Big Tech Has Til Year-End…or Else.

[BEEPING] [BEEPING] Today's show is sponsored by Tukrem. Looking to diversify your portfolio beyond stocks and bonds, commodities are getting more and more attention as we head to 2026. Tukrem's agricultural ETFs offer a way to access the futures prices of essential crops. These funds may help manage inflation risk and add diversification to your portfolio. Ask your financial advisor or explore Tukrem ETFs on your own. Visit Tukrem.com that's teu-c-r-i-u-m.com. Click the link in the show notes for more. All right, guys, welcome to an all-new edition of What Did We Learn on Today's Show, we are going to attempt to answer one of the biggest questions facing the stock market today. How much more time will investors give the hyperscalers before they turn negative on all of this cap expending? I'm here with my friends Nick Colis and Jessica Raib, co-founders of DataTrek Research, and the authors of DataTrek's Morning Briefing Newsletter, which goes out daily to over 1500 institutional and retail clients. Nick and Jessica also have their own YouTube channel, which you can find a link to in the description below. Welcome back, guys. Good to see you. Thank you. Thank you for having us back. Oh, it's my pleasure. And I miss you guys. I know it's been a whirlwind start to the year, but we're back into our thing. And what a great topic, because Nick, you're making a pretty big announcement here. Big tech has 12 months to show that AI is worth it. Do you really think that's it? The clock is ticking. They have to prove it by the end of this year. The clock's been ticking for a while, I think. If you look at the charts on these stocks, they're kind of flat for just not just year to date, but for the last couple of months been the end of last year. So the clock actually started probably October, maybe even September of 25. And so I think I'm being a little bit generous actually about the year timeframe. Okay. And what just so we can frame why this matters so much before we get into the details. Why is this so important? Is this going to be, will we see the referendum show up in the stock prices? Yeah, it's the only referendum that matters, right? I mean, we'll ultimately decide. And we all know the numbers, the big tech, the top 10 names are 35 plus percent of the S&P Jessica will go through this, this math. You know, the three names we'll talk about today, alphabet, Amazon meta or 11% of the S&P. These companies, these stocks kind of define large cap returns. So it's super important. Okay. So you say big tech's business model has changed dramatically in a short period. Why don't you walk us through what you're telling clients about what's happening here? Sure. The way I approached this was the way I looked at auto stocks back in the 1990s, which may sound weird, but auto stocks auto companies are hugely capital intensive. And so the same kind of analysis you use on them, you can use on big tech now, which didn't use to be the case. So let's just start by looking at a couple of tables. The first one we've got is acid efficiency. Acid efficiency is revenues divided by property, plant and equipment. It's an item on the income statement revenues and I'm on the balance sheet property, plant and equipment. And it shows you how efficient a company is with its physical capital. And the big tech companies used to be very efficient. So on average, alphabet, Amazon and meta ran a ratio of 2.2 times back in 2023, meaning for every dollar of capital they had, they generated over $2 in revenues, which is a great ratio. But because they've been investing so heavily and will continue to invest so heavily this year, their acid efficiency is going to be down 42% from 2023 in 2026. And a company like Alphabet will literally be half as efficient as it was just back in 2023. Other ones are 30 or 40% less efficient. So over the last three years, these companies have gone from being very capital efficient, looking at low cap X for every dollar revenue to not being very efficient. And I'll give you sort of one kind of scary sound bite. Ford's revenue to P.P. ratio is 5X way higher than any of these companies. And Ford is a very capital intensive business, but tech has become even more capital intensive that didn't used to be the case even three, four years ago. It is absolutely the case now and the direction is very troubling. Nobody would nobody would have been able to guess what you just said that Ford is now more efficient in that what is it their revenue versus their capital expenditures. But they're capital on their balance sheet. Yeah, I don't think anybody would guess that that's the case. Can we go back to that chart so I can ask you about one stock in particular. Sure. I know the one. Meta is cheating. Meta is, OK, so meta is committing to these long term operating leases in exchange for someone else being willing to stand up these data centers, which is rational. And I think shareholder friendly. I don't think anyone invests in meta hoping to own piles of servers. I get it, but are we measuring them using the right yards that are given that they're doing so much of this not only building but financing off balance sheet. Yeah, and you've raised a great point. I'm glad you did because the numbers that we looked at on that table do not include capitalized leases. This is just that he P and E that meta actually owns. So if you lay around that additional level of complexity, which I agree with you is smart financing, but also worry some financing because it's ultimately debt. Then you end up with an even more capital intensive picture. OK, do people ask you specifically about that one and was that the one that you thought I would ask you about? I thought about you, I thought you'd ask about it because meta is the only one at less than one. So literally meta has less than revenues than it has catfx, which again, crazy. Yeah. So how do they prove it? What would what would what would happen would the 2027 estimates start to trend back in the right direction, meaning the revenue is now catching up to all the spending that they've been doing or what would a what would a successful test look like. That's a great question. Let's go to the next slide, which is profitability. So this is operating cash flow divided by revenues. How many dollars of cash flow they make for every dollar of revenue. And these companies as we all know, very profitable. So running 34 36 39% average operating profit margins over the last three years. Then a decline this year on average to 34% so for every dollar of revenue 34 cents of operating cash flow that is down five points from last year the margin compression is across the board. And the way you prove any any investment is worth it is to show incremental margins to show better margins. So the bottom line is without a C profitability begin to increase in 27 because of these investments. It's not just going to be revenue growth. It's going to be revenue growth that is profitable. And that's really the core of the issue. And again, I think we all know this, but at bearish repeating markets do not like it when margins compress. They worry about committed advantage. They worry about profitability. They worry about those cat X budget. So seeing margins come down this year, not a great sign, which is just one more layer on the story of these cat X numbers being scary in and of themselves, but also worrisome because profitability is declining. Now, presumably the people making these spending these spending decisions at these companies, they see the same numbers that you say they may be looking at them differently or thinking about them differently, but the dollar amounts or the dollar amounts they're doing is for a reason. And I think what they would say is it's not like we have a choice. It's some some people have called it a suicide pack that wouldn't go that far. But you can't be in this group of companies that and I guess we could throw Microsoft in here too, where you're going to spend materially less than your peers and be able to maintain your market share as all of these workloads move from traditional data centers to GPU stacks and and AI data centers. So I think that's like the really important caveat that almost all of them have this like plausible way of looking back and saying, well, what choice did we have. Do you see it the same way? It's a very fair point and let me just make one answer and then go to the last slide because I think it addresses piece of your question. And I wrote this last night for clients, there is kind of a subtle agency problem going on between the management of these companies and the shareholders because the shareholders can owner diversified portfolio of stocks and they don't actually care which company wins. And that's the companies to allocate capital intelligently the companies have a more existential problem as you pointed out because they can't be so far behind they can't under invest and this is the rap on apple right now right there not investing enough and a fine. They might just be saying we don't know who the winners are and they'll have to run through our platform anyway so who cares we're not going to spend that money but the rest of them kind of do and let me go to the third slide that we have because I think it addresses one question I think a lot of people asking which is. How did these companies come up with the numbers that they are announcing as catbacks but. for the year. And the simple answer is they figured out they're operating cash flow for the year and they said we're doing all of it. And that is different from the last three years. So for example, back in 2023, these companies spent about 44% of their operating cash flow on CapEx. Then it became 50, then it became 70 last year. And this year, alpha, this is going to be 103%, but it is 106% in Amazon spending way more than its operating cash flow of 133%. So these companies basically said, okay, what's the maximum we can spend on this project? And so they went to their budget department and said, hey, we're going to make a cash flow this year. Okay, we're going to make 200 billion. Okay, cool. We're spending all of it. That's the answer. That's how they got to these numbers. So you say these companies don't really have a choice. They have to do it. Falling behind is not an option. In these sort of tech platforms shifts, the companies that fall behind never come back. It is existential, but investors have a choice. And this is you. They don't have to wait around and see who wins the science fair. They can reallocate capital elsewhere. And I know we're going to get to that with Jessica now. But that's really the, that's the key thing is that investors could say, okay, maybe they're allocating wisely. Maybe they're not. It's too soon to tell. I'm going to put this in the too hard pile and allocate somewhere else while the world figures the answer to that question out, you probably hearing that more and more from investors as these stocks flat line somebody is selling. Yeah, yeah, no, I think that's that's very well put and look, I mean, I want to make one point and I'm pointing at hand over Jessica because she's got a ton of good data on how this rotation is happening. But the bottom line is that investors are a little bit complicit in this bet because they're still awarding these companies huge valuations and those valuations come from the assumption that they will find the next big thing and make a ton of money off of it. So it's not like these companies are trading at 10, 12, 15 times earnings because their cap X-Bot process is broken. They're trading at 25 and 30 times because the markets giving them a load of confidence. So management can tell investors you're paying us to do this. This is what our stock price implies. We have to do it. There's no not doing it. Yeah, okay. That's a really good point. Jessica, you say equity investors have a stark choice right now either stick with big tech as they shift their business model into this hyper investment mode or go elsewhere. When I look at the stock market on a daily basis, it looks like more and more people are choosing the go elsewhere option. But why don't you tell me what it looks like from your standpoint. Sure. Yeah, just building off what you're saying the stark choice is really they can stick with big tech as it goes through this huge shift in their business models, which is taking all their cash flows to execute and hitting margins. Or they can be good risk managers and park their capital elsewhere as the story plays out. And really the macro backdrop is so good that they can justify taking and taking incremental risk. And that's proven by the fact that last year's global trade shock didn't cause a global recession. So I've three points on this topic and they're all anchored in the same index based framework. And that's that there's over 2200 stocks in the MSCI all country world index. So of course, that's just too many to evaluate individually. So investors sink in terms of buckets. So you have the S&P 500 and they know you have rest of world, which is the MSCI all country X US index or the ETF symbol is AC WX. And my first point is that the S&P and AC WX sector waiting are super different and we have my first try if you please pull it up the the S&P 500 over weights relative to AC WX are on the top and the underweights are on the bottom. So the takeaway here is that the S&P has a 17 percentage point overweight to tech, which is almost exactly equal to its combined underweights and financials and industrials. And it's also meaningfully underweight materials. So the S&P is structurally skewed towards growth and innovation, whereas the MSCI of country X US index has a much stronger value and sickle call bias. The S&P and AC WX also differ and that the S&P is much more concentrated in its top 10 holdings, which we have in our next table if you could please bring that up. Thank you. This is where the S&P and AC WX really diverge because as you can see over third of the S&P is in its top 10 holdings and an AC WX that's just 14%. Let's let's let's let's pause on this. This isn't this is incredible. So for those listening, not watching the largest holding in the all country world index X US is 4.1%. And that's Taiwan semi, which you might have guessed. The next largest holding is Samsung, which is already down to 1.6%. Then you have a sml 1.6 and then they get smaller from there. Tencent is the last one above 1%. Every other international holding is less than 1% of that index. Contrast that with the S&P where Nvidia is 8. Apple is almost 7. Alphabet 5.5. Microsoft 5.5 Amazon 3.5. Broadcom 27. Meta 2.5. So that obviously you're talking about a lot more stocks in that all country world index universe. Of course, because it's what you say 2200 versus 500. But that is a massive skew away from concentration. Right. So and that's a great point Josh because US mega cap tech alone accounts for about 35% of the S&P versus only about 10% for comparable names in the rest of world index. So I thought now we could move on to my second point and that's just how dramatic the recent move in non-US stocks has been. And this next chart shows the trailing 100 day relative price returns between the S&P 500 and rest of world stocks for 2010 to the present. And since 2010 the S&P has beaten rest of world stocks by about 3.5 percentage points over a typical 100 day holding period. And as you can see in this chart, this relationship is asymmetric and that's largely because of the S&P structural out performance when rest of world stocks catch up the rotation tends to happen quickly and violently. So the recent the recent 11 percentage point move in favor of rest of world over US large cap stocks is between 2 and 3 standard deviations. So it's extremely unusual, but per usual this out performance came right after a period when US stocks were exceptionally strong up 10 points or more than one standard deviation in September of 2025. And this next table shows what every investor knows and that's namely that the S&P has outperformed rest of world's over the longer term. So the 3 5 and 10 year annual compounded returns have been in the S&P by 4 to 6.5 percentage points. This really gets back at what Nick was talking about in order for the S&P to keep its longer on edge US big tech companies need to prove that their AI investments are worthwhile really over the next 12 to 24 months and frankly the sooner the better. Because of the 3 year data starts showing rest of world out performance investors may start questioning whether big tech AI investments have not fundamentally changed the story around US stocks for the worst and that brings me to my third and last point. And that's that US stocks have outperformed rest of world over the long term because US companies leverage disruptive innovation at scale and our laser focused on growth and profitability. And the US also dominates the global venture capital market. So public markets have a stronger and deeper pipeline of disruptive companies focused on monetizing monetizing gen AI because the end of the day it's disruptive innovation that drives longer and equity returns and the US markets have a strong bench currently with SpaceX open open AI and a drop at planning to go public this year or next. And we'd rather lean on believing in the track record of American capitalism and big tech history of executing on its goals then assuming you know suddenly that's come to an end. I meet with a lot of wholesalers or at least I used to a lot of wholesalers of equity funds different themes different strategy styles and whenever you met with the people selling international invariably they would say when international outperforms the US. It's typically not a one year phenomenon. It's usually part of a multi year cycle and if you miss it you're going to be in big trouble with your clients when you had that second chart up showing how how it oscillates back and forth. I guess the thing to say here is yes it looks like there are some extended stretches in 100 day trailing returns but like could you speak to the multi year opportunity for the person that says let me get the straight all country world just outperformed by what was it 30% or just one of 30% of the last year. What why do I want to buy it now why do I want to allocate their now what's the what's the historical data driven answer to that question. What's a really good point because I think it gets back at the crux of the issue with big tech and that's. that they really need to prove that their AI investments are worthwhile, like I was saying within the next year or two, because if not, there's such a large part of the S&P that they won't be able to mathematically outperform rest of the world. So the cornerstone of the American exceptionalism trade is that US stocks outperform over three year cycles. If non-US stocks outperform another year, it only gives US stocks one year to make up for those two bad years. And I can't so far, like Nick was saying, given US stocks along leash, and if AI does pay off, then the American exceptionalism trade will continue through the end of this decade. But if not, there would be such a large paradigm shift that non-US stocks would likely outperform through the decade, because this kind of answers your question, gets to what you're asking Josh's money has to go somewhere. So if AI doesn't look like it's going to pan out, people are going to look elsewhere and they're going to go to non-US equities because of big techs, has such an outsized large weighting in SDS and P500. Yeah, and I would add to that, Josh. I mean, I know that argument extremely well. I remember working with wholesalers in the 1980s, who made exactly that pitch. It's different. The question is, how similar are the 2010s to now versus the 80s, the 90s, the 2000s? And I think you have to make the argument that it's extremely different because you now have technology really running the ability to surprise investors to the upside. And that's been the case now for 15 years and most tech is domiciled in the US. If you look at the top 10 weightings of MSCI Europe versus the US, do you want to own Nestle and Rose? Should you want to own Amazon and Meta? That's the key question. Japan's had a great run. It depends on if there's an ROI on all the tech spend, I guess. That would be how it would answer. That is the right forward looking answer for sure. But in terms of like, if you had to lock your money away, let's put it this way, you lock your money away for five years and you cannot touch it. Where do you want to be? Honestly. Do you want to be MSCI Europe or US? It's so funny. If I'm talking about the entirety of those two markets, I think I would obviously answer US like 99 out of 100 people I know would probably also say US, but maybe the value investor if there are any left, they would still just say, I want cheaper assets. And like for a five year hold, I'm willing to believe that ultimately somebody will care that this is selling at a discount and they might focus less on why the discount exists. Yeah. No, I get that. But typically that's you know what happens when that trade works is because you're losing less money than you would be in growth, which is a pure, pure victory at best. Look, we just kind of talked about this like ad nauseam for the last couple of weeks just trying to assess this out. And there is one argument for Europe and that is that the social safety net is so strong there that you're not going to get the same labor market disruption with AI that you might in the States. Now, that blows out the budgets and that increases yields and so that's a touchy way to think about it. But that's kind of like our best argument for Europe right now. Another argument for Europe is that they are going to look at the example of Japan and actually push through with the sort of massive corporate reforms that triggered a wave of domestic buying enthusiasm for their own stocks. Finding that with the threat that Russia poses to Western Europe, Eastern and Western Europe and all of these fiscal programs and all of these programs around defense spending. And I'm not saying that explains the re-rate for European stocks last year, but earnings growth definitely doesn't because it wasn't any. No, no, I mean re-rating is re-rating was well, we have to be careful about this because a big part of the quote re-rating was currency. So the euro was up, what, called 10% last year, pound, I think might have been up a little bit more. So a good, call it third to 40% of the gains that we saw in European stocks as American investors was currency, not underline fundamentals. The balance of it was probably some re-rating because of all the things Jessica talked about. Okay, money's got to go somewhere. So we got to wait out this whole tech thing. Europe is cheap and fine. So there are good companies to go there. The question is forward looking, look, I mean the dollar could be another 5% this year, no problem. And European stocks on dollar terms would do fine. But that's not really the fundamental issue that we're talking about. And the last point I'd make is Japan went through the wilderness for 20 years. I mean, I remember studying the Japanese stock market in Chicago and B School in 1990 as this miracle of high valuations and cross shareholders. And it was all wrong. And the thing went through 40 years of nothing and then finally started coming back. So I think we have to be careful in the comparison because European stocks in Europe didn't go through that. It's a really, it's a really good point. I would also just make the point that in thinking about rest of world stocks, yes, momentum is a super powerful factor in capital markets. But just realize like if you want to get in now, you are getting in when rest of world stocks have outperformed by two to three standard deviations over the S&P 500. That's extremely statistically significant. So just realize you're getting in extreme levels. Okay. So to sum up, this is the big bet that you have to make. If you're going to be long the US or overweight the US relative to rest of world, you are de facto betting these CapEx investments are going to start paying off. And in order for them to matter to the stock prices, that has to happen between now and the end of this year. Shareholders are not going to give these companies a leash into 27, 28 in order to be able to prove why this makes sense. Is that that's for that where we're landing? Perfect. All right. Guys, this has been so much fun as always. And I want to let people know if you guys enjoy learning from Nick and Jessica as much as I do, make sure you're following DataTrek on their YouTube channel. And of course, DataTrekResearch.com where you can subscribe and get their daily note. And that's literally daily. They're putting out research every day and lots of really bright, successful people on Wall Street rely on Nick and Jessica's insights. And maybe you will too. So by all means, check that out for yourselves. Guys, we'll talk soon. Thanks so much. All right. [MUSIC PLAYING]