The AI trade is growing up

The AI trade is getting a lot bigger than Big Tech: Investors are increasingly looking beyond the Magnificent Seven and toward the companies supplying the chips, power, real estate, and infrastructure needed to build out the technology. At the same time, stubborn inflation, a strange labor market, and growing access to private investments are giving investors plenty more to think about beyond AI.

Few people enjoy untangling all of that more than Callie Cox. A former Bloomberg reporter turned market strategist, Cox has built a following by making Wall Street a little less intimidating through her OptimistiCallie newsletter. Brew Markets caught up with her to talk about where the AI trade goes from here, what’s really going on in the labor market, and why buying into private companies isn’t always as simple as it sounds.

There’s been a trend emerging where investors are rotating out of your typical Magnificent Seven stocks, and the AI ecosystem is broadening out. Can you speak a little bit to that trend? Do you see this as a new era for tech?

The AI trade has been going on for four years now, and AI in itself is a compelling story. Your neighbors probably know about OpenAI and Claude. They’ve probably used AI to help them in some way or another in their daily routines. And the stock market picked up on this back in 2022, 2023.

But the thing with innovation is that investments around an innovative theme tend to go through phases. There’s the “everything works” hype phase, and then investors start scrutinizing what could work and who the winners and losers could be. And we’re a few years into that, I’d say.

So what we’ve seen this year is a rotation out of the hyperscalers, the big spenders, the names we all know that have deep pockets to chase AI ventures, into the “picks and shovels,” they call it: the industrial companies, the real estate companies, the materials companies that could help build out what we need to power the technology and data centers.

And to me, that’s just another step in this big, compelling story that’s AI. But of course it’s painful, because investors are forced to make choices here.

So I think investors are realizing that and trying to skate where the puck is going. And unfortunately, that means they have to make tough choices. And the hyperscalers seem to be the have-nots now.

The other thing I’ll add is that I think Big Tech is going through an interesting identity crisis where they’re the strongest, most profitable companies on the market, but they need to spend hundreds of billions of dollars to stay abreast of the AI trend. And you can’t be both at once. If you’re spending hundreds of billions of dollars, you’re cutting into your free cash flow.

And investors are looking at these huge conglomerates and saying, okay, are these the nimble startups that we think could win the AI trade? I’m not so sure. Will we see a payoff after they spend hundreds of billions of dollars to build this out? So I think there’s a secondary story going on with that.

You talked about the “picks and shovels.” Can you go a little deeper into that?

On the AI side, it’s really interesting if you look at the top performers in the S&P 500. You see a lot of semiconductors at the top, but you also see Caterpillar. You see a lot of industrial companies, which shows that the AI trade is moving into more of a buildout phase.

I think that’s AI-related. That can also be economically related because we’ve seen economic momentum pick up in the first half of the year. Typically, industrials, materials, and energy stocks tend to do better when it looks like the economy is doing better.

But overall, when it comes to AI, I think it’s so important to own the whole thing. Every geography, every size of company.

The one trend that I haven’t seen talked about a lot is how small-cap tech is outperforming large-cap tech. And part of it is that hyperscalers and Big Tech aren’t doing well. But I think investors are finally realizing that this AI story touches every corner of the economy. And within that, there’s opportunity.

Even if you just want exposure to the story and you don’t want to pick three stocks, understanding how to get exposure to that story requires you to visit those corners of the economy.

What about the broader economy, especially with inflation fears and the new Fed? What are your thoughts on that?

My hill that I will always die on is that the job market is crucial to understanding the economy. Consumer spending is 70% of GDP. Most Americans make their primary income through their full-time job. So if the job market breaks down, it’s the engine of the economy—the whole economy falls apart. Or at least that’s how it’s worked throughout history.

The job market is in a really weird spot right now because the labor force isn’t growing. You’re not seeing a lot of available workers looking for jobs, and that changes all the data that you look at because the amount of jobs or hiring needed to soak up that smaller pool of workers is much less.

So it’s really hard to judge where the job market is right now. And if the job market is the central tenet of your thesis, like it is for me, then I’m probably flailing a little bit. What do I base my views on now?

But I think if you take a step back, the job market isn’t in the most ideal spot, and a lot of Americans have expressed frustration around being able to find a job and advancing their careers. You see that in consumer confidence data. You see that in initial and continuing claims data. There are a lot of Americans that are out of work and have been out of work for a while.

It’s a very imbalanced economy. Some say a K-shaped economy.

So the way that I see that from an investment perspective is that the divide in markets makes a lot of sense. If you have a K-shaped economy, then there are different opportunities and risks when you look over to the stock side of your portfolio and the bond side of your portfolio.

Inflation: We’re in a weird spot where inflation is elevated, but growth is kind of a question mark. We’re going to find out a lot over the next few quarters, but inflation looks to be the bigger risk for portfolios, and it forces you to be more intentional and strategic with what you’re invested in because inflation is like your bogey rate. Your investments need to grow more than inflation. That’s the least you can ask of them.

So we’re in a weird spot where inflation seems to be the bigger risk, but growth and economic health can swoop in as the hidden risk if we see just a little bit of deterioration. And that’s a hard place to be in.

So in that environment, yes, it makes sense that we’re seeing a lot of dispersion in the stock market. We’re seeing a lot of winners and losers, a lot of haves and have-nots.

But I think it’s important to understand how much of a return we need, where inflation is, and what you can invest in to get that return. And what I tell people all the time is that if you have years ahead of you, you probably don’t need as much return as you think.

The game is all about consistent base hits, not home runs.

We’ve also been watching the jobs data very closely. Initial jobless claims recently fell to the lowest level since 1969, which doesn’t necessarily feel consistent with what we’re seeing.

I saw that reading and immediately told my team: It’s the lowest initial jobless claims reading since the ’60s, but that does not mean the job market is at its strongest point since the ’60s.

This is mostly technical. It’s mostly seasonal. You really have to look—this is the nerd in me coming out—but you really have to look at jobless claims on a state-by-state level to understand why they’re declining, because sometimes states can have funky things going on.

My takeaway from that is it’s obviously a piece of good news, but it’s not historically good. You’ve got to give me more data than that.

You’ve written about private markets previously, and right now everyone’s still talking about Situational Awareness and how its private-market investment helped cushion losses. Can you speak a little bit about the rise of private markets and what investors should watch out for?

Private investments are all the rage. We get a lot of questions about them from clients. Obviously, some of the most popular companies out there right now are private, and being a private company is almost worn as a badge of honor: I don’t need to tap the public stock market for help. I can kind of do this all on my own with my small group of investors.

But as a private company, you still have to fundraise. You just don’t have the guardrails and the requirements of being a public company to lean on. And there are pros and cons to that, right? As a public company, you have to be extremely transparent. There’s a higher compliance cost in being a public company. But at the same time, millions of investors can access you.

So more companies are opting for the private route today. And along with that, investors have become so much more sophisticated. A decade ago, I don’t think I would be talking to a reporter about private investments. I don’t even think I’d be talking to my friends or family about private investments. Yet I get that question all the time now.

America as a whole has learned more about Wall Street, and access to more exotic investments has grown. In general, I think that’s a good trend. I think higher accessibility to all kinds of investments is beneficial for everybody, especially because it’s your money. You do whatever you want.

But I think investors would do well to understand exactly what they’re buying into if they’re buying a private investment.

A lot of investors see a private investment as a story: I can buy Anthropic before it goes public. But oftentimes what you’re doing is buying trust and faith in a manager, or you’re buying trust and faith in a structure. You’re often buying a lot more than just a story.

A perfect example that I put in there: One way that everyday investors get access to private investments is through ETFs—ETFs that are built to provide exposure to private investments.

ETFs are a familiar wrapper. We all know what an ETF is. But the tricky thing is, for that familiarity and for that transparency, you give up some of the direct exposure to the asset and you take on a little bit more risk in being able to trade in and out of it, because other people can trade in and out of it.

And an ETF often moves around its net asset value because of liquidity, because of flows. You also have to consider the ETF issuer and if the ETF issuer can make good on the ETF.

The risks are layered. If you’re investing in a private investment that has high minimums, but it’s your classic drawdown fund, your list of risks is usually lower. But that accessibility is also lower. You’re investing in an ETF where it’s easy to get in, your risk list is higher, your accessibility is also higher. There are a lot of trade-offs, and I don’t think access to private investments is going away. I think the drum will only get louder.

So it’s a good time to learn what they are and understand exactly what you’re investing in: the structure, the exposure, and the manager.

We’ve talked about tech a lot. Are there any other sectors that you’re watching that you think have potential to grow?

One thing—and I don’t make projections, I don’t necessarily believe this—but one thing I find interesting is that interest rates are so high right now that if you have a contrarian opinion on housing or rate-sensitive sectors, this is probably a good time to make your move.

And if you think about defensive stocks—now, defensive stocks serve different roles in different portfolios—but if you want to pick up some cheap defense in your bonds through rate-sensitive sectors in the market like consumer staples, then now is probably the time to pick it up for cheap.

And that’s not me saying they go up anytime soon. But if you think about the risk-and-reward balance of investing in cheaper rate-sensitive sectors, it looks like the balance has shifted pretty far to the risk side.

So if we see housing pick up, if we see economic momentum keep growing this quarter, then looking at rate-sensitive sectors could be pretty interesting.

If inflation isn’t as big of a story as people fear, then—again—rate-sensitive sectors will probably get the benefit of the shift in flows that we can see.—SY