tech drives returns, rates tilt toward cuts, and policy shifts reset the playing field for defense, infrastructure, and the power grid behind modern computing. Our conversation covers:
• AI-led gains versus broader market breadth
• Rate cuts, earnings growth, and valuation pressure
• Circular financing and hyperscaler CAPEX ROI
• Earnings season expectations normalizing
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https://podcasts.apple.com/us/podcast/rhp-market-talk/id1538051530
Hi everyone, I'm Natalie Picha, Chief Experience Officer and Partner at RHP Wealth Management, and this is Market Talk. In this episode, we're asking the question: what is AI hiding? Discussing AI and how it's shaping our economy and ultimately affecting the stock market. I'm joined today by our Chief Investment Officer and Founding Partner, Glenn Royal. Glenn is responsible for directing our firm's investment strategy, portfolio management, and market analysis. Our goal is to help our clients and listeners understand the relationship between the financial markets, the overall economy, and how it affects their personal financial goals. Glenn is a Navy veteran and has been studying markets since his investment career began in 1984. We always appreciate his historical perspective on today's market. As the saying goes, history may not repeat itself, but it often rhymes. And we're excited to hear his insights during this episode. Hi Glenn, how are you today?
Glenn Royal:Hi Natalie. I'm well, Natalie. How are you today?
Natalie Picha:I am doing well and I am excited about this conversation. AI is certainly all the buzz right now, for sure.
Glenn Royal:It is. I'm gonna bring out my AI chat agent, let it start take over for me from this point on. How's that?
Natalie Picha:Okay, perfect. So we should let our audience know that actually Glenn's um AI chatbot is actually the one having this conversation with us today. Yeah. Um I we're we're jokingly saying that because we're just not quite that savvy, I'm afraid. So that that is truly just joking. But this is a subject we've been kicking around the office, and something that came up during our investment committee meeting this last week. What is AI hiding? Uh certainly one of the things that's come up in conversation is did the AI trade mask the tariffs?
Glenn Royal:Yeah, it's a great question. And you know, uh, we have a year where you really have had AI stocks generally as a basket, one recorded, it's up 36% year to date. Wow. When I look at more of an equal weight S&P 500, it's up about 8.5% year to date. So you'd clearly have seen AI is got all the investor attention, all the enthusiasm for right reasons. The amount of money being spent is astronomical. It is a lot of profits to be made if you're in the right spot. Uh, and so that has been the main driver, throwing some tariff news and all that other good stuff and government shutdowns, and you got quite a bit of witch's brew here in October. But happy Halloween.
Natalie Picha:Right, right. You know, and what's interesting is I our last podcast when you and I had a conversation about September, and September being historically one of the um, you know, worst months of the market during a year. And actually, September, again, proved to be uh it was actually a pretty good month. And I'm I'm looking at this market strength kind of being driven by that AI narrative, semi-chips, infrastructure services. Like, what about the traditional economic, you know, indicators where we talk about inflation and labor and supply chain? Are those just getting lost in the mix?
Glenn Royal:They may have been like last month, we saw a little bit of kind of parabolic trades, these moonshot trades going on as some of the more speculative stuff. But really also coupled with this is the realization that the Fed's in an interest rate cutting cycle. And at time we expect corporate profits to still grow. So I think that is what's getting investors' attention as much as the AI story is what what you're really seeing is years of you know, the government, how they've run procurements, different things that nature, department of war, now they call it doing different things to spin, mainly benefited these legacy type big companies. There's a whole shift with the Trump administration, and and I think part of that is how they uh acquire things, that's generating some activity and interest in in the system. Uh defense contract procurements are changing as we see. They're getting ready to actually, you know, I I'd love to pick on McKenzie. I love to pick on McKenzie, and this is time because it seems like McKenzie model is breaking, and they're going over to Wall Street private equity model. They're looking at for advice from the KKRs and people like that of the world of how do we do procurement for the Department of Defense again quicker, faster, and more and right to repair. So there's a lot of cool stuff going on that's yeah, I have the AI story, but I also have military industrialization going on, and I got this big power grid underneath it that supports uh the military as well as AI. So there's a lot happening, but AI certainly is uh is the buzzword, it's about three years old in this trade. You do have to ask yourself would we be up 20%, 20%, 15%, you know, year after year after year if I hadn't had this AI story? Probably not. We'd have been more normal economic. So in that case, look for the Fed to cut rates and that'll help us.
Natalie Picha:Well, and I think when we talk about what is AI really doing to the underlying market, we have to ask are the productivity gains and the growth how much are we going to get, or has it been overinflated?
Glenn Royal:We're just starting to see it's too early to say. Because even us here at our small firm, and we're one of thousands in this in the world right now, are trying to understand how do we use this technology, this new technology, you know, consumer protection, things of that nature we have to deal with. But how do we use it to enhance our business to make it more efficient? And so that productivity gain is real and it is happening, and you can see it across the board. I I think there's a big concern about jobs, job losses, things like that with AI. And um we've seen the job market, it was 150,000 jobs a month printed at the first of the year. It's dropped to 25,000 jobs. Number one reason immigration, uh, both legal and illegal. You you took out 50,000 people off the rolls, whether one way or the other, they're gone. So we're now seeing the real numbers. So now I get in this labor of really a full employment environment and labor, but we're not seeing while you're hearing stories of AI replacing some jobs, copywriters, different things like that, call centers. It's just it's just small, it's at the margin, it's it's just not significant at this point. So I don't see AI as a risk in that world of jobs, but I just see it more as a productivity enhancer. And also going to use it one way or another. Uh, I just the the telltale for me about AI, what I'm watching closely, is Oracle. You know, we'll talk about probably something here in a minute about the circular financing stuff, but you know, Oracle uh recently did this deal. This this is the circular financing. He had um NVIDIA invest in OpenAI, who in turn buys the computing power from the hyperscaler Oracle, who in turn buys NVIDIA's chips. So you get this circular deal, and that's new for us. I don't know quite yet what that means in the long run. We're still trying to understand that, but uh but what I do know is that Oracle is probably the gonna be our canary in the coal mine for the return on investment. So investors are starting to shift from the impressiveness of the capex build out. I mean, I was looking at the hyperscale growth. Uh, sorry, looking at the numbers here real quick, but you know, up uh we were looking at 20 when we came into 24 at the start of the year, we were looking for capex by these hyperscalers to grow by 19%. This is up 54%, 25 coming this year. We were looking for 22% growth time, they're up 64%. So next year is expected to be 19, probably higher than that. So that continues to grow. So what we want to know now is am I going to get a return on that investment? Are these hyperscalers, these big cloud warehouse guys that are buying all this, creating this scalability to compute power? Are they going to get that return? And Oracle will kind of be the canary and a coal mine. You know, I think they announced a $900 million deal with the Chat GPT deal. And uh I think a profit margin was about $150 million, which sounds great, but these are typically much bigger margins that we see out of these companies. So I think the focus will shift a little bit more maturation of the hyperscalers, a lot of the build-outs being done as they go forward in the next year. Investors are going to start looking on the winners and losers because we know we talked a bit earlier about early adoption, the advantage of early adoption whenever we have these big technological evolutions.
Natalie Picha:Right.
Glenn Royal:But it doesn't mean that you're the winner, you're the survivor if you're an early adopter. You can actually go out and build all this stuff and not succeed, and someone can buy your assets out and do something else with it. So we need there's going to be winners and losers, just like the dot-com era. You know, for the Cisco that was the backbone that built out the dot-com era, I have NVIDIA today. That spawned off back in the old era, Amazon and Pets.com.
Natalie Picha:Right.
Glenn Royal:It was the better trade, yeah. Right. So that's the kind of the world we're going to be in, winners and losers, and uh we'll be shifting that focus next year.
Natalie Picha:And I I want to kind of circle back to what you were talking about on the circular financing and what that means for markets. So just so that our listeners really understand that circular financing kind of refers to a lot of different things. But in this context, what we're talking about, it's when companies or investors finance their own demand by investing directly or indirectly in their own customer base. And just the one that you just the example you used with Oracle, again, like you said, we're at the very beginning stages of this. What does that really mean long term? And how really productive are we going to be just because we're using AI? Is it going to be a ship that right or a sea that rises all ships, right? A tide that rises all ships.
Glenn Royal:Yeah. And I suspect there's going to be some startup company with a hundred employees that booms up to a billion in revenue by using AI and is uh uh you know that creative destruction that we is so popular in finance. Come out and break business models with the result of AI. So I'm looking for those kind of uh opportunities in this market. Smart people out there now use this stuff.
Natalie Picha:Um, and then of course we have we're we're coming right up on quarter, you know, third quarter earnings. Uh we had tech at an uh basically expectations for the technology space to be at 7.4%. What are your thoughts on earnings coming up? It's gonna be a big week next week.
Glenn Royal:It is, yeah. So the next two weeks, that's you know, spooky Halloween here. Earnings, you're gonna get the technology guys, and we're gonna look for that ROI story. So where's it at? So that's that's a big deal the next couple weeks, and you know, reopening government and all that. But this time, you know, going into earnings period, analysts um do estimates before the reporting period, right? And uh for the last several quarters, really come out of COVID, these analysts' estimates were too low. And so when we actually did the reportings, we've been beating them by the proverbial country mile, right? Right last quarter we were looking for 2% growth that came in 11. You know, big, big out outbreaks. This time it's not so much of a delta. We were looking for growth pre-u-earnings season of about 7.4 percent right now, with just early, you know, 15, 20% of the companies reporting uh we're at 7.6. So we're just slightly beating it by two tenths. So we're largely coming in line. Yeah, you got to take that for what it means. It's uh one is analysts have caught up with earnings, but um, we have it's kind of reflecting in this fully valued market that you're seeing. You know, we're hitting everything. So I don't have what's my catalyst to continue to go higher. It's gonna probably be rate cuts and this movement from the federal government, uh, the excesses that we see in the federal government that are being cut out or being to the private sector, and the private sector can profit from that. So this is what gets me excited as an investor. Um, I I know the AI story and and the valuations have caught attention. There was a uh 60 Minutes a couple weeks ago. Andrew Ross Sorkin wrote a book 1929. It's probably a great book to read. I'm I plan on reading it, but it shows parallels of today's economy versus 29, including the figures you know that we had then versus today. And so you can really relate to it. And it and it makes you go and our recency biases.com, it's it's 2008, right? And that's in their mind. But uh I need to really point out that all this capex that's being spent by these hyperscalers is done out of free cash flow, they're financing, self-financing. They're not going to the debt markets, they're not going to, you know, the credit equity markets issuing more uh securities, they're self-financing. Right now, now we get into next year, you know, one of the drivers of market returns is stock buybacks and dividends. So there could be where the trade is with that. They're spending all this money, which is great. It probably means they have less to buy, do buybacks and dividends. Exactly. Little trade-offs there and there, but it looks like you kind of get into next year, you know, after such big booming years. I'm starting to come around thinking that I don't necessarily need a negative year, but can I have a single digit year?
Natalie Picha:Yeah.
Glenn Royal:That feel like a negative year after the last three, right? Yeah. Okay, that's great. If I had a single boring, please bring me a boring year.
Natalie Picha:That would be great.
Glenn Royal:Yeah.
Natalie Picha:Can we get back to boring?
Glenn Royal:But I do think the bigger picture is I want to be where the government spends money and nobody moves the needle like Uncle Sam, right? They got the biggest checkbook. So there is a major shift of how our our government operates. No secret. But that is shrinking the size of government and pushing as much as the government off into the private sector, find the private sector to do a better job with it. And in turn, learning from the private sector, not the McKenzie guys, but the Wall Street dudes, of how to get better deals out of the system, particularly in defense contracting. So my our thesis kind of is investors, we look forward, you know, it's the military industrialization. I may much as I hate to say that, but it's the reality is we're behind times on shipbuilding and everything else, and that's where we're going, right? Yeah. Um, in order to enable that is uh AI, AI assists the military. We see what the new warfare battlefield is in Ukraine, right? Drones, things like that.
Natalie Picha:Yeah, yeah, yeah.
Glenn Royal:AI is super critical. If you look at all the government agencies, the biggest spender of AI and their budget is the Department of War. The second biggest spender is NASA. And you know the NASA budget compared to the Department of War. It's stocked. Yeah. They're spending big time. So I've got the military investing into AI for their needs, supported by the industrial power complex. Our grids are 50 years old, our transmissions line, they're 40 years old in Europe. They're like 15 in China. Yeah. We have a lot of catch-up to do in those spaces. And so I think making America first is going to cause investment, government transfers into the private sector to build this thing out as they shrink government. And so we we have some pretty good opportunities in light of these rich markets that uh if the earnings growth that's expected to be, you know, 10%, 12% next year, followed by another 10% two years out. Also, by the way, I'm getting better earnings growth from small and mid-caps than large caps the next couple of years. So that starts to maybe get me a broadening out of this market and participation, those equal weights. So kind of, I you know, I'm throwing a lot at you there, but yeah, the question is how to investors position.
Natalie Picha:Exactly. Yeah, that that was actually where I was gonna go with that. It's like, so all of this information, and it's a lot. I think part of, I know even within our firm, it's trying to figure out what's noise and what's information. And now we thought the internet brought about the you know, proverbial fire hose drinking from the fire hose. Well, AI has just multiplied that a million times over.
Glenn Royal:Um create an email chat bot agent that can screen my email and just give me the most important things I need to know. Wouldn't that be awesome? You know, just little things like that. Yeah, move the needle on productivity.
Natalie Picha:Yeah, well, and it's it's out there now. How well it works, I don't know. If you've been trying to email us and we're not returning, right?
Glenn Royal:You get it.
Natalie Picha:Exactly.
Glenn Royal:Um this today, recent market news today is that ChatGPT announced a browser. Well, Google's down 2% on that news. Bam. So look for that kind of yin-yang in the tech world as they try to take market share.
Natalie Picha:But with all this information, how do you position yourself ahead of what where's where are we sitting today with all this information?
Glenn Royal:I still want to remain invested, but I understand the richness of the AI sector of the market. S&P 500 is weighted towards that area. So I want to diversify my portfolio. This is where the old asset allocation, the old stock sponds, cash, large cap, small cap international. I want a diversified portfolio. And then, too, if if equity risks are a little much, or you know, bond market. I mean, it's yields have down from where we were pounding the table, you know, earlier, but um, they're still attractive. And and you can go hang out there and you know, you won't get rich in the bond market, but you'll keep your principal and keep your income, and life's good in that light. So when you pair a little bit of bonds off your equity and de-risk a little equity, that always kind of helps. It still works for you in this environment, uh, if you if you're a little concerned about risk profiles. But um I think that diversification international still makes sense. There's a lot of interesting things going on, and then what you may be seeing here is that the US, because of tariffs and different reengineering we're doing, actually sees this sticky inflation of 3%, while the rest of the world has a deflationary impetus coming from China as they ship their goods to the rest of the world and dump it there. So there's weird stuff going on, but it also creates a lot of opportunity emerging markets uh that are going to be swing players as we shift production from China to other countries.
Natalie Picha:Yeah.
Glenn Royal:And GM General Motors announced this morning they had a big blowout. And one of the things I'm listening to from the management calls in the survey's period is how's your supply chains? And they're fine. They're they're holding up and they're they're they've got them all corrected, everything's flowing, you know. And I think too, what helps next year is CEOs now have greater clarity around tariffs. You know, it's largely abating that story. It pops up every once in a while, but it's largely abating, and that's going into next year, coupled with lower interest rates. That's what I'm gonna be in the stock market, I don't want to get out. I think that the market looks pretty good, albeit rich, right? There's that risk. Right, right. Diversify and there's a lot of opportunity out here because you will start seeing that spreading out small caps and mid caps.
Natalie Picha:Yeah. Well, if you're a current client, you know that we look at our investment portfolios every single day. Um, our eyes are on it. And so we value having your financial plan right there, well balanced with your investment portfolio, so that both of those pieces work together. That's that's really what we do well at RHP. We encourage those listeners. If you haven't, you might want to pull your portfolio out and take a look at it and think about all of this information that we just said and think about are you diversified in the right areas where you want to be, right?
Glenn Royal:Those non-profitable tech companies, that's where the bubble is. So watch those. If there's a bubble, it's in non-profitable tech.
Disclosure:Royal Harbor Partners is a registered investment adviser, and the opinions expressed by Royal Harbor Partners on this show are their own. Registration as an investment advisor does not imply a certain level of skill or training. All statements and opinions expressed are based upon information considered reliable, although it should not be relied upon as such. Any statements or opinions are subject to change without notice. The information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. The information expressed does not take into account your specific situation or objectives and is not intended as recommendations appropriate for any individual. Listeners are encouraged to seek advice from a qualified tax, legal, or investment adviser to determine whether any information presented may be suitable for their specific situation. Past performance is not indicative of future performance.
