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Good morning. That quote just perfectly illustrates this moment we're in right now. We are questioning both. Do you think it's valid to question both? I think it is. But I think before we get to the fundamentals, we have to appreciate the technicals because so much of the upside was driven by positioning chases and squeezes and flows. And so what we're experiencing now is effectively the mirror image of that. Because flows were so aggressive into leverage products within the semiconductor space, not just in the US, but of course in South Korea, what we're seeing is the dynamic is that as that leverage unwind, you're seeing a lot more downside. Effectively, these stocks got so overbought by the time you got to the middle of June that even though we've seen things like a 40% drawdown in something like SK Hynix, you're technically not oversold yet. So if you look at a name like Micron, yes, it's down over 20%, but it's still 40% above its 200-day moving average. You can say the same thing for the stocks overall. So it's important to remember, narrative follows price. So all of these negative narratives on the fundamentals we're talking about it's effectively just following the negative price action. Okay, so is this a price move looking for a narrative or is there a story here? I think it's a matter of both. I think some of the dynamic that we saw in the upside move was ignoring the fact that a lot of these capacity additions, whether you're thinking about Micron itself adding capacity, SK Hynek, Samsung adding capacity, and now China adding capacity, we've all known this for the last six months over a year because we've known that there has been a capacity shortage. But now the market is starting to wake up to it. And at the end of the day, you had this clarion call from big bulls on things like Micron saying, of course, the 85% gross margin is sustainable. This time is, in fact, different. But this is still a very, very cyclical business. And so given the fact that you are going to have capacity additions over the course of the next few years, you will see downward pressure on those gross margins. The big difference or the big thing to watch is that is there any downward pressure on the revenue line? Because that's really when you start to see the deleveraging and the operating leverage of these businesses. And if you continue to see weakness within the hyperscaler names, the question that we have been asking is, if the stocks continue to get pressured, will they continue to raise capex? At the same time, there's this issue of exactly whether the economics are changing and moving away from certain companies. And I'm thinking of, say, the closed models like the open AIs and the anthropics that are suddenly coming under pressure from open source models that are coming out of China but are being adopted rapidly by a lot of U.S. companies. I mean, the search for cheaper models is definitely taking steam. Do you think that does fundamentally alter the tech story? Yeah, because I think the big question that you have is a scaling factor. We know that we are getting growth because of some of this CapEx investment, but effectively the growth is coming in slower than what the CapEx investment is. So you can see that by looking at free cash flow. Free cash flow for a name like Google was negative in the corner because their CapEx is growing faster than their operating cash flow. You go to 2027, that's going to be the case for all of the hyperscalers. And so you're going to have a world where CapEx grows faster than operating cash flow. You're not seeing it show up in the operating fundamentals yet. And this is in a world where we're still thinking that we're going to be at the leading edge and those are going to be the areas, those leading edge models are going to be the areas that drive growth. If you have competition, then you could still be in a world where CapEx continues to grow faster than operating cash flow, not just in 27, but potentially in 28. That of course would come into a head with where consensus is simply because consensus is expecting a big acceleration in operating cash flow in 28 Have chip stocks and hyperscalers sold off enough to make them attractive to you On a technical basis no I think that if you looking at oversold indicators for something like the semiconductor area, certainly you're not at that level of a total wash and flush out yet. For the hyperscalers, you're now trading at a valuation that is as low as it was back at Liberation Day, valuations that are as low as it was back in the lows in 2022 for certain names. Meta, for example, has undercut those lows. You can also look at ETF flows. MAG7 ETF flows have been very aggressive outwards over the course of the last month or so. So there's probably some opportunity there to step in. The challenge that we have is that we know these businesses are fundamentally changing. They were monopolies that had very high return on invested capital because they didn't have to spend a lot of money to make money. These are now competitive businesses. is they're having to spend a lot of money to make money, which means that ROICs are going lower. So we think structurally valuations will go lower as well. It's why Meta and Microsoft, to some extent, are in a bear market. You alluded to it earlier in the conversation. I don't want to bury it. It's important. Do you think they respond to what their stocks are doing? Do you think the stock moves shape their approach to CapEx? Well, in a way, they kind of have to. Because if free cash flow is negative, that means that you have to rely on outside funding to meet your CapEx goals. But now that outside funding is getting more expensive. If your equity price is down, your incremental equity raises will be more dilutive. If your credit spreads are up, your incremental debt raises will be more expensive. So they cannot ignore the markets. And if you're a name like Microsoft, who's seen its valuation fall by 45% since October, at what point do you say, hey, maybe this is being perceived as being profligate and we need to pull back on that spending? That has been a massive tailwind for this economy. So let's work through it, the year so far, rolling shocks through energy, through rates, now through tech. Does that become a growth scare at some point? Does the shakeup in tech translate into some kind of fundamental story down the road? Potentially, yes, if we see more weakness within the S&P 500. The strength of the equity market has been such an important driver of economic growth or support for economic growth in the U.S. It's allowed the consumer in many ways to deal with the fact that real income growth has been negative because of higher inflation and low wage growth. But if you continue to see pressure within equity markets, and put this into context, we're still 3.5% off highs, so this is nothing to necessarily cause a big pullback in spending. But if you were to see a deeper, more protracted route, you could effectively have a negative feedback loop where the equity market weakness translates into economic weakness. Stay with us. More Bloomberg Surveillance coming up after this. As markets move and headlines break, what matters most is context. A Bloomberg subscription gives you unmatched reporting, sharp analysis, and powerful tools that help you connect the dots. Visit Bloomberg.com slash podcast offer to learn more. So here's the latest this morning. The U.S. and Iran pausing strikes for a fourth consecutive night. The president saying both sides are engaging in talks. Let's build on this with Stephen Cook of the Council on Foreign Relations. He writes the following. The Trump administration made it clear that it was standing down because the United States does not have the weaponry to carry on. The Iranians now know that they have impunity. Stephen joins us now for more. Steve, you say in your words the Trump administration made it clear. Did they make that clear? Well, all of the reporting from the advice that the president has gotten from the secretary. I'm sorry, not the Secretary of State, the Chairman of the Joint Chiefs of Staff, as well as Admiral Bradley Cooper, the head of CENTCOM, was that we were running out of munitions and that the bombing in the strait had diminishing returns. So that the president called it off and is now relying on the Oman channel where the real negotiations are underway. Meanwhile, Iran's proxies, the Houthis, as well as Iraqi militias, are doing a lot of damage to Saudi oil processing facilities and other energy infrastructure around the region. The Iranians are doing what they normally do, is that they are signaling directly to the United States and its neighbors in the region that it's willing to talk while directing its proxies to sow chaos. When it comes to rebuilding stockpiles, it's not like turning on and off a light switch. So do you expect this pause to be a long one? Well, it does seem that despite the president's threat of escalation that he has made the decision that that's not really in the card. So I think that the pause will go on longer than he was indicating on Air Force One yesterday, which has really become just an idle threat. The last two weeks of bombing did not change the Iranian position at all in fact left them in a somewhat stronger position because it was the United States that essentially called off the campaign We know that Oman tries to keep friendly relations with everyone. They somewhat play both sides. Do you expect them to come out and support Saudi Arabia for a toll? The Omanis have, at times, sounded a lot more like Iran's lawyer than a mediator. They maintain that they are being bullied by the Iranians because there is some daylight between Washington and Muscat. That, of course, is a self-serving statement. But it does seem that the Omanis are really the best chance for trying to figure out how to reopen the strait, whether it will be a toll or not. They say publicly at the moment that they don't support a toll. We'll see what happens as the negotiations take place. It's important to note that there is a negotiation going on between Oman and Iran right now, not between the United States and Iran and Oman. At the same time, Stephen, attacks are continuing. There were reports on satellite images of smoke coming from an oil facility in Saudi Arabia in Bahrain. There were two Amazon centers, data centers that were reportedly under attack. How much do you expect to see a region-wide war amplified and participation of the likes of the UAE as well as Saudi Arabia? It's a good question. And it seems to me, as I was noting before, that while the Iranians are signaling a willingness to talk through the Omanis, its proxies are being directed to attack American partners in the region, And with the exception, I should say, of the United Arab Emirates, which has not taken any hits thus far. But the Houthis, who have a separate conflict with the Saudis, have hit Abqaq, a major oil processing facility in Saudi Arabia, as well as a number of other facilities. Iraqi militias have also joined in in these attacks. So once again, it is the Iranians talking from one aspect of this while at the same time their proxies undermining hopes for regional security. I'm just wondering what it's going to take for some of these Middle East economies to really become once again a safe haven for businesses. Hilton just reported earnings and said that revenues from the Middle East and Africa declined by nearly 30 percent as a result of the war in the region. This was the hotspot for so many different companies to really go and do business. I mean, is that kind of over for the foreseeable future? Well, this war has raised a question about the Gulf development model, which was based on security and stability and attracting the talent of the world to these city states and thus attracting lots of investment. If you cannot provide security, people are not going to come and people aren't going to invest. The Emiratis have taken somewhat different course. They have invested in the relationship with the United States and Israel. while at the same time signaling to the Iranians that they want to have better relations. That seems to have shielded them during this round. It's possible that the Bahrainis and others will follow suit. But once again, the Iranians are intent on disrupting American military operations in the region. And as long as the Kuwaitis and the Bahrainis and Qataris and others have major American bases there, they're going to come under Iranian fire. Stay with us. More Bloomberg Surveillance coming up after this. The Bloomberg This Weekend Podcast. News, politics, and the lighter side of Bloomberg. The great wealth transfer includes $570 billion in classic cars. I'm not in a position to be inheriting any classic cars. Do you? No, but my brother did inherit my non-classic car when I moved to New York, so. Ew. He still has not paid me for it. Coming for you, Joey. The Bloomberg This Weekend Podcast. Subscribe today on Apple, Spotify or wherever you listen. on just now for more. Matt, good morning. Good morning. How much dissent are you expecting tomorrow afternoon? Well, it's interesting. I mean, we are expecting a couple of dissents coming off out of the committee. But I do think that you could make the case that there may not be any dissents, actually, John. Because in the end, if we look at what has happened since the June FOMC meeting, where there were no dissents, the data has been better. The inflation data has been better The labor market data has been somewhat disappointing relative to the trend that we had seen in March April and May And so if they weren willing to dissent in June why all of a sudden the change of heart I mean crude oil prices are roughly where they were going into the June meeting They're obviously a lot lower than they were three months ago. What's the rationale to dissent? You can make the argument that there will be no dissents tomorrow. Beth Hammock, Cleveland Fed president, making a statement on LinkedIn, going into the quiet period, which was interesting timing. Making the statement, the suggestion that companies in her district are telling her that prices are too high and perhaps ultimately this Fed should do something about it. What was your reaction to that piece? I think people have thought prices were too high for 20 years, John. The real question is, have the increase in prices that we've seen over the past five years fed into inflation expectations such that people continue to expect inflation to be running very, very hot for a very, very long time to come? There's not a lot of evidence to suggest that that's the case. And when you look at markets, just look at five-year forward, five-year break-even inflation rates. The Fed publishes this measure. It's on the Bloomberg terminal. all, it's been very stable since the Fed hiked rates in 2022. Where is the need for the Fed to get inflation fighting credibility? It already has. I don't see the rationale for a rate hike on Wednesday to solidify credibility the Fed already has. It doesn't make much sense to me. Well, does it still have it in the same way? And I ask this because I'm looking at long ends of the yield curve continuing to rise and this feeling that right now in markets people are pricing in more than a 70 percent chance of a September rate hike. If there are no dissents, do people take back some of that pricing of a potential rate hike ahead? Absolutely. The thing that we have to recognize is that real rates have gone up a lot. Financial conditions have already tightened a lot. The big question facing the Fed today is have they tightened enough? And I just don't think that they have enough information to say one way or the other. Does it behoove them, though, to take that pricing out of the market, to give a sort of dovish signal at a time when the market is doing the work for them and could potentially get inflation lower without them even having to act as long as there are dissents, as long as there is this family fight? Gosh, I think if they were being that clever, then we've got a whole other situation on our hands. I mean, do they manipulate the dots to try to get a certain outcome? I think the answer has always been no. They do, of course, look at the statement language. They have a message they want to convey to the public. But are they going to play games with the public's perception of? I think the answer is no. I think they have a clear mission. They've made that very transparent to the public. They want inflation to come down. Interest rates have gone up a lot since Chairman Warsh delivered that message at the June FOMC meeting. The question they face today is, have those rates gone up enough to help inflation come down in the manner that they would like to see? It's only been six weeks. I don't think they have enough information in hand to say one way or the other with confidence, which is what I think you need to have if you're delivering a rate hike that isn't fully priced in by the market. You need to have confidence that you're doing the right thing. I think the answer is that they don't yet have that confidence. We don't think they're hiking rates. But at some point, if inflation doesn't come down quick enough this year, don't they have to hike or they just look like they're talking out of both sides of their mouth and not delivering? It's just empty promises? Absolutely. If inflation doesn't come down in the way that they would like to see, rate hikes are on the table. I mean, that's what we're saying at Morgan Stanley. Our chief U.S. economist Mike Gapin is making that point very, very clearly. He happens to believe inflation will come down such that the Fed isn't going to deliver rate hikes this year. It's a view based on a solid rationale. The issue that we face today in this moment for this meeting is, do they have enough information to say with confidence that financial conditions haven't tightened enough? And I think the answer is clearly no. So, Matt, just quickly, do you expect that gap between the two-year yield and the policy rate just to be sustained for the time being? For the time being, absolutely. After this meeting, we're going to get two rounds of economic data before the Fed has to make a decision in September. That is a lot of economic data that will inform their decision in September. We think the data will come in and tell them they don't need to hike rates. We'll see. This is the Bloomberg Surveillance Podcast, bringing you the best in markets, economics and geopolitics. You can watch the show live on Bloomberg TV weekday mornings from 6 a.m. to 9 a.m. Eastern. subscribe to the podcast on Apple Spotify or anywhere else you listen and as always on the Bloomberg Terminal and the Bloomberg Business app
