Episode 27 - The Great Rotation? Summer update with Lance Peltz.

Is the AI trade beginning to unwind—and could the UK market finally be having its moment?

In this episode of Bassline, Dave Wallace is joined by Lance Peltz, Chief Investment Officer at Cavendish Ware, to examine the forces moving global markets.

They begin with the UK stock market’s push towards record territory. Lance explains why Britain’s concentration of energy, mining, financial and pharmaceutical companies may now be working in its favour as investors rotate away from the dominant AI stocks.

The conversation then turns to the enormous sums being invested in AI infrastructure. Chipmakers, memory manufacturers, generator producers and power-management companies have enjoyed remarkable growth, but Lance warns that momentum investing works brilliantly—until it suddenly does not. With new manufacturing capacity being built and retail investors arriving late, could the familiar semiconductor cycle be about to reassert itself?

Dave and Lance also explore the changing balance of supply and demand in US equities. The technology giants are spending heavily on data centres, borrowing more and buying back fewer shares, while a wave of major companies prepares to enter the public markets. Lance explains why this shift in liquidity may matter more than small changes in interest rates—and why parts of the market remind him of the dotcom era.

Attention then moves to the continuing conflict involving Iran and the United States. Despite disruption around the Strait of Hormuz, oil prices have remained more restrained than many expected. Lance considers the role of American production, Chinese reserves and changing regional trade flows, while warning that depleted inventories, rising food costs and persistent geopolitical tension could still produce another inflationary shock.

Finally, the discussion returns to Britain and the arrival of Andy Burnham in Downing Street. What might a more left-leaning government mean for spending, taxation and consumer confidence? With limited room to raise conventional taxes, Lance considers whether pensions and housing wealth could become the focus of the next Budget.

In this episode

• Why the UK market is benefiting from a global rotation
• Whether enthusiasm for AI infrastructure has gone too far
• The risks facing momentum investors
• Why semiconductor booms tend to create their own downturns
• How hyperscaler spending is changing US equity markets
• The importance of liquidity, valuations and bond yields
• Why the oil market has remained surprisingly resilient
• The inflationary risks posed by energy, fertiliser and food
• How Cavendish Ware is positioning portfolios
• What the “Burnham effect” could mean for Britain
• Why pensions and property may face greater taxation

This podcast is provided for general information and discussion only. Nothing in the episode constitutes personal financial or investment advice. Investments can fall as well as rise, and past performance is not a reliable guide to future returns.

Transcript

Dave (00:00)
Hi Lance, how are you?

Lance (00:02)
I'm not too bad. I've just returned from my two-week summer holiday in Sicily and whilst it was a bit too hot I would rather be there than here but here we are.

Dave (00:17)
Fantastic,

fantastic. Well, we were just having a quick chat, but you've come back to the stock market, which may hit 11,000 today. So it's up. And I don't know, for me, that seems a bit crazy. But I just wondered if you could give your perspective on what you think might be going on.

Lance (00:40)
Sure, I'm not a big believer in round numbers in indices, but it is pleasing to see that the UK is beginning to do better compared to other markets and there's definitely a degree of catch up going on. It also is explained by

characteristics of the UK equity market. The UK is as a listed market more overweight in the oil sector, in metals and mining companies, in financials than a lot of other markets.

and pharmaceutical. All of those sectors have kind of been on the back burner while everybody's been focusing on AI and AI related things. There's been a big rotation and the UK is benefiting from that. It's also benefiting from a bit of bounce from the data is not as bad as expected to even some.

I would say possibly good data. GDP growth has been okay. There's been a bounce in consumer sentiment and that's been backed up by activity.

we can put that down to a number of factors. None of them are truly scientific. It could be the weather. It could be the success or not, depending on your view of England in the World Cup. Or it could be politics. But all that helps.

I came back from this holiday to see that at the headline level, a lot of indices were barely changed. mean, notably the US equity indices. But within that, that disguises some very big rotations. And it does look like the AI theme is beginning to unwind. Last year, we had...

the market focusing on the hyperscalers or the Magnificent Seven, these were the companies like Amazon, Microsoft, etc. that were spending billions on data centres. This year they've actually lagged the market and all the attention focused on

the companies that were really benefiting from the infrastructure of Buildout. And it's that old adage in a gold rush, you want to buy the people who made the picks and shovels.

Dave (03:23)
Ahem.

Lance (03:25)
And this year's been all about...

chipmakers and not even the high-end chipmakers like Nvidia but companies like Intel and SK Hynix.

memory manufacturers. Some of these have gone up a tremendous amount and whilst their earnings have grown hugely, mean in absolute terms the profit growth in these companies is astounding. Basically they can't make enough of their product quickly enough and they are setting the price because the hyperscalers in aggregate are spending

hundreds, literally hundreds of billions of dollars in building out data centres. And these guys are the beneficiaries, along with mundane companies like Caterpillar, which build generators. And these data centres are incredibly power hungry. So it's people who build generators, it's people who build power regulators, which are industrials, but definitely not high tech industrials.

And some of those companies have seen incredible increases in their share price. SK Hynex, which is a Korean company, I actually took a note of this. Year to date, it's up 112 % from start of the year to its peak.

But from the peak, it's also fallen 40%, leaving it up a mere 30 % year to date. We're only just past the halfway point. So there's still been fantastic gains to be made in these stocks, or has been made. But the real...

issue is that there's been a lot of retail money flowing into these stocks. There's a lot of leverage through financial instruments in these stocks and the risk is that a lot of retail investors have been burned because they're late to the party.

This type of investing, chasing stocks that go up rapidly, is called momentum investing. And it's absolutely fantastic. It works fantastically until the day it doesn't work. And then the implosion or the reversion is very, very painful. there's a headline in the FT today, or a headline for an article, which basically quotes...

a Korean retail investor basically. The headline says, I'm screwed. The FT has never been afraid to use a little bit more colorful language occasionally. Now we can take a, if you're mean-spirited, bit of Chardon-Froid in

pain suffered by these retail investors who got rich quickly instead of taking measured investments, which obviously I would always encourage clients to do. The risk is that there are wider impacts on consumer activity. The US seems to

Consumer activity in the US does seem to be significantly buoyed by the wealth effect of markets. And it's interesting, it's markets because US housing has actually been quite soft recently, but US consumer activity, US consumer confidence is still at good levels. And there's leverage in US return investing. So it's easy to enjoy.

that pain of a Korean retail investor, but it could be the heartbringer of wider problems. We've already seen stuff like SpaceX now trading below the IPO issue. that's also the the SpaceX thing is also very interesting, because there's a huge raft of very large companies coming planned to come to the market in the US.

this year, including the two big AI companies. At the same time, the hyperscalers that we mentioned, Amazon, Alphabet, is a parent of Google, Meta, which is a parent of Facebook, etc., have gone from companies that have been incredibly cash generative

Dave (08:06)
Thank

Lance (08:07)
and been buying back a significant proportion of their stock.

to companies are spending so much money that they've actually now become net cash negative. They are borrowing significant sums of money, but very importantly, they are no longer in aggregate buying back their shares at a rate that we used to have over the last decade. And this is going to be the first year that net equity issuance in the US.

is positive. In other words, are going to be more shares issued than redeemed and retired. And one of my principal beliefs is that markets are driven by the balance between buyers and sellers. And so now in the US, you've got more supply, more sellers than they used to be. So the slack has to be taken up by retail investors and institutional investors.

And whether that will happen, we will see. We've positioned our portfolios for some time to be underway at the US. Valuations, flows, and the rotation in markets away from these stocks does look to be coming towards us. In May, we sold the iShares World Value ETF.

because it had a very large position in these value technology companies, which went parabolic, as did the iShares value ETF. And that, think, is going to be a very timely example of how we view managing the portfolios when valuations are excessive. The risk reward is against you. Valuations...

have a significant impact on the long-term returns an investor will receive. And that's again one of our core beliefs. But whether this rotation brings with it wider pain that sets markets back, I don't know. But the other thing that whilst equity markets get just...

a lot more of the headlines, a lot more of the investor focus. The thing that's going on in the background is that the inflationary pressures haven't gone away and bond yields in most developed markets are creeping up. And so the cost of money, the cost to borrow money is increasing. We've also got a new Fed governor in the US, Kevin Walsh.

And whilst Trump could have appointed many other candidates that were, I can't put this any other way other than poodles, he actually chose amongst the candidates the most credible candidate and the one that actually has more chance of upsetting the bull market than any, because not only is Kevin Walsh

got good credentials about monetary policy, he's also very much in favour of reducing the size of the Fed balance sheet. And that's basically jargon ease for basically doing the opposite of printing money, the opposite of quantitative easing, which is quantitative tightening.

Again, another one of our philosophies, which goes to more buyers and sellers, is that the price of money doesn't really matter too much. It really doesn't matter if interest rates are 3.75 % or 4.5%. But if the volume of money is increasing, if liquidity is easy to come by, that supports markets. And we could be on the cusp of a change.

in that liquidity situation, which we've positioned the portfolios for. We're underweight equity, we've been underweight. A lot of the stocks that we've been just talking about. As I said earlier in our quick pre-podcast conversation,

There's aspects of this that feel very much like 99-2000.

Dave (12:49)
Mm-hmm.

Lance (12:50)
In 2000, I promised myself I would never be too early to exit the bubble. Looks like at the beginning of this year, or certainly in the huge rally that we had when the missiles stopped flying, it really did feel like I was too early.

things are coming back onside now. And we will see at end of the month how portfolio performance is.

Dave (13:23)
It's really interesting.

I'm just picking up on one point you made, which is about what the hyperscalers, the focus on data centers. But then underneath that is, you know, you've got people producing essentially the raw ingredients like the chips and, you know, and it's fascinating. My son wanted to buy a new PC and he was like,

dad, have you seen the price of a PC now compared to like two, three years ago? So it was, it was a real reminder to me that, you know, the knock on impacts of all of this is, is going to be on the company. So there's going to be winners and losers around all of this. But, you know, I guess supply becomes a gating factor in terms of what these hyperscalers want to achieve as well. you know, it's, it's fascinating that the

I guess the laws of the markets and the economic, you can't actually break free of them, can you?

Lance (14:28)
No, can, momentum, themes, vibes and liquidity can carry you a lot further than rational valuations. But eventually, reversion to mean is a very powerful and enduring force in markets.

Chipmakers is a really interesting thing. It's historically been a very, very cyclical industry. Chipmakers over-invest in capacity when they think they're in great times, eventually leading to too many chips, prices fall, they cut back on capacity, et cetera, and it's rinse, wash, repeat. They've actually had massive...

growth in profits as I mentioned. Revenues, profits are absolutely booming but then they're all chucking money at building new capacity and it's inevitable, it's a cycle, it's human nature, it doesn't change. So maybe if you can hold off buying that new PC next year it might be better value.

Dave (15:41)
Yeah,

indeed, indeed, indeed. Well, you also mentioned missiles. So, I mean, that's something I wanted to move on to now is we're as of today, we're in what seems a very uncertain moment. think I read that Iran attacked the US unprovoked for the first time yesterday. And so and

you know, it sort of looks like things might be widening out. I mean, again, you know, I know you don't have a crystal ball, but I just wondered if you've got any thoughts on where we're at at the moment in this sort of troubling situation.

Lance (16:24)
I think...

the evolution of events and the main transmission mechanism for those events to

economies markets and profitability remains the energy price and also the price of other commodities that are affected by

I wrote in the quarterly commentary that if, let me take a step back, we were surprised at how well behaved the oil price was. And despite the Straits of Hummus, which substantial flow

a substantial proportion of the world's oil flow through. The reality is that the oil price has been relatively well behaved. It may not feel like that when you fill up your car. And certainly in the West, we've not had a supply shock. Asia, gets, is by far the largest destination for Middle East oil, has had more of a price and supply shock at one point.

Asian refineries were paying over $150 a barrel for immediate delivery to keep the refineries flowing, whereas Brent peaked at about $120 a barrel. But what this teaches us is that trying to make predictions is difficult, making predictions about the oil price is also very difficult. It seems that other producers, the US,

notably have been able to ramp up production very quickly, but also that the reserves of oil are probably larger than were estimated and particularly in China. And the estimation is now that Chinese reserves were significantly higher than the market estimated. And that means that Chinese import demand has been

as much about building stockpiles as meeting immediate use needs. And that makes sense. China still needs to import a lot of oil despite significant electrification of its transport network. It's also a way of diversifying where you put your dollars,

Dave (18:54)
Mm-hmm.

Lance (18:55)
which is one of the reasons why gold was so strong.

last year and the year before. And then China is able to quite easily tone or reduce its imports and has been exporting refined products to its neighbors, which as an aside has increased China's

leverage and influence in the region. And so if this is about one of the great superpower struggles between China and the US, the US has totally played into Chinese hands by their recent actions. However,

the conflict has flared up, the volume of shipping moving through the Straits of Khumbuz is still significantly down on pre-conflict levels. And it's difficult to see how that will be resolved quickly. And we don't have enough time to go into all the details about...

ship movements, refinery loadings and so on, the sort of detail that I love reading about. But even if peace broke out tomorrow that was enduring, it would still take a lot of time to rebuild supplies.

they would also need time to rebuild stocks and this is the issue stocks are running low.

And so it's because of the resumption of persistent conflict, we still face the risk of an energy price shock.

Dave (20:42)
Hmm.

Lance (20:43)
You asked about conclusions.

I don't know how you get out of this mess. I'm actually beginning to think that this could remain as a kind of a low level war of words, occasional exchange of missiles for quite some time. If you remember the hostage crisis back in the time of original Iranian revolution.

the Iranians held out until the day Carter left office and then they released the hostages.

It's not inconceivable that this persists until the end of Trump's term in office.

And that comes back to what I mentioned, is the...

area of concern that gets me is actually the moving in bond yields which reflects the building persistent inflationary pressures that we're seeing. And I could talk about the inflationary pressures of for instance agricultural commodities. A very large portion of fertiliser feedstock comes from the Gulf. We've got

whether the heat wave and drought in Europe, which will impact yields. We've also got a super El Nino in the Pacific, which will impact yields. again, prices of food are likely to go up.

Dave (22:16)
Hmm.

Lance (22:18)
So it's not a central forecast that we'll get an inflation spike like we had post Ukraine inflation.

post-Ukraine invasion, but inflation remains persistent and that means that bond yields and the price of money will remain high.

Hence, the bond exposure in our portfolios is very low duration. It has a shorter maturity than the market. And we've made a position in only having high grade corporate bonds, high grade credit. Even though there's been great money to be made.

in areas like high yield, is also called junk bonds. And that's because the adage of investing in junk bonds is picking up pennies in front of a steamroller.

Dave (23:12)
Fantastic.

Lance (23:12)
So it's,

as usual, interesting times.

Dave (23:16)
No, it's fascinating. I think it's one of the so thank you, because it's one of the things I've been surprised about is the lack of the shock. then, you know, it's good to kind of understand about what's happened in terms of places like America ramping up production and then China using some of its reserves to sort of sell to other countries.

So yeah, I mean I think I was reading one of the potential ways out of this for Trump is just for him to declare he's won and you know walk away type thing. So that seems to be under serious consideration but I think the impact of that will be just like having an open wound won't it?

Lance (24:04)
Yeah,

but the US is the most immunized from the

Dave (24:10)
Yes.

Lance (24:11)
shocks and they are broadly self-sufficient in food and although a net exporter of oil, still, again, it's details, but they're for all intents and purposes self-sufficient in oil. So they remain the most...

immune to the damage caused by transactions. But nevertheless, the price of gasoline remains high, the price of eggs remains high and the reason that one of the reasons Trump won was domestic inflation.

Dave (24:51)
Yeah, that's interesting. Interesting. Well, listen, thank you. That's great. for the final segment of the podcast, I wanted to move on to changes in number 10. So we now have a new prime minister. And, you know, I was kind of keen to get your reflections on what the Burnham effect might be.

Lance (25:14)
Well, in very short term, we mentioned UK consumer confidence that does pick up with most changes in PM, not least because the outgoing PM has probably not done a good job. I read a statistical analysis, we're actually quite good and it's quite frequent that PMs don't make their full...

we will see this is definitely a move to the left this is definitely about more spending.

The government saw the lessons learned from trust. It will mean more tax.

how that lands, we can speculate. I like speculating. Adrian says I shouldn't do it, but he's not here to say I can't do it. I have always said that there's really only two pots of money left to meaningfully. If we take a step back,

income tax take in this country is very skewed. We have one of the most skewed income tax takes of a lot of OECD countries. The median income earner in the UK pays one of the lowest income tax rates. I'm being very careful about this, income tax rates, amongst the OECD.

and even twice median income, the income tax rate is still quite low. On the other hand, the top payers, this data has been aired a lot now, but basically approximately 60 % of income tax receipts come from the top 10%. So it's difficult to raise income tax receipts meaningfully.

governments made or the Labour Party made promises about income tax and VAT and national insurance which painted them into a corner in my view unnecessarily in the the pre-election period. So there really are two pots of wealth left to tax which is housing wealth and pensions and between now and

the budget in October, we're going to get lots of noise from all these think tanks and vested interests airing their view on how the government should raise more tax. I suspect this will be a more disciplined government than the Starmoriv's combination, where we got a lot of ideas floated through friendly media to see the reaction.

and I suspect there'll be more discipline in the run up to the October budget, but in the end those are really the only two sources of wealth left to tax, meaningfully.

Dave (28:22)
Interesting. No, think it's really good. mean, and you know, it's going to be faster. I mean, I think your point there is a great one, actually, that I think part of what happened with Starman Reads was this sort of sending mixed messages, but basically just trying messages and seeing the reaction. I think that just got everybody spooked and, you know, there was confusion and, you know, that.

led a degree of mistrust. So it'd be interesting to see if Mr. Burnham and his team are a bit more tight-lipped around all of this stuff. I mean, it's interesting because he's come as a mayor as well. And we had, again, in our little chat beforehand, you have degrees of freedom as a mayor that perhaps he doesn't have as prime minister. So it will be interesting to sort of see what that.

that does as well.

Lance (29:23)
Well, the last

mayor we had elected as prime minister, actually, if you cast your mind back, had a reasonably good reputation as a mayor.

Dave (29:32)
Yeah,

yeah, yeah, yeah.

Lance (29:37)
I was fortunate to have, to attend a lunch presentation where Rishi Sunak spoke.

putting aside people's personal politics, he's actually a very intelligent and very considered person. One anecdote that he said was that most incoming prime ministers totally underestimate the amount of their time that is spent dealing with security, both international and domestic issues, that they just can't talk about.

He quoted a figure of like a third of his time was taken up with those kinds of topics, which was a bit of

Dave (30:24)
Wow.

Lance (30:25)
an insight into the job. And I'm certain it's not going to get less in the near future.

Dave (30:32)
No, and I think I mean, you know, I guess like there's that that is Dealing with Trump must take a lot of people's politicians brain

trust at the moment, you know, just in terms of what they're able to sort of think about. you're absolutely, I mean, it's an interesting position to find yourself in with all these great ideas and then sort of slowly seeing your levers disappear in terms of what you're able to do.

Lance (31:02)
Yeah.

Dave (31:03)
Fantastic. Well, listen, thank you so much. Is there anything we've missed? Do you think? I think that was a really good round up for me.

Lance (31:14)
I hope I don't sound too negative.

Dave (31:17)
No, to be honest with you, the fact that there's brightness in the UK, I think is worth highlighting. It's interesting because I had a chat with someone from the FCA yesterday about AI and finance and you you do walk away with a real sense that actually the UK has got like some really interesting perspectives.

that we could really double down on. So, you know, I walked away from that conversation feeling quite positive about AI and finance in general, but from a UK perspective. So, you know, I think it's always good to remind ourselves about what's going on here.

Lance (32:00)
The UK suffers. Yeah, we've got problems.

yet we suffer from this once a broken Britain narrative as an illustration. I live in West London, cause important middle

Dave (32:15)
Okay.

Lance (32:16)
class household.

I actually counted up the majority of our friends are not British. Brazilian, Finnish, Indian, Swedish, German. And they almost uniformed and they all live here. They live and work here. They're all French. can't say French. But they're all amazed by how much the UK press

does the UK down, this broken Britain narrative. Every country's got problems. Actually Finland, even Finland, because

Dave (32:57)
Mmm.

Lance (32:58)
they're right on the front line. They've joined NATO, Conscription, Sweden Conscription, etc. Sweden's got problems with migration. They've all got problems, but the way that the UK press majors on that...

and also the fact that everybody in those countries, if they're going to read an international newspaper, they're going to read an English one. It's either going to be the Wall Street Journal or the FT or the Times or the New York Times. So we are very good at bad publicity and self-flagellation.

I think that's one of the reasons that the UK bond market, the UK is economy is prone to higher inflation, but mathematically UK gilts are too cheap compared to other G7 bonds. We have in terms of debt metrics, probably one of the least ugly debt metrics. Germany and Canada are probably better, but you compare to the US and

the European members of G7 and Japan, our debt metrics are nowhere near as bad as France or Japan. Yet the bond yields in the UK, price of the government has to pay to borrow is ridiculous by comparison. It's defied explanation.

Dave (34:18)
Yeah, very interesting. Well, thank you so much. I look forward to catching up with you again in the not too distant future. But I think that's been a fabulous roundup.