Peace in the Middle East | AI Export Bans | Inflation

Andrew Sarna and Vanessa Hui break down three topics influencing markets: the prospects and pitfalls of a Middle East peace deal; the growing national security implications of frontier AI models; and what reaccelerating inflation above 4% means for investors.

WHAT TO LISTEN FOR

0:22 What should investors make of the anticipated Middle East peace announcement?

4:01 Why did the US government force Anthropic to pull its Mythos class of models?

7:41 What does headline CPI above 4% mean for markets?

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This podcast is for informational purposes only and does not constitute investment advice. Views expressed are those of the speakers and should not be relied upon for investment decisions.

Transcript

Andrew Sarna (00:04):

Welcome back to Forthlane's Off the Charts podcast where every two weeks we cover three market headlines that matter. I'm Andrew Sarna, portfolio manager.

Vanessa Hui (00:11):

And I'm Vanessa Hui, senior client advisor.

Andrew Sarna (00:14):

It was a busy news weekend, three big things to cover this week, peace in the Middle East, AI export bans, and inflation.

Vanessa Hui (00:22):

Andrew, jumping into our first topic. The hope for peace in the Middle East has been dominating headlines this weekend. Oran's foreign minister and parliament speaker are both expected in Switzerland on Friday for the formal signing of what could be a landmark agreement. What do you make of this announcement and what should investors be watching for?

Andrew Sarna (00:45):

So number one, I think any progression towards peace here is obviously very good news. The problem is Trump has declared victory over this one. I think it was upwards of almost 30 times and it's almost like a boy who cried wolf situation so you never know what to believe. In hindsight, it was pretty clear that with the Trump birthday celebrations at the White House that there needed to be a splashy announcement. I'm kicking myself in hindsight that it wasn't obvious that this was going to happen, at least getting an announcement. I see a few problems with the deal and let's keep in mind this is an announcement that a deal is going to be signed. We've heard rumors and reports about the terms of the deal, but we have not seen official terms of the deal. So the problems that I see based upon what has been reported so far, number one, Israel doesn't support the deal.

(01:42):

So there's three parties essentially involved. And if one of the parties doesn't agree, I think there's going to be problems moving towards peace. And this coincides with Israel continuing to bomb Lebanon on Monday and no signs at least when Iran views it as critical that strikes on Lebanon saw and Lebanon is part of the peace agreement. Number two, there are reports that Gulf allies in the US will be potentially on the hook for a $300 billion reconstruction fund. This is just really hard to believe these are super large numbers. If you can remember DOGE where the US government brought in Elon Musk, the verifiable savings were one to seven billion and I just don't see how Trump could ever take a loss like this at $300 billion sent to Iran as part of a peace agreement. And the third sticking point that I see is a clause on the straightforward maritime as a service fee.

(02:46):

So they're essentially going to be tolling passages out of the straight and at one point it was declared that the Gulf allies in the region would not deem this acceptable. And then later on Monday, we saw reports that the US Navy had not lifted their shipping blockade and sent out a message to maritime vessels in the region that they were not allowed to pass the straight yet. So there's a lot of conflicting information as well experts estimate that it's going to take 40 to 50 days to clear all the mines. So I think although the market is signaling this isn't all clear, I think there's some pretty big hurdles. Eventually there's going to be a price where it makes sense to add energy to the portfolio from a strictly valuation perspective, but more importantly, energy throughout the crisis has acted like a hedge in case we see another downturn in equity.

(03:40):

So there's some interesting perspectives from a portfolio construction perspective as well. I think it's hard to see a reescalation ahead of midterms given that's such a big date on the calendar. So we may have a good summer and it may be time to be bullish equities throughout the summer, but it just really seems like this war is still far from over.

Vanessa Hui (04:01):

Now shifting gears to our second topic, AI export bans. There was a lot of news and noise this weekend around Anthropic and some serious concerns being raised about their newest models. Can you walk us through what's happening?

Andrew Sarna (04:17):

Yeah, prior to the peace deal, this was the big news over the weekend. So back in April, Anthropic announced Mythos and Anthropic has had the lead across the frontier models and Mythos was the first of a new class of model that was supposed to be more powerful. The concern about releasing this model to the public was that this model could present cybersecurity threats to the rest of the internet. So in a hacking sense, anyone could become a hacker or those who had the expertise could take it even further. So what Anthropic did was they initially released the models to a select group of clients, government and select enterprise clients. Then last week, what happened was they released a version to the public with guardrails that essentially you couldn't use for hacking or biology. So you would type in a simple prompt around biology and it would just say, "Oh, we can't answer this question.

(05:11):

That was really to protect against homemade bioweapons being able to produce." So on Friday night it surfaced that there were initial reports that at least a few stakeholders had raised concerns that their engineers were able to bypass the guardrails and anyone could access the full power of the model. And then on top of that, on Monday, A16 alleged that one of the early access members actually had sold API access to a member of a CCP affiliated group. So essentially what happened was the government asked Anthropic to take the model down due to some of these concerns and then Anthropic didn't play ball. So the administration forced their hand and essentially said, "You need to take down the models." And then I think the last interesting part of all this is the model was called Fable and not to read too much into it, but it's kind of ironic that a Fable is a short fictious story intended to teach a moral lesson.

(06:10):

So there's a lot going on here. It's not clear exactly what's going on. We just know that the public no longer has access to these frontier models. So super interesting times. It's becoming very clear that these are becoming societal issues, one from a job loss perspective. So we saw Stanford grads walk out last week prior to a commencement speech from the Google CEO, likely this was driven by concerns over AI and replacement of humans over machines. And then on two separate occasions, one on a Buffalo station and then I was watching the news in Nashville and there were reports of on both stations in their respective cities of protests against data centers. So the public is starting to turn against AI at the same time that this is becoming a national security issue. So Carney tweeted on Monday and he used this episode to make an example that if the US can just remove access for everyone, well, they can certainly ring fence countries so we can't fully rely on them.

(07:16):

And I think this is the start of we're going to see more regulation. I mean, the government's starting to step in and we're starting to see that this technology is almost akin to nuclear technology where governments are concerned about who can get access to it and what sort of things can be built with it. So it's clear that governments are going to be more involved moving forward.

Vanessa Hui (07:41):

Now for our third topic, inflation CPI numbers were released last week and headline inflation is back above 4%. Andrew, I know many people are hoping this is just a blip tied to energy prices, but what are your views?

Andrew Sarna (07:57):

Last week headline CPI jumped 0.5% month over month, 4.2% from 3.8% and striping out energy and food costs to get core CPI, we went from 2.8 to 2.9%. Headline back above 4% is bad news. Bank of America highlighted some data last week that essentially summarized once CPI breaks above 4% for the first time and normally spells bad news for equity markets. This is partially going to be driven by the yield curve. Now the Bulls will say it's transitory once again, especially with this peace deal in the Middle East and I side with the bulls on the fact that 44% of core CPI is going to be shelter and those are going to be driven by independent factors such as immigration likely not going to be impacted by supply chains or energy costs. But if you dive into the report and yes, all the energy adjacent categories like jet fuel and airline prices are rising, you're also seeing broad-based inflation like dental services, sports equipment, footwear, video rental, home healthcare, all two standard deviations above their 2005 to 2019 baseline.

(09:09):

So the concerning part about all this is there isn't really a clear trend between dental services and sports equipment is just inflation is arising across the economy and it's unsurprising given the energy shock and the impact energy has across the supply chain, but it's something we're definitely keeping our eyes on as a risk to markets. And keep in mind inflation is essentially baked over the next few months. The decisions that drive inflation, the price increases have already been decided on. So we're likely going to see another couple months of high inflation and we can only hope for relief after that and hope that inflation doesn't become ingrained in the economy and spiral out of control.

Vanessa Hui (09:57):

So putting it all together, on prospects for peace in the Middle East have improved, but significant hurdles and realities remain. Second, AI is increasingly becoming a matter of national security with export controls and regulation likely to play a larger role going forward and inflation is showing signs of reaccelerating, creating risks and challenges for both markets and policymakers alike.

Andrew Sarna (10:29):

Thanks for tuning in to this week's Off the Chart. Please like and subscribe on your favorite podcast listening service.