Equities, Bonds, and AI

Fatima Boolani · CitiBullish

Zscaler's investor day was strong, and it is an underappreciated leading cybersecurity name.

Zscaler is a lesser-known but leading cybersecurity company, and she says management did a very solid job at its investor day. It gave a financial framework for the growth trajectory over several years and laid out an architectural vision for governing agent interactions. The stock is down nearly 6% year to date, which she frames as a valuation arbitrage in a market that prices expensive names up.

“There were two major areas that I think the management team did a very solid job on.”at 22:51

Fatima Boolani · CitiBullish

Datadog is among Citi's favored names for the incremental opportunity from AI agents.

Agents will be trawling company websites and the burden of managing the digital experience falls on companies, creating more investment in that area. Citi has thought very highly of Datadog for this incremental opportunity around agents, which she describes as a compelling investment area.

“Cloudflare and Datadog are the ones that we've thought of very highly in in this sort of incremental opportunity around agent.”at 26:53

Fatima Boolani · CitiBullish

Cloudflare is well positioned for the incremental opportunity of gating AI agent traffic.

As agentic commerce grows, companies will need to manage agents trawling their websites, and some will block bots entirely. Burden of managing the digital experience falls on companies, who will need gates and firewalls. Citi has thought very highly of Cloudflare for this incremental opportunity around agents.

“you ought to have the right, you know, gates and firewalls put up. And, you know, there's investment opportunities there, and, you know, Cloudflare and Datadog are the ones that we've thought of very highly”at 26:53

Alicia Levine · BNY Wealth

Owning the S&P has worked; growth and earnings keep beating expectations despite narrow leadership.

The index has held up through the rate selloff, a hawkish Fed and turmoil in European bond markets because growth keeps exceeding expectations, and so do earnings. Leadership is narrow, roughly 15 stocks carrying the market, as in 2023-24, but she argues the narrowness can continue. Semis and software have rallied together at times while growth is winning even with rates higher.

“and everybody's wringing their hands that it cannot continue when in fact it can continue. And if you simply own the S and P, you've been fine throughout all the policy discussions...”at 2:24

Chuck Clough · Clough Capital Partners

Markets' strength despite a hawkish Fed signals reasons to be positive on financial markets.

Productivity equals profits, and productivity is rising, much of it technology-based. Stocks are strong despite a hawkish Fed, quality spreads remain narrow, and the dollar has held up despite heavy government borrowing. He sees the market itself as evidence that conditions are fine, though he expects final demand to slow as cyclical sectors remain under pressure.

“I think there are reasons to be positive about the financial markets. And the fact that financial markets themselves are giving a lot of evidence of that.”at 11:28

Alicia Levine · BNY Wealth

The Fed looks more hawkish than markets priced six months ago; she assumes higher-for-longer rates.

Markets have struggled to price the Fed's reaction function. The Fed now looks much more hawkish than the market priced in six months ago, and combined with a 145 basis point move in the ten-year yield, this is what is squeezing the weakest borrowers. She therefore assumes rates stay higher for longer.

“a Fed that looks to be a lot more hawkish than the market priced in six months ago.”at 7:50

Chuck Clough · Clough Capital Partners

Short rates are vulnerable to falling as the financial sector shrinks and private borrowing declines.

Apart from the Fed, the main determinant of the short rate is how willing the financial sector is to bid for its own liabilities such as deposits, commercial paper and asset-backed securities. As the financial sector shrinks and profitability falls, that bid goes down and the short rate falls with it. Supply shocks may take a while to work out, but he calls that short rate a very vulnerable number.

“Other than the Fed, the most important determinant of what the short rate is, what is the financial sector willing to bid for its own liabilities?”at 19:47

Alicia Levine · BNY Wealth

Companies using AI tools to expand margins will see strong operating leverage; these are the winners.

Amid credit stress among weaker borrowers, she argues the strength is in firms levered to using AI tools to expand their business and margins. Because of this, she expects a lot of operating leverage across many companies as a result.

“I'd say the strength is really those who are levered to using AI tools to expand their business and expand their margins, and you're going to get a lot of operating leverage”at 8:38

Fatima Boolani · Citi

AI agents will autonomously run important business processes within three to five years.

Within three to five years, agents will be treated as teammates and will carry out important business processes completely autonomously and without human mediation. This raises the question of who will govern those interactions, which creates a need for new architecture and governance.

“I think three to five years from now, no one is going to bat an eyelash if I say agents are gonna be my teammates. Agents are going to be undertaking important business processes completely autonomously”at 23:39

Chuck Clough · Clough Capital Partners

Current inflation is supply-shock driven, not permanent, and capital will fix it over time.

Shortages and the war-related supply shock are behind current inflation, and there is plenty of investment capital to fix them. The insurance example shows this: property insurance rates were soaring about 15 months ago, but they are now down roughly 9-30% year over year after capital flooded into the industry. Longer term, demographics, slowing private borrowing and narrow spreads point to lower inflation and interest rates.

“It is not a permanent inflation. It's inflation based on a supply shock and there's plenty of investment capital to fix it.”at 16:56

Kyra Fecteau · Wellington Management

Headline inflation overstates what most consumers feel; lower-income households face higher costs.

The BLS basket assumes everyone consumes the same goods, but lower-income households are more exposed to food and energy inflation. Cumulative headline inflation was about 30% over six and a half years, and lower-income households experienced more of it. Stripping out shelter, which about two-thirds of homeowners and 40% who own outright barely experienced, consumers feel roughly six points less than headlines suggest.

“what I observe is that cumulative inflation over the last six and a half years in the post pandemic era was upwards of 30%. But that lower income people experienced more inflation than higher income people.”at 30:23

Alicia Levine · BNY Wealth

Huge deficit issuance is fine as long as there is demand for the debt to absorb it.

The dollar amount of issuance is eye-popping, but the test is whether auctions can place it. So far there is demand, so the debt gets sold and the market moves on. She concedes a price exists at which that stops happening, but she does not see the market there yet.

“If there's demand for the debt, it's fine. Like, the the dollar amount is eye popping. But if there's demand, you can place it.”at 4:00

Alicia Levine · BNY Wealth

The 10-year Treasury yield can easily reach 5.5%, consistent with 6.2-6.3% nominal growth.

Debt demand is sufficient to absorb large issuance, so supply is not the constraint. An industrial boom is visible in rising wages and manufacturing that is moving straight up, and this drives the long end higher. Nominal growth of 6.2-6.3% supports a 5.5% ten-year yield.

“we think the ten year can easily get to five and a half that works with nominal growth at 6.2, 6.3%.”at 4:12

Alicia Levine · BNY Wealth

S&P 500 profit margins have been walking higher for two decades; the expansion is structural.

Her argument for equities is to follow gross profit, not just revenue. Fast revenue growth gets passed down to the bottom line because of fixed costs, and margins keep moving higher. She points to the S&P margin trend over the last twenty years as evidence that the margin expansion is structural and not just a feature of this year.

“not just revenue generation, but massive profit generation because margins keep on moving higher. Look at the margin of the S and P over the last twenty years. We've been on a margin walk much higher. It's structural.”at 6:01

Alicia Levine · BNY Wealth

Stress in weak private-credit borrowers is normal cycle Darwinism; not worried, some distressed trades mispriced.

Distressed loans, many held by software companies, are trading below 60 cents on the dollar at the highest level since the pandemic. Weaker companies that borrowed at low rates, partly through private credit outside the traditional system, are showing stress as rates rose and the Fed turned hawkish. She sees this as a normal part of the cycle where weak firms show problems first, and says distressed capital is arriving to clear it.

“the weaker companies that borrowed at lower rates and funded through maybe some of the private credit a few years ago outside of the traditional financing system, but in the alternative capital providers are showing some stress.”at 7:43

Chuck Clough · Clough Capital Partners

The dollar's strength reflects corporate capital flowing to the US, not deficit-driven weakness.

A year ago the consensus was that heavy government borrowing would damage the dollar. Instead it held up well and strengthened on only a modest rise in rates. He ties this to corporate investment flowing from Europe to the US, which is part of why the dollar is so strong.

“Dollars held up fairly well. And of course it strengthened with just really a modest increase in interest rates.”at 11:44

Chuck Clough · Clough Capital Partners

Market is signaling final demand will slow, with cyclical sectors under pressure for a long time.

Productivity gains will keep lifting profits, but the market is telling you that final demand will slow. Virtually every cyclical sector has been under pressure for a long time, including autos, big retailers and McDonald's, which are fighting tailwinds. Consumers adjust to inflation quickly, and the airline industry is extending the life of older aircraft as a result.

“the market's telling you that final demand will slow. And it's telling you that by virtually every cyclical sector has been under pressure for a long time”at 13:45

Chuck Clough · Clough Capital Partners

Europe is regulating itself into no-growth and no-profit-growth; bearish on the region.

He argues that Europe's regulatory approach is suppressing growth, leading to a no-growth environment and certainly no profit growth. He compares this with the US, where corporate investment flows are moving from Europe to America.

“Europe is regulating itself into a no growth environment and certainly a no profit growth environment.”at 15:02

Chuck Clough · Clough Capital Partners

Latin America is the only region becoming more interesting, given pro-market elections and resources.

Elections in Argentina and, lately, Brazil have brought more conservative governments, and the region is resource-rich. He also sees the rule of law becoming more intense across Latin America. Together these make it the only area in the world he finds becoming more interesting.

“I'd say the one part, the only area in the world that I think is becoming more interesting is Latin America.”at 15:02

Chuck Clough · Clough Capital Partners

China is uninvestable right now; the US is the place to be for investors.

He calls China uninvestable outright and says the other markets are too small to consider. He concludes the US is the place to be, and that overall investment flows, especially corporate investment, are moving to the US from Europe.

“Outside, I think China is uninvestable right now and the other markets are too small to even think about.”at 15:33

Chuck Clough · Clough Capital Partners

Politics is mostly noise; markets like gridlock, which the coming midterms look likely to produce.

Markets usually respond to monetary policy, not fiscal policy, so political events are overemphasized. Gridlock is what markets like, and it looks like the country is heading for gridlock in the coming election, so he says not to worry about the political side.

“Markets love gridlock and it sure looks like we're heading for gridlock...”at 16:33

Chuck Clough · Clough Capital Partners

Financial sector's S&P 500 weight has collapsed from 33% in 2006 to 13%, with consolidation.

The financial sector was 33% of the S&P 500 in 2006, or 37% including the balance sheets of GE and Ford, and it is about 13% today. Its profitability has been shrinking, which drives consolidation across the sector, and he says this is already visible in banking. He argues the sector's relative size has shifted dramatically.

“The financial sector was 33% of the S and P 500 in 2006... If you include balance sheets of General Electric, Ford Motor, it was 37%. It's 13% today.”at 19:11

Fatima Boolani · Citi

We are in a generational period for cybersecurity risks and investment spending.

Organizations face a dizzying amount of change, such as the rise of agents and new risks, that forces them to batten down the hatches. This drives the investment, and she calls the current period an absolutely generational one for cybersecurity risks and investment.

“we are in an absolutely generational period for cybersecurity risks, cybersecurity investments, but at the same time, you know, a lot of dizzying amount of change that organizations have to batten down the hatches around.”at 23:08

Fatima Boolani · Citi

Expensive high-quality software names keep getting bid up, leaving valuation arbitrage in lesser names.

Valuations feel stretched, and the expensive and high-quality names keep being bid up as investors let the winners win more. This has produced a bifurcation of haves and have-nots that compounded over the last year. She sees a diamond-in-the-rough opportunity, a valuation arbitrage in lesser-known names, in a market where things are priced in instantly.

“the expensive names and the high quality names continue to be bid up.”at 24:10

Kyra Fecteau · Wellington Management

Credit stress is spreading to prime borrowers but stays contained while the labor market holds.

Credit stress is migrating from subprime and near-prime borrowers up into prime, and delinquency rates are climbing, with roll rates rising. But consumer credit on balance sheets is at historic lows, money market balances are at historic highs, and home equity is at historic highs. She says the pressure stays contained as long as the labor market keeps doing what it is doing, and if jobs go, all bets are off.

“[Not] in a worrying way, but we are absolutely seeing credit stress migration up the quality spectrum.”at 32:42

Kyra Fecteau · Wellington Management

Real wage growth is positive for the top 60% but negative for the bottom 20-40% of earners.

When inflation is adjusted for what each cohort actually experiences, real wage growth for the top 60% of earners is still positive and healthy at about 1%. For the bottom 20%, and increasingly the bottom 20-40%, real wages are negative or approaching negative. Those consumers need higher wages or slower inflation in energy and other essentials.

“real wage growth for the top 60% of income earners is still positive and healthy at 1%. Where lower income cohorts, your bottom 20%... is actually in negative or approaching negative territory.”at 34:51

Kyra Fecteau · Wellington Management

El Niño will hurt crops and push food inflation higher, hitting lower-income households.

El Niño is a real phenomenon that will affect crops and food. As a result, food inflation is going to rise, which will hurt the lower-income cohorts that are already struggling, given their greater exposure to food and energy costs.

“El Nino is a real thing and it's going to affect crops and food. And food inflation is going to go higher”at 35:56