Ketu Desai
By Ketu Desai
What a difference a month makes! A month ago, the market was afraid of rate hikes and the potential for stagflation. The combination of cooler inflation data and resilient growth calmed both fears. Second quarter growth is tracking just under 3%. We are in a cycle that is driven by fiscal policy. We are still in the early stages of the money from the infrastructure bill, inflation reduction act, and chips act being spent. This is $2.4 trillion in spending and less than 20% of that has been spent. Only a third of the infrastructure bill, the largest of the bills, has been awarded. Only 5.6% of the inflation reduction act has also been spent.
We will be feeling the impact for a while, likely years. We are also in a significant corporate CapEx cycle driven by AI, which is also just getting started. Large cap tech alone will spend approximately $350bn this year in CapEx, up 40%. This is becoming an arms race. Low unemployment, rising real wages, and low debt to income will keep consumers spending. The combination of fiscal policy, corporate CapEx, and a consumer that is in good shape means that growth should remain supported. While we will likely get a rate cut this year, expect this cutting cycle to be gradual and shallow.
Strong nominal growth has led to rising earnings. Second quarter earnings are tracking up 10.6%. More importantly, earnings are expected to continue to hit records for the rest of the year. The second half of the year should see 10% earnings growth. Not only is earnings growth strong, but earnings breadth is also strong. Nearly half of stocks are showing quarterly EPS growth greater than 10%. By the fourth quarter 7 of the 11 sectors will have double digit growth. Leadership comes from cyclical sectors. Discretionary, financials, communication services, materials, and technology are expected to have north of 15% growth. The earnings growth is expected to stretch far beyond this year. Earnings are expected to grow another 14% next year and 13% in 2026. Stocks follow earnings. This type of earnings growth, sector leadership, CapEx cycle, and rate cuts are a lot more indicative of early cycle rather than late.
It’s not just earnings that are supporting the market, but the technicals themselves. Corporate buybacks are going to hit nearly $1 trillion this year and hit a record $1.075 trillion in 2025, a 16% increase from this year’s total. There is $6.3 trillion in money market assets. As rates get cut, money market assets are less attractive. If the stock market remains strong, it’s likely FOMO will set in for those sitting with high cash positions. Equities have been net-sold for four consecutive weeks. CTAs still have room to add to positioning. Hedge funds (just in the 27th percentile) continue to add short positioning while S&P futures positioning is still net short. With this kind of fire power on the sidelines, dips are likely to be bought.
The major driver of earnings growth is the new CapEx cycle. It spans infrastructure, clean energy, manufacturing, and technology. It is funded by fiscal spending from the infrastructure bill, chips act, and inflation reduction act, as well as corporate CapEx, and private capital. At the heart of it is AI. The AI infrastructure buildout is significant, it includes data centers, building semiconductor fabrication plants, and supplying significant energy to power them.
We are in the early stages of infrastructure buildout. Areas that are benefiting, range from semiconductors to infrastructure companies, industrials, and utilities. Vertiv, which makes cooling systems for data centers, said that their AI project pipeline doubled from January to March. The market is just starting to reward such derivative plays as it grasps the magnitude of the buildout. Utilities are now one of the hottest sectors in the market as the required energy for AI buildout will be significant.
An AI search consumes 10x more electricity than a regular Google search. Electricity inflation is the highest in 40 years. NextEra said on its earnings call that electricity demand from data centers alone would grow 15%/year through the end of the decade. Companies such as NRG and Vistra are guiding up by over 20%. Three of this year’s five best performing stocks are utilities. Utilities are beating tech this year. As more and more sectors get impacted by the CapEx boom, the rally will broaden. It will eventually broaden from the infrastructure plays to applications and to the consumers of AI, including healthcare, financials, and discretionary.
Looking forward, the market will focus on the economic data, geopolitics, and the 2024 US election.
Ketu Desai is the Principal of i-squared Wealth Management Inc. (www.isquaredwealth.com), an investment management firm based in New Jersey. ketu@isquaredwealth.com
