What if the Productivity Shift is Real?

THIS IS NOT INVESTMENT ADVICE.

Markets are people. Investing is guessing when opinions have swung too far in either direction. The more optimistic the expectation, the higher the reward for pessimism and vice versa. Because markets impact politics and politics markets, both matter. This year, optimism is getting rewarded because pessimism was and is widespread. A reasonable question is what happens if the current productivity shift turns out to be real rather than a bubble. Earnings would be stronger than expected, inflation lower than expected and the debt bomb would not explode. But it would also dampen wage growth. The root cause of political instability is often the inability of the rulers to boost living standards.

In more detail.

1. Many investors anchor on the last financial disaster. My father, a child of the Great Depression, first invested in stocks fifty years later. After World War 2, many investors warned of a depression like the one that followed the Civil War. Today, many investors recall the 2000 internet bubble, look at high valuations and, if they buy, do so with a nose pinched shut.

2. This year the fear was tariffs would lead to high inflation, a long-end bond sell-off that would crush stocks, which were (and are) trading at elevated valuations. There were glimmers of this, but it faded. Stocks are up, bond yields steady, the dollar steady.

3. In reality, tariffs touch only a part of the economy, a chunk of the cost increases were absorbed by companies and the sharp rise in inflation has not come to pass (at least so far). High valuations were more a US phenomenon than global and global earnings have been strong and stocks have gone up all over the world.

4. These fears were magnified by politics. The tariffs were a political choice as were many other quixotic policies that to me look like quasi-fascism (masked agents with no warrant) but to others look like a much-needed revamp of sclerotic institutions.

5. The consensus on productivity and politics remains pessimistic. Be it Ukraine’s ability to exist, rule of law in the US, the stability of US bonds, or equity valuations, the fear is palpable.

6. These fears are not without reason. The WSJ published an article Friday comparing this AI spend to the internet bubble. ChatGPT indicates there is a long line of such articles predicting companies like Meta and Amazon would keel over when they were also early in their journey. Major tech companies are now using debt to finance spending, which increases the risks. They are also financing their customers, which creates a dangerous circular risk. Moreover, I know people whose lives have been upended by erratic politics. I think of a Moscow heart surgeon who quit the country after Russia invaded and saw his livelihood plummet, a US furniture importer whose business is sharply down, or Jim Comey, who I had on my podcast.

7. But what if the productivity shift underway actually works? Few I speak to believe it. In fact, I’d put that number at zero. Even tech optimists believe US debt is a ticking time bomb. And those I know that are bullish on bonds are bullish because they think stocks will crack.

8. US companies make about $3.5 trillion in profit a year. Only a portion of the AI spend is on chips that quickly depreciate. If $500 billion of AI spend leads to an even modest improvement in corporate margins through increased efficiency, AI might both make money and reduce inflation, bullish for stocks and bonds. This “optimistic” read is considered silly right now, which is why it might turn out to be true. Similarly, the authoritarians might run out of gas. In Russia, that is literally true. High oil prices fuel their foreign policy. Lower oil prices, which have fallen this year, hurt them. In the US, the current administration is facing lower approval ratings despite the soaring stock market, which may lead policies to evolve toward something less extreme. I think about the risk of much worse outcomes, and have some of these bets on, but I am also keeping an open mind to a better outcome.

9. Will such a productivity boom exacerbate political swings? Possibly. Though it’s important to note that economic-fueled angst has caused plenty of political turbulence in the past and somehow life continued on. Looking at the betting odds on Polymarket, the most extreme outcomes like war between NATO and Russia or Lisa Cook getting arrested all have tiny odds, an indication that the headline might be worse than the reality.

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