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- [00:00]
A
Foreign. Remember that whole thing? In February, markets got spooked by this sudden moment of dread that AI would demolish everything in its path, starting with software companies and ending in our livelihoods. It wiped a trillion dollars off the value of software stocks, and those stocks are still down as a group, about 20% from where they were a year ago. The rest of the market is up a fair amount. And look, it remains possible that AI will kill all the jobs and then, I don't know, kill all the humans. But here at Unhedged, we are humble markets people ill equipped to tackle such grand moral and social issues. What we want to figure out is whether that market shakeout was overdone or a warning of things to come. This is Unhedged, the Markets and Finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist at the FT in London, where the producers have tried to ban me from talking about the weather, but, God, it is so hot, like, insanely hot. Joining me, joining me down the line from New York City. We just can't keep him away from the show. And if we did, Donald Trump would call FIFA up and make us take him back. It's Rob Armstrong off of the Unhedged newsletter.
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B
Katie, it's just a law of nature that British people must talk about the weather. Trying to stop them is like trying to travel at greater than the speed of light or have gravity go the other direction. I don't know why the producers even ask you to not talk about the weather. There's nothing to be done about it.
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A
But the other thing that we are, like, genetically programmed to talk about is the football. Yes, your boys took a hell of a beating off Belgium last night.
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B
But if they'd won, there would have been this horrible asterisk next to it after the President tried, you know, reverse the red card thingy. And look, I mean, there is a kind of aspect of this which is like, FIFA corrupt. Stop the presses, you know, but, you know, still, it's. It's not a good look and that we would have had some explaining to do anyway.
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A
Yeah, moving on. Yes. Matter at hand is like AI and tech and which bits of the market is eating first and what that is all telling us. Why don't you take us back to that weird period in February when everything went a bit skewy?
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B
Well, we got that report from a research firm that sketched in possibly incoherent terms, how AI might cause the economy, as we now understand it, to collapse. And everything would be different now. Citrini Is that. Was that the name of the firm?
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A
Yeah, Citrini Research.
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B
Anyway, what that report showed was that the market was searching about for a reason to panic about AI. And panic it did. And a lot of stocks got punched in the face. But the stocks that got punched in the face hardest then and kind of throughout the whole AI excitement are companies that make software, basically big corporate software companies. And the picture is you're going to be able to make your own software by Vibe coding, and you won't need to buy software from Adobe, Intuit, Workday, Servicenow, Salesforce, Oracle, or the rest of the lads.
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A
Now, it wasn't just the Citrina research paper, though, was it? It was also the anthropic launched Claude Cowork, which is, you know, this sort of AI coding thing. And people started using it and they were like, holy smokes, this thing is good. Like, it massively speeds up my coding time. This is a total game changer. I mean, I really don't know anything about coding. I'm going to put my hands up here and say, no clue. But people who do have a clue are like, whoa, this thing is the real deal. So suddenly, as you say, we had this big hit to software stocks. So in the US, the S&P 500 software and services index, the stocks index covers this sector, is still down 21%
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B
from a year ago, and some big constituents of that index are down a lot more than that.
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A
Yeah. And that's hugely out of whack with the rest of the market. So the rest of the market is saying, yay, AI. It's also fantastic. This is going to, you know, pay for our retirements, but there's this, like, subsector that's, like, bleeding out. So we did a bit of work on this, on the. On the newsletter this week, didn't we? Just trying to figure out, have some babies been thrown out with the bathwater here, or does this actually make sense?
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B
I just want to shout out to the person who did the work, Dara McFadden, your selfless understudy in the London office who you wouldn't let come on the podcast because you have him slaving over a hot keyboard writing something else.
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A
Need him to keep.
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B
While you flounce around making podcasts, he's out analyzing things.
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A
Yes. I'm like, AI taking all the credit.
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B
He is your AI. Dara basically is our AI. We just talk to him and he creates things for us. Yeah. Anyway, we did a bit of work, and it's pretty remarkable. I just reeled off that list of names. And those are kind of the biggest companies that sell software as a service packages to companies. And that's why that's. They call that SaaS, the business model where the business pays a subscription every month and they have access to this software package that helps them do business things as such. This event has been called the saspocalypse
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A
and it's like a really bad name for.
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B
I kind of like it. Saspocalypse.
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A
It's a no from me. Anyway, it's the saaspocalypse.
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B
If you look at these companies, the big business software companies like Adobe, Intuit, Workday, ServiceNow, Salesforce, Oracle, they are trading at 40%, maybe even a third of their recent highs. A lot of them can be snapped up at PE ratios. You would associate with like banks or highly cyclical businesses or businesses that are not doing well yet they're still growing businesses. The AI bomb has not yet landed on these companies. Their businesses are still growing as they have been growing for years. It's just a vision of the future, not what's happening in the present that has caused these huge moves in these stocks.
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A
But that's what markets are supposed to do, right? They're supposed to guess what's going to happen next and not reflect what's just happened happening today. But for example, one of the reasons why some people think this is all massively overdone is that if you're a big business, you make widgets, whatever, and you have software in the building that helps you dispatch those widgets and you use it to order new bits to make your widgets and you use it to communicate with your bank so that the people who work making the widgets all get paid.
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B
Yes.
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A
You, you don't just like switch that off and plug your business into Claude? No, that's just ridiculous.
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B
You certainly do not.
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A
If you do, you shouldn't do that.
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B
And it is an epic pain in the neck to get your business running on one of these software platforms. So like, okay, we're going to load up all of our, spread our databases onto Oracle, that you are then an Oracle company. And the nightmare of switching all the people who know how to run the Oracle system and all the data that's in the Oracle system and all of that into a new system is just a nightmare. I mean, I remember writing a piece about database software probably 20 years ago now and you know, new kinds of databases were coming out, more flexible, you know, trickier databases basically than the standard kind of spreadsheet y ones you know, and everybody was like, oh yeah, told me, oh yeah, Oracle's dead. You know, they're the thing of the past, you know what I mean? And boy, did that not happen, you know.
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A
So is your hunch that some of these individual stocks and that we're not in the business of giving stock tips or financial advice, but is your sense
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B
that some we are in that business, we're just really bad at it, Katie?
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A
Yeah. But do you think some of them have been punished, like too much? Like, does this not make sense?
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B
Yes. I mean, the one I would call out, I mean, I think, I mean, Dara made this point really clear. If you have a software platform that holds your business's mission critical information, and most especially it's how your business's information interacts with the regulatory mechanisms that dominate your industry, you know what I mean? This is how you make your reports. This is how you tell your compliance officer that this is going on. This is how you tell the SEC that this, you know, all of this stuff, you're just not going to rip that stuff out anytime soon.
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A
So why don't the stocks just recover then?
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B
That's a great question. I mean, I think it's. You said just now, Katie, that the job of markets is to predict what's going to happen in the future. And that is true. But what we know as well as we know anything about markets is that they systematically overshoot and undershoot and they do this time and time again. And while over the long run developed countries, stock markets, stock charts move up and to the right and everyone is happy when you zoom in, they're constantly becoming euphoric and then panicked and back again. Right. I mean, these companies are probably worth less than they were before the AI revolution, I would say. But are they worth 40% of what they were worth? So maybe you will have this basic. And Dara talked about this a bit in his piece. Maybe you have this basic data layer that these companies still handle, Right? Or the best of these companies still handle and then where they lose out is like all the fun doodads on top of the, the kind of user interface innovation. Look at these new cool things we can do with the data layer that gets taken over by AI.
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A
Maybe the other possibility is that all the enthusiasm about AI itself is like wildly overdone.
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B
Yes.
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A
So earlier today bank of England put out its Financial Stability Report and it told us lots of things that we know but are not paying enough attention to or that not enough people are paying attention to. So they were talking about the AI trade writ large. Right? We've spoken about this plenty of times on the show. There's all the chip stocks that go to making AI. There's all the hyperscaler stocks like the companies that buy loads of this technology. And they're all kind of off to the races and competing with each other and dragging the indices up and everybody's happy. But what the bank of England is saying is, first of all, as we know, the concentration risk here is crazy. There's a tiny number of stocks that are lifting up the whole world, holding up an awful lot of sky. So bank of England was saying the s and P500. So the kind of go to US stocks index as a whole accounts for about half of the global equity market, which is like mad. And within that index it says AI companies now account for about half of that, up from about a quarter in 2022. So like the entire global stock market is balancing on this tiny, tiny pinhead that is like a tiny number of AI stocks. And you've got these stock valuations that are like pumped up by incredibly bullish forecasts of earnings growth. But we still don't actually know how this technology works, how you make money out of it, where the bottlenecks are. So they sketch out a hypothetical scenario in which AI related stocks take a nosedive, by which they mean, what if we saw a 45% drop in the US stock market over six quarters as a result of this going wrong? They're sketching out extreme scenarios here, but how do you like that? So what they're doing this exercise for is to say, how would this affect the UK economy and how would this affect UK financial stability? And the answer is we'd probably be okay over here because we haven't got very much AI in our stock market. We're not quite so reliant on it as a theme. But my point is just that central banks are like banging the drum and they're being the monkey on your back saying you have to think about what happens if this all goes wrong. And there's a number of reasons why this could go wrong. And everyone is ignoring them because the line is going up and to the right. But we should be more worried about this.
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B
I think so. But let me complicate the story for you a little bit. 45% is a big decline in the market. That's like 2008 style. But I will say this. Stock markets go down by say a third all the time. Not like every year, but. But like, you know, in a decade That'll happen a couple times, you know, and if you're not planning for that, you're doing it wrong. AI aside, that's point number one. Point number two, we all but know that in massive technological revolutions there is the inflation of a bubble and then a shakeout. And there is every reason to believe that will happen in this case. But that piece of information plus $20 will buy you exactly one ticket to the movies. Right. You know what I mean? It's like, yeah, but when and why and which part gets hit the hardest, you know what I mean? There's a sense that it's like, thanks for the warning, bank of England. And now I'm going to get back to living in real life where I have to make decisions. So, like, I guess you could make a case, if you are an equity investor, make sure you are diversified away from the top half of the capitalization spectrum in the United States and out of the United States, you know, good
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A
luck with that when it, when it's so big. Yeah, I mean, look, I think you're right. You get a lot of these things from, from central banks and other others that are effectively like CYA exercises. Right. Cover your ass. So if and when this does go wrong, they can say, I don't want anyone to say that we did notice
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B
this the way I didn't notice the housing Crisis coming in 2008. Basically, yes.
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A
As ever, you know, investors who are used to kind of, you know, looking at numbers on a screen and figuring out what's fairly valued and what's undervalued and what's too expensive. Now they're being asked to say, okay, but imagine the whole world, but totally different, where AI is either completely incredible and it overtakes everything, or actually it's rubbish and the markets crash. What are you supposed to do with that? With that information? So I guess this is why you get things like software stocks having a really bad run and you get this change in leadership that we've spoken about before. Between the hyperscalers and the chip makers,
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B
a lot of general volatility.
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A
Yeah. So markets look like they're kind of just sailing higher. But there's some really big questions under the surface and regrettably, neither Rob nor I know the answer to them. If you do unhedgedt.com in the meantime, we'll be back in one second with long Short. Okey doke. It is time for Long Short, that part of the show where we go, long a thing we love or short a thing we hate. Rob, what you Saying I'm going long
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B
an individual person who I know almost nothing about. I am long Keith Snyder, who is senior Equity Analyst at CFRA Research. And I am long Keith because he is the one analyst, so far as I know, who has a sell rating on SpaceX.
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A
Yeah.
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B
And I have no idea whether SpaceX deserves a cell rating, whether Keith Snyder's work on the topic is good or not. But I do know that the ratings from the big Wall street banks read something like this. Buy, buy, buy, buy, buy, buy, buy. And it's nice that somebody out there, for some reason is taking the other side of that disagreement.
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A
Yeah.
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B
So good on you, wherever you are. Keith Snyder, Senior Equity Analyst at CF Research.
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Go, brother. We believe in you. I am going to be long. Integrity. I bet you know where I'm going with this, Mr. Mr. Armstrong.
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B
I do.
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A
So monkeying about with benchmarks is bad. We know this because people got in lots of trouble for monkeying about with the Libor benchmark. And people got in lots of trouble for monkeying about with currency benchmarks. But news reaches us that three big US egg producers have agreed to settle accusations by the US and state authorities that they colluded to manipulate the benchmark for the price of eggs. I just think this is a massive scandal.
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B
Yes, it's food. People need to eat eggs. You can't just be messing about. It's all fine. And it's fine and good to mess about with Libor. A little light insider trading between friends is fine, but you mess with the eggs.
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A
Well, first of all, I think as a point of principle, yes, it's eggs, it's food. You can't just do this. This is like protein that humans need. But the other bit of it is, do you remember that whole period when all of the kind of benchmark inflation data was completely sent bananas by the price of eggs? And because it looked like the price of eggs had gone up massively because of an outbreak of bird flu, all of a sudden the inflation readings were much, much higher than we thought they should be. And there was this wild, wild gyrations in the price of eggs that were completely screwing up the inflation numbers. And now it looks like a lot of those gyrations were, like, possibly made up. I think this is like a data. Again, integrity. I hope you get my joke. A data integrity issue.
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B
Oh, we got it, Katie. Thank you.
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A
Thank you.
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B
I just want you to know I am very tempted to make another egg pun here, but I'm not going to do it.
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A
So on that extreme. On that excellent point. I'm sorry. I'm sorry. We are going to be back in your ears on Thursday, so listen up then. Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forehead. Special thanks to Laura Clark, Greta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free and a 30 day free trial is available to everyone else. Just go to ft.com unhedged offer. I'm Katie Martin. Thanks for listening.