1 00:00:02,400 --> 00:00:08,240 Speaker 1: Bloomberg Audio Studios, Podcasts, radio News. 2 00:00:08,480 --> 00:00:11,200 Speaker 2: I'm Stephen Carol and this is Here's Why, where we 3 00:00:11,240 --> 00:00:13,400 Speaker 2: take one news story and explain it in just a 4 00:00:13,440 --> 00:00:15,800 Speaker 2: few minutes with our experts here at Bloomberg. 5 00:00:19,239 --> 00:00:21,759 Speaker 1: Microsoft became the second company in the world today to 6 00:00:21,800 --> 00:00:24,799 Speaker 1: hit a four trillion dollars market cap, alongside Nvideo. 7 00:00:24,800 --> 00:00:28,080 Speaker 2: This is after reporting earnings that beat Wall Street's expectation. 8 00:00:28,280 --> 00:00:31,600 Speaker 2: This AI revolution, it's in his next major growth. It's 9 00:00:31,640 --> 00:00:35,080 Speaker 2: Goldiewox for tech. These are trillion dollar companies and they're 10 00:00:35,080 --> 00:00:37,839 Speaker 2: managing to post for Meta more than twenty percent growth, 11 00:00:38,040 --> 00:00:40,320 Speaker 2: much ahead of expectations and singling it's going to be 12 00:00:40,360 --> 00:00:44,080 Speaker 2: twenty five percent potentially for the next quarter. Isn't that extraordinary? 13 00:00:44,280 --> 00:00:47,120 Speaker 1: We have companies that valuable growing at that run rate. 14 00:00:47,560 --> 00:00:50,600 Speaker 2: It's been another bumper earning season for the world's biggest 15 00:00:50,680 --> 00:00:53,760 Speaker 2: tech firms. Silicon Valley seems to have shrugged off the 16 00:00:53,800 --> 00:00:58,560 Speaker 2: economic uncertainty, reporting strong revenues and planning more massive spending 17 00:00:58,760 --> 00:01:02,840 Speaker 2: on artificial intelligen Investors have cheered most of the reports, 18 00:01:03,120 --> 00:01:06,360 Speaker 2: but amid the optimism, some key market watchers are starting 19 00:01:06,360 --> 00:01:09,840 Speaker 2: to voice concerns about whether the tech stoc rally has 20 00:01:09,920 --> 00:01:15,039 Speaker 2: gone too far. Here's why big tech's soaring valuations have 21 00:01:15,200 --> 00:01:21,479 Speaker 2: some worried Gina. Mark Adams, chief equity strategist at Bloomberg Intelligence, 22 00:01:21,680 --> 00:01:24,600 Speaker 2: joins me now for more. First of all, Gina, big 23 00:01:24,680 --> 00:01:27,280 Speaker 2: tech names doing well feels like a story that we've 24 00:01:27,319 --> 00:01:30,880 Speaker 2: been telling for years. What's driving the strength in the 25 00:01:30,920 --> 00:01:32,039 Speaker 2: sector right now. 26 00:01:32,160 --> 00:01:33,479 Speaker 1: So if you go back to the summer of twenty 27 00:01:33,520 --> 00:01:35,880 Speaker 1: twenty four, I think it starts to sort of paint 28 00:01:35,880 --> 00:01:38,280 Speaker 1: the picture for you as to what's really happening with tech. 29 00:01:38,840 --> 00:01:42,200 Speaker 1: At that point in time, valuations were reaching new peak levels, 30 00:01:43,040 --> 00:01:47,400 Speaker 1: but also earnings growth was peaking out, and we started 31 00:01:47,440 --> 00:01:49,640 Speaker 1: to see earnings growth accelerate in the latter part of 32 00:01:49,680 --> 00:01:52,280 Speaker 1: twenty twenty four. In early twenty twenty five, with that 33 00:01:52,360 --> 00:01:56,400 Speaker 1: deceleration and earnings momentum inside the tech space, we started 34 00:01:56,400 --> 00:01:59,720 Speaker 1: to see valuations rationalize a little bit, came back down 35 00:01:59,760 --> 00:02:03,920 Speaker 1: to around twenty times forward earnings, a little bit higher 36 00:02:03,960 --> 00:02:06,560 Speaker 1: than twenty times forward earnings, but at the very least 37 00:02:06,680 --> 00:02:09,639 Speaker 1: we were sort of off of those what we thought 38 00:02:09,680 --> 00:02:15,520 Speaker 1: were unsustainable peaks and experiencing some tech companies effectively growing 39 00:02:15,560 --> 00:02:19,639 Speaker 1: in to their valuation multiples. And then the tariff turmoil hit, 40 00:02:20,240 --> 00:02:24,760 Speaker 1: and what became very clear in the second quarter is 41 00:02:25,520 --> 00:02:30,600 Speaker 1: tech companies are still experiencing steady growth while the rest 42 00:02:30,639 --> 00:02:34,639 Speaker 1: of the market is experiencing a accelerating growth rate due 43 00:02:34,720 --> 00:02:40,440 Speaker 1: to tariffs and uncertainty economic uncertainty affiliated with tariffs. So 44 00:02:40,639 --> 00:02:44,000 Speaker 1: the natural byproduct of that is capital flows right back 45 00:02:44,080 --> 00:02:48,959 Speaker 1: to tech, even though we're not seeing necessarily a reacceleration 46 00:02:49,120 --> 00:02:51,560 Speaker 1: in that tech growth pace. In order to drive that 47 00:02:51,639 --> 00:02:55,280 Speaker 1: capital back, we're seeing damage emerge to the non tech 48 00:02:55,360 --> 00:02:58,840 Speaker 1: segments that wasn't anticipated at the start of this year, 49 00:02:59,280 --> 00:03:02,480 Speaker 1: and that's create this rotation that's favorable for tech. 50 00:03:02,600 --> 00:03:05,720 Speaker 2: But why is that, I suppose a problem. If people 51 00:03:05,760 --> 00:03:08,480 Speaker 2: are seeing strength in the company and they're seeing something 52 00:03:08,520 --> 00:03:10,600 Speaker 2: that's worth putting their money into it, why do we 53 00:03:10,639 --> 00:03:13,440 Speaker 2: have warnings, like from Michael Harten's statement Bank of America 54 00:03:13,520 --> 00:03:16,000 Speaker 2: that they're worried now about the stritch of valuations. 55 00:03:16,080 --> 00:03:19,640 Speaker 1: Well, I think it's mostly because valuations have reached that 56 00:03:19,760 --> 00:03:23,200 Speaker 1: new peak level. So the tech sector specifically, if you 57 00:03:23,200 --> 00:03:25,639 Speaker 1: look at tech and communications together, which is kind of 58 00:03:25,680 --> 00:03:29,240 Speaker 1: how we think about tech, you're looking at valuation multiples 59 00:03:29,240 --> 00:03:31,720 Speaker 1: that are at all time highs, even higher than they 60 00:03:31,720 --> 00:03:33,760 Speaker 1: were in the peak in the market in twenty twenty one, 61 00:03:33,880 --> 00:03:36,840 Speaker 1: even higher than they were in twenty twenty four. They've 62 00:03:36,880 --> 00:03:42,080 Speaker 1: accelerated to levels that we're looking at near thirty times earnings, 63 00:03:42,680 --> 00:03:46,040 Speaker 1: So very clearly what has happened is this concentration of 64 00:03:46,080 --> 00:03:50,880 Speaker 1: capital has flooded into the space absent any other perceived 65 00:03:50,880 --> 00:03:53,360 Speaker 1: opportunities inside the rest of the S and P five 66 00:03:53,480 --> 00:03:56,480 Speaker 1: hundred for the most part, and even though the companies 67 00:03:56,480 --> 00:04:00,880 Speaker 1: are earning very strongly and earning even better than analysts 68 00:04:00,920 --> 00:04:03,480 Speaker 1: had anticipated, which is helping to create a short term 69 00:04:03,560 --> 00:04:07,840 Speaker 1: flight back to the segment, their earnings momentum is still decelerating. 70 00:04:08,680 --> 00:04:12,480 Speaker 1: So what you have is a slower and slower pace 71 00:04:12,520 --> 00:04:16,280 Speaker 1: of earnings growth that is continuing to emerge. These companies 72 00:04:16,320 --> 00:04:20,200 Speaker 1: are facing higher and higher expectations even though their earnings 73 00:04:20,200 --> 00:04:23,520 Speaker 1: are decelerating, which creates a little bit of friction, creates 74 00:04:23,520 --> 00:04:26,320 Speaker 1: a little bit of risk because as earnings are decelerating, 75 00:04:26,360 --> 00:04:30,880 Speaker 1: the companies are most vulnerable to a potential disappointment. Right, 76 00:04:31,040 --> 00:04:35,080 Speaker 1: we know that capex spending peaked last year, and we 77 00:04:35,160 --> 00:04:37,040 Speaker 1: know that even though they're still spending at a very 78 00:04:37,160 --> 00:04:40,600 Speaker 1: robust pace, we're still past that peak. The tech sector 79 00:04:40,640 --> 00:04:43,400 Speaker 1: is really interesting because the cycle is really meaningful to 80 00:04:43,480 --> 00:04:46,280 Speaker 1: driving relative performance typically, and I think this is what's 81 00:04:46,320 --> 00:04:49,520 Speaker 1: creating the problem for strategists at this time is the 82 00:04:49,560 --> 00:04:52,839 Speaker 1: cycle very clearly is not necessarily working in tech's favor 83 00:04:52,920 --> 00:04:55,680 Speaker 1: because we had that peak in earnings growth and in 84 00:04:55,720 --> 00:04:59,040 Speaker 1: sales growth. We are decelerating off that peak. Even though 85 00:04:59,080 --> 00:05:01,279 Speaker 1: the relative growth rate is stronger than the rest of 86 00:05:01,320 --> 00:05:04,120 Speaker 1: the index. We are in that deceleration mode, and that 87 00:05:04,160 --> 00:05:07,720 Speaker 1: creates a foggier environment for investing in tech then the 88 00:05:07,839 --> 00:05:09,960 Speaker 1: environments say we were in twenty twenty three and twenty 89 00:05:09,960 --> 00:05:14,039 Speaker 1: twenty four, where earning's momentum was persistently improving, and that 90 00:05:14,200 --> 00:05:16,880 Speaker 1: was a very clear case for why tech should lead. 91 00:05:17,360 --> 00:05:19,800 Speaker 1: We're just in a messier market, is the best way 92 00:05:19,839 --> 00:05:23,080 Speaker 1: to describe it. It doesn't necessarily mean that all is lost 93 00:05:23,120 --> 00:05:25,360 Speaker 1: and you know, you should just dump all of your 94 00:05:25,360 --> 00:05:29,240 Speaker 1: tech exposure, but it is a bit of a concerning 95 00:05:29,279 --> 00:05:32,080 Speaker 1: market because valuations are so high and momentum is slowing. 96 00:05:32,240 --> 00:05:34,440 Speaker 2: What's the risk? Where As we'd be looking for the 97 00:05:34,839 --> 00:05:37,320 Speaker 2: perspective to things to go wrong, especially. 98 00:05:37,760 --> 00:05:40,560 Speaker 1: The risk is and this doesn't appear to be playing 99 00:05:40,600 --> 00:05:42,520 Speaker 1: out in the short term. So I have to say 100 00:05:42,640 --> 00:05:45,520 Speaker 1: in the second quarter, for the most part, the companies 101 00:05:45,520 --> 00:05:48,839 Speaker 1: have been able to satisfy expectations, have been able to 102 00:05:48,920 --> 00:05:51,680 Speaker 1: suggest that growth rates are going to sustain themselves into 103 00:05:51,680 --> 00:05:54,479 Speaker 1: the future. But the real risk is that that doesn't happen. 104 00:05:54,520 --> 00:05:56,760 Speaker 1: At some point in the next quarter or two, that 105 00:05:56,960 --> 00:06:01,080 Speaker 1: a tech company or a few tech companies will say, oh, actually, 106 00:06:01,120 --> 00:06:06,240 Speaker 1: we are seeing some real deceleration in demand from our customers, 107 00:06:06,600 --> 00:06:10,440 Speaker 1: or we are seeing a deceleration in capex emerge. We've 108 00:06:10,560 --> 00:06:15,120 Speaker 1: passed peak capital spending cycle and the migration in the 109 00:06:15,160 --> 00:06:20,440 Speaker 1: AI cycle from infrastructure spending cycle to the manifestation of 110 00:06:20,720 --> 00:06:26,360 Speaker 1: AI in actual business process. Maybe that doesn't go so smoothly, right, 111 00:06:26,440 --> 00:06:29,440 Speaker 1: and we have to price different outcomes. I think that 112 00:06:30,120 --> 00:06:33,640 Speaker 1: what is happening in tech right now is we're pricing 113 00:06:34,120 --> 00:06:38,440 Speaker 1: close to ideal scenarios, and if anything emerges that is 114 00:06:38,560 --> 00:06:41,599 Speaker 1: less than ideal, that makes the sector somewhat vulnerable to 115 00:06:41,760 --> 00:06:42,800 Speaker 1: short term weaknesses. 116 00:06:42,880 --> 00:06:44,720 Speaker 2: Do we have a good example of when this has 117 00:06:44,720 --> 00:06:47,000 Speaker 2: happened in the past, perhaps in a different sector, that 118 00:06:47,080 --> 00:06:49,120 Speaker 2: might give us an idea of what that could look like. 119 00:06:49,360 --> 00:06:52,839 Speaker 1: Yeah, the most representative example, and I hesitate to bring 120 00:06:52,839 --> 00:06:55,360 Speaker 1: it up because it will create a lot of hate mail. 121 00:06:55,600 --> 00:06:58,719 Speaker 1: Is probably the tech bubble, okay, And I want to 122 00:06:58,720 --> 00:07:02,880 Speaker 1: be very careful to clarify that, you know, no bubble 123 00:07:02,920 --> 00:07:06,320 Speaker 1: works out the same. Sure, every mini bubble is different. 124 00:07:06,640 --> 00:07:09,960 Speaker 1: This bubble is different in that there is actual earnings 125 00:07:10,040 --> 00:07:13,000 Speaker 1: growth affiliated with these companies, which is naturally going to 126 00:07:13,120 --> 00:07:16,880 Speaker 1: make it manifest. Any kind of deflation of that bubble 127 00:07:16,880 --> 00:07:19,560 Speaker 1: will manifest a bit differently than the tech bubble did. 128 00:07:20,120 --> 00:07:22,760 Speaker 1: But if you think back to the late nineteen nineties, 129 00:07:22,880 --> 00:07:25,520 Speaker 1: it again was all about we've got to invest for 130 00:07:25,560 --> 00:07:27,760 Speaker 1: the future. The future is going to be magnificent. We're 131 00:07:27,760 --> 00:07:30,600 Speaker 1: going to invest a tremendous amount of capital and infrastructure 132 00:07:30,600 --> 00:07:33,320 Speaker 1: and laying pipe everywhere. This is now we're laying AI 133 00:07:33,400 --> 00:07:37,800 Speaker 1: pipe everywhere effectively, right. But nonetheless, when we moved from 134 00:07:37,840 --> 00:07:42,560 Speaker 1: that initial infrastructure investment to the long term benefits of 135 00:07:42,720 --> 00:07:46,840 Speaker 1: having the Internet and on everybody's desktop and ultimately everybody's phone, 136 00:07:47,200 --> 00:07:52,240 Speaker 1: the run rates of growth were significantly slower than investors 137 00:07:52,280 --> 00:07:55,400 Speaker 1: had priced over the long term. There were also quite 138 00:07:55,400 --> 00:07:57,480 Speaker 1: a few companies at that point that weren't making any 139 00:07:57,520 --> 00:07:59,520 Speaker 1: money and had nothing to do with tech that investors 140 00:07:59,560 --> 00:08:01,480 Speaker 1: were still in investing in so it was a different 141 00:08:01,520 --> 00:08:05,520 Speaker 1: scenario than it is today, but at its fundamentals, there 142 00:08:05,520 --> 00:08:07,840 Speaker 1: are two things that are similar. The one big thing 143 00:08:07,960 --> 00:08:11,880 Speaker 1: is that infrastructure is the investment right, and when you're 144 00:08:11,920 --> 00:08:15,160 Speaker 1: in the early stage investment on infrastructure, your growth pace 145 00:08:15,280 --> 00:08:20,440 Speaker 1: is extraordinary. Investors start pricing in the prospects for that 146 00:08:20,520 --> 00:08:23,680 Speaker 1: infrastructure to have meaningful impacts all the way down the chain, 147 00:08:24,080 --> 00:08:27,280 Speaker 1: you know, right through to the healthcare companies and consumer 148 00:08:27,360 --> 00:08:30,240 Speaker 1: companies that are going to benefit from at that point 149 00:08:30,280 --> 00:08:35,560 Speaker 1: having Internet and now having generative AI. So the concern 150 00:08:35,720 --> 00:08:39,280 Speaker 1: is how much then do we price and are we 151 00:08:39,360 --> 00:08:44,040 Speaker 1: pricing too much growth and too rapid AI proliferation? Because 152 00:08:44,080 --> 00:08:46,840 Speaker 1: of course the Internet as it emerged became a very 153 00:08:46,880 --> 00:08:49,400 Speaker 1: long term term driver of productivity. I think you know, 154 00:08:49,800 --> 00:08:52,640 Speaker 1: you would argue it did ultimately have very positive long 155 00:08:52,720 --> 00:08:58,000 Speaker 1: term impacts, but we had priced such extraordinary circumstances. There 156 00:08:58,080 --> 00:09:00,680 Speaker 1: was no way for the company fund mentals to be 157 00:09:00,679 --> 00:09:04,480 Speaker 1: able to achieve those expectations in such a compressed period 158 00:09:04,480 --> 00:09:08,200 Speaker 1: of time. They did achieve magnificent progress, but over a 159 00:09:08,240 --> 00:09:11,400 Speaker 1: long period of time at slower growth rates than we're priced, 160 00:09:11,800 --> 00:09:14,480 Speaker 1: and that's very possibly what we're facing with AI now 161 00:09:14,720 --> 00:09:20,680 Speaker 1: is we're pricing extraordinary growth almost immediately, and we probably 162 00:09:20,720 --> 00:09:24,360 Speaker 1: will get very meaningful change, but maybe it'll take a 163 00:09:24,400 --> 00:09:28,400 Speaker 1: little while to actually manifest itself in real growth, real 164 00:09:28,480 --> 00:09:30,600 Speaker 1: change to productivity, real economic conditions. 165 00:09:30,720 --> 00:09:33,160 Speaker 2: Okay, Gina, thank you very much. Geena Martin Adams, our 166 00:09:33,200 --> 00:09:37,240 Speaker 2: chief equity stratchist at Bloomberg Intelligence. Thank you. For more 167 00:09:37,280 --> 00:09:40,120 Speaker 2: explanations like this from our team of three thousand journalists 168 00:09:40,160 --> 00:09:42,480 Speaker 2: and analysts around the world. Go to Bloomberg dot com 169 00:09:42,520 --> 00:09:47,679 Speaker 2: slash explainers. I'm Stephen Carroll. This is here's why. I'll 170 00:09:47,720 --> 00:09:49,920 Speaker 2: be back next week with more. Thanks for listening.