One week / one topic: A tale of two cities

What happened?

While we can’t seem to agree on anything anymore, there is a growing consensus about the bifurcation of the global economy into winners vs losers.

It works on many levels: stocks vs bonds, AI stocks vs everything else, gold/bitcoin vs fiat currencies, and so on.

Given the size and importance of the US stock market, its recent very narrow breadth – i.e. the fact the index has been rising in aggregate, but very few stocks are actually up – stands out in particular.

Once again, following the (undeniable) price action of ‘AI winners massive outperformance’, the narrative of course writes itself… “why would you want to own anything else?”

The problem is that the numbers are truly staggering – see below – and big enough to sway the macro picture, with just 5 companies spending in one year the equivalent of 1% of US GDP on capex… (yes, Nvidia is ringing the register).

Meanwhile, the latest news from the wrong side of the tracks is really not great… McDonald’s actually just said the following during the latest quarterly earnings call:

“Visits from lower-income consumers to fast-food restaurants continued to decline by double digits in Q2… They’re skipping a daypart like breakfast or trading down—either within our menu or to eating at home.”

So, one hand you have Mira Murati turning down Mark Zuckerberg’s $1bn job offer – while on the other, the low end consumer is increasingly hurting.

Of course, investors could not resist the temptation to extrapolate these and other developments into another diatribe:

• Bulls: The ‘AI gold rush’ tide is big enough to lift all most boats, Fed cuts will come to the rescue sooner than you think, and tariff announcements are largely just a show

• Bears: There has been no job growth over the last 3 months, the consumer is really hurting and AI is going to displace many, many jobs.

Conspicuously missing from this debate is the rest of the world, with many countries licking their wounds (India, Switzerland), pretending that nothing has happened (Europe, Japan), or playing dead so that they don’t attract the unwanted attention of Tariff Man. (large swathes of Emerging Markets (EM) )

Meanwhile – taking Brazil as a representative example – there are markets that are appreciating strongly despite being in the crosshairs of President Trump.

While the aforementioned question about the US remains central, are we perhaps looking at continued decoupling of various equity markets?

Could the appeal of non-US allocations – and EM in particular – survive a meaningful US slowdown?

Our observations

• Fundamentals: As mentioned before, equity markets have always been dominated by outliers. Why would you expect anything different, especially with Artificial General Intelligence (AGI) allegedly in sight? Meanwhile, EM equities seem to be responding to more mundane – yet perhaps also more intelligible – drivers, like valuations and country risk.

• Price action: Faced with the huge challenge of managing money vs such concentrated returns, many investors are trying to get even more exposure to the theme. (see below) Maybe you want to play a different game…

• Investor beliefs: Illiquid summer tape can engender volatility, but – interestingly – it seems that this year many are happily heading to the beach while running lots of concentrated risk?

So what?

While the tariffs schoolyard scraps are unlikely to end anytime soon, investors are seeking comfort in the belief that AI hyperscalers are destined to capture an ever larger portion of global GDP. And indeed, they might well do…

At the same time, not only emerging markets are going to keep doing what they do (ahem, emerge?) – but important considerations clearly stand out as well.

First, the perceived gap between emerging and developed markets – loosely measured in terms of policymaking quality and stability of institutions – keeps shrinking.

This is due to both sides converging towards each other, and not ‘just’ to the continued development of emerging market economies.

While many EM policymakers keep earning more and more credibility – for example, by better managing the post-Covid inflation surge – the unseemly spectacle of continued attacks on institutions is not doing any favors to the other side of the equation…

Furthermore, the continued dominance of Mag Seven stocks means that – as their weight in global equity indices keeps going up – a passive, market cap-weighted allocation to stocks is increasingly fragile to anything going wrong with this dominant narrative.

While acknowledging that these are indeed very high-quality businesses – and we do own these stocks in our portfolios, also on the back on their stellar abilities to keep making huge profits – the allure of more diversified bets clearly stands out.

Mood music: Journey – Don’t Stop Believin’