The Great Debate

NOT INVESTMENT ADVICE.

Investing is like prosecuting a case—there is evidence, both to acquit and convict; you need to render a verdict. The case being tried on Wall Street and the Fed is on the current productivity shift.

Is AI an inflationary, debt-fueled boom?

Or is AI:
a) Already powerful enough to clip jobs by the tens of thousands at the direction of CEOs eager to meet elevated earnings expectations?
b) Reached the point where the additional spend is impairing balance sheets?
c) Far from the point where AI can be broadly impactful?

This debate is overlaid on a political debate.

Are tariffs, zero immigration and other White House policies leading to a boom or a slowing?

My bias is that disinflationary forces are ascendant, and the White House policies have obscured this fact because the erratic application of tariffs boosts uncertainty and, temporarily, prices.

As always, I will be guided by the evidence and adjust accordingly.

In more detail.

1. Markets are stuck in ranges. Below I show on one chart the Nasdaq, euro vs. USD and 5-year US government bond yields. The euro has not moved since June; 5-year bond yields are unchanged since August and the Nasdaq has not moved since September. Why? Because investors can’t fully commit to a direction unless they know the outcome of the debate. Is the Fed done cutting rates (because of the AI boom) or on the cusp of doing more (because of the deflation and slowing capex)?

   

2. Job growth is weak. The most important development in the debate this week was three sentences uttered Wednesday by Fed chief Powell. “Unemployment is now up 3/10 from June through September. Payroll jobs averaging 40,000 per month since April. We think there’s an overstatement in these numbers by about 60,000. So that would be negative 20,000 per month.” Said differently, based on the Fed’s analysis, job growth is contracting. This is important but complicated. The labor force growth is slowing because immigration has slowed to very little (roughly 25% of what it was) and the tariffs are contractionary. In any event, job growth is weak, so the hundreds of billions of capex spent this year does not seem to be net job positive.

3. Inflation is off the boil. Inflation was around 2% in most of the world, leapt to 6%-8% and has since declined. It is at target in many countries. In the US it is above target because of tariffs. Central banks have cut rates, including the Fed, but rates are nowhere near where they were before the inflation began so the response to cuts so far is relatively muted. Inflationary pressures are weak if the labor market is weak. Energy prices are also weak. Below I show inflation in the US, Canada, Japan and Germany.

   

4. The big capex spenders are being punished. Today stocks are getting whacked due to a report that Oracle will be delaying some spending. I noted last week that Meta cut some of its capex. Below I show a chart of Meta, Oracle and CoreWeave versus Apple. The market is not rewarding the big capex spenders because investors are not confident the spend is justified. That does not mean the market is right but it does point to a disincentive to spend. Apple (the purple line), which is not a big capex spender, is being rewarded. Incentives matter. Moreover, the big AI spenders are at war with one another. Google is trying to undermine Nvidia, Nvidia is trying to support Tesla/X, Meta and OpenAI, China is trying to undermine America and America China. While there will be some winners, it’s also highly likely that there are spectacular losers. The message for many investors could well be “who knows who will win.”

   

The counter argument to the above is that this AI spending is transformative enough that the money is going to be spent no matter what and this will create a significant lift to the economy. AI acolytes suggest that the point at which the AI can meaningfully replace a personal assistant that books airplane tickets, balances books, closes sales deals, etc. is close at hand. (That said, I’ve been tracking how long it has taken to build technology that can answer a telephone call from a customer, and so far it is forty years and still counting). If AI is on the cusp of a new breakthrough, then that recognition combined with fiscal stimulus tied to defense and we could be on the verge of a mini-boom. I am watching each piece of data and adjusting my expected odds in real time but as I said at the outset, I’m inclined to believe growth will ebb.

The next piece of the puzzle is US employment out next week.

This document is strictly confidential and is intended for authorized recipients of “A Letter from Paul” (the “Letter”) only. It includes personal opinions that are current as of the date of this Letter and does not represent the official positions of Kate Capital LLC (“Kate Capital”). This letter is presented for discussion purposes only and is not intended as investment advice, an offer, or solicitation with respect to the purchase or sale of any security. Any unauthorized copying, disclosure, or distribution of the material in this presentation is strictly forbidden without the express written consent of Paul Podolsky or Kate Capital LLC.

If an investment idea is discussed in the Letter, there is no guarantee that the investment objective will be achieved. Past performance is not indicative of future results, which may vary. Actual results may differ materially from those expressed or implied. Unless otherwise noted, the valuation of the specific investment opportunity contained within this presentation is based upon information and data available as of the date these materials were prepared.

An investment with Kate Capital is speculative and involves significant risks, including the potential loss of all or a substantial portion of invested capital, the potential use of leverage, and the lack of liquidity of an investment. Recipients should not assume that securities or any companies identified in this presentation, or otherwise related to the information in this presentation, are, have been or will be, investments held by accounts managed by Kate Capital or that investments in any such securities have been or will be profitable. Please refer to the Private Placement Memorandum, and Kate Capital’s Form ADV, available at www.advisorinfo.sec.gov, for important information about an investment with Kate Capital.

Any companies identified herein in which Kate Capital is invested do not represent all of the investments made or recommended for any account managed by Kate Capital. Certain information presented herein has been supplied by third parties, including management or agents of the underlying portfolio company. While Kate Capital believes such information to be accurate, it has relied upon such third parties to provide accurate information and has not independently verified such information.

The graphs, charts, and other visual aids are provided for informational purposes only. None of these graphs, charts, or visual aids can of themselves be used to make investment decisions. No representation is made that these will assist any person in making investment decisions and no graph, chart or other visual aid can capture all factors and variables required in making such decisions.