How Chip Stocks Became Wall Street’s Favorite AI Bet (ft. Jason Ware)

Welcome back to the rundown interview edition today. I am talking to Jason where the chief investment officer at Albion Financial Jason is one of my favorite people to talk to this is this third time on the show and in today's conversation We looked back at Q2 and why chip stocks like micron went parabolic by max seven stocks continuing to struggle and what Jason is watching for as we enter earning season Jason also gave his thoughts on the Fed and why he doesn't think that we'll see any rate hikes this year This was a really great conversation. I think you guys are going to really enjoy it. So let's get into it All right guys today. We are talking to Jason where chief investment officer at Albion This is this is Jason's third time back on the rundown. He's one of my favorite people to talk to Jason. Welcome back Hey, thanks for having me. It's good to be here. Appreciate you having me back. I always enjoy this Of course we do this every quarter at this point. So I'm gonna kind of look back at when you came on last time Which was early April And back then the markets were just a total mess. We were just at the middle of the iron war oil prices were surging software stocks were selling off And then the market bounce back pretty quickly for Q2 we had the best quarter since 2020 I believe were you surprised to see the market bounce back so quickly last quarter um You know not really. I think we talked about this Because like you said it was early April so you know, we were kind of in the throes of the War in the Middle East and I think we had talked about the idea that Oftentimes these corrections are very symmetrical in terms of their shape, you know like a v recovery Um, and I believe that we discussed Um, I should have watched the last interview before we did this one just so I can make sure I'm like No, you're a hundred percent. We did talk. What I said. Yeah, I think we talked about the idea that it would likely be short-lived That you don't follow the developments of the war but instead pay attention to oil prices And that stocks would likely bounce back fairly quickly because our view was that there was gonna be some type of off-ramp here That oil would settle down and then at the end of the day earnings would be the biggest story of the quarter And of course all of those things proved to be true And so I wouldn't say that I was surprised by what happened. I would say that it was expected It's hard to time these things You know precisely but overall it sort of went the way that um, I think we discussed Yeah, and you kind of made the similarities to the terror freak out we had Um last year right where like the markets 10 they bounce back so that's right I did play out that way the the earning story did dominate and the other big storyline in Q2 was of course like The chip rally right and like the semiconductor stocks were just going crazy um, you know micro on sk high nakes became household names What did you make of the chip surge and more importantly like the fact that the max seven stock which were the hottest thing last year kind of got left behind And everyone's just running into these uh memory and chip names Um, I mean, I think it's a natural rotation within what overall has been a healthy bull market Um, if you take a step back um, obviously like we're We've come a long way from the pandemic lows March 23rd of 2020 um, we um Had a bear market in 22 and then we kind of had a reset of the bull market Which I think sort of began in the early part of the decade like I said post covid um And so I think the last three-ish years of the bull market three and a half years Uh have have largely been a story of tech leadership of AI excitement But also at times periods of internal rotation. I mean, I can't I've lost count how many times I've heard strategists and portfolio managers Talking about the the the rally or the bull market broadening out quote unquote broadening out it feels like You know, we see that for a couple of months and then we see it fade and we see tech Leadership reassert dominance and I think in particular to your point this year what we've seen is you know tech is done largely quite well, but I think the big driver um of that performance both in terms of earnings and stock price has been what's happening in semi conductors when we look at Q2 I would say that mag seven actually did okay as a group it was up 11% in the quarter um the s and p was up 14 and some change off of Off of the lows in March But semi conductors were you know up almost doubled like 95% and so there's definitely been this um Move into What I call AI bottleneck plays and away from the more obvious hyperscaler, you know compute story that drove chips like Nvidia the big GPU winner In the space we've seen kind of a move away from what was obvious to Some of the pain points in the AI infrastructure build out you know what really caught my attention this week was there was a There was a chart that was going viral on on X where it showed the free cash flow of the hyperscalers Essentially going negative over the last few quarters versus the free cash flow of the semiconductor companies and they did they've gone parabolic essentially It's all the money that these hyperscalers are spending is going to the bottom line of the semiconductor companies names like Sanders names like micron and so I wonder when that's gonna Revert back and and is it gonna revert back sooner rather than later Do you see a scenario where maybe some of these hyperscalers take their foot off the gas tank when it comes to cap-ac spending because now they're actually getting Punished a bit Yeah, by the markets. Yeah, it's such a good question and you're spot on in your observation It's like fault the classic rules like follow the money and we've seen you know The one person's one company spending is another companies revenue and that revenue was showing up in particular in the semiconductor group obviously the first Order winners were Nvidia and Broadcom and now we're seeing memory stocks which by the way Arguably one of the most boring parts of technology at the last 25 years prior to the last six to 12 months like Memory stocks were boring and cyclical and commoditized and like you were you know As a portfolio manager, why would you ever invest in these these stocks? And then suddenly that changed when we realized oh there's massive bottlenecks using that phrase again that might be the The term that defines this conversation here as we look back at Q2 but the bottlenecks happening in terms of the AI buildout are showing up in massive Revenue and earnings and free cash flow growth Of the microns and the sand discs and even intel is joining the party and has been this year And so I think that's a it's a it's a logical shift for portfolio managers to say the revenues are Really really strong right now in some of these semiconductor areas in particular Memory stocks But the big question in my mind if you're an investor not a trader and we're an investor where investors at Albion Longterm oriented Our view is like how long can this last right and you know we have so many analysts out there saying but these stocks are cheap Look at microns trading at 10 times earnings or nine times earnings or whatever Forward earnings and I say yes And if this is still a commodity business and I think it probably is longer run if it's still a commodity business You want to buy commodity Type stocks when the PEs are high and sell them when the PEs are low And so we'll see what happens with the earnings. I will say these companies are sold out in 6 and probably most of 27 because they're trying to bring new capacity and that takes time But for now it's it's definitely working in terms of the bottom line for these these semiconductor companies Right, I think the fact that the that the stock is trading at nine times ten times forward earnings tells you the market Is it isn't fully bought into the i8? These are going to be long-term Companies that have modes compared to a company like Nvidia which obviously isn't performing as well as As these Memory companies right now, but you know Nvidia is still trades at a 20 plus 20 plus P e for E so I just I just yeah I also find it interesting to see how long this is going to last because One's the supply demand imbalance gets figured out like How are these companies going to you know, maintain their profit margins the 80 plus 90 plus profit margins that they reported recently How are they going to maintain that right well? They say that the cure for high prices is high prices In a commodity business right because that brings on new supply And so if I'm an analyst or a portfolio manager or a trader chasing these things that is the key question is when is that supply going to Catch up I think it's probably sometime away, but the market's going to be well ahead of that So you can't sit back and say well. It's two years away. I'm fine for the next two years You might be fine for six months until we get a data point that shows Okay, supply is finally coming online or to your point and you ask this as part of your question You know, do we see a slowdown in all the cap expending if we do it doesn't even have to be a pivot It just has to be a slowdown these things are going to get hit pretty hard given the massive runs that they've had Right, I feel like they're going to be the ones that take the biggest hit like if Microsoft gets on their next earnings call a suddendella tells everybody hey our cap X is flat for the next quarter Or I mean that what is that going to do to the market that that's going to get really interesting Speaking of Microsoft. I mean they've been beaten up just one of the one of the worst beaten up max seven names right What do you see? I mean there's some people that are starting to get back into the into the name What do you see is Microsoft's biggest problem? Can they turn things around this? They've lost a lot of aura when it comes to just like their position in the AI space, right? They had this early investment in open AI. Everyone thought they were going to be big winners. Their cloud business was booming. It still is doing pretty well, but they just lost that edge that they had early on. What do you think is going on? So I think the last time we chatted, did the Q1 in review, you asked me a similar question about Microsoft and I was wrong then. So I might be wrong now. But I think my answer at the time and this is still true in my mind is that Microsoft is suffering from two primary negative forces right now. The first one is they're being lumped in with the software trade. They're being lumped in with the software group. This idea that AI is going to eat software and that software termin evaluations have to come down. So that's one. I think that's pretty absurd on its face. This idea that AI is going to disrupt the enterprise software business of Microsoft and how entrenched that is, how established it is, how moody that is. I just don't think that's going to happen. But it's showing up in the valuation. It's why the PE's gone down. And then the second piece and you touched on this is their relationship with open AI. That was at one point that was an asset for them. And now it's become a liability. And so Microsoft is sort of like trapped in this AI strategy where what used to work really well for them, this exclusive arrangement with open AI being an early investor and having Sam Altman on speed dial is now seen as a headwind because open AI has sort of lost its edge in the LLM space, not my view, but view of others. They've essentially given that away to Anthropic, which is a cloud. And they're struggling to get their mode back. So Microsoft is trying to figure it out. They have co-pilot, which has sort of had mixed reviews. But I think when you take away the headlines that are creating the situation where Microsoft has gone from a 30 PE down to a sub 20 PE, which is the only reason the stock is down. It's not because of earnings. When you strip away all of that and you look at the fundamentals, this is still a business that's growing. It's top line. It's revenue at a 13 to 15% rate. And their earnings are growing at a similar pace. So you can get a great business that has a great mode. And that we think is a winner in all of these tech tailwinds and this transformative technology. You can get it for less than the S&P multiple and it has double the earnings growth of the S&P 500. So we still like it, but the market right now, Sauron, I feel like Nvidia is somewhat of a similar story. It hasn't been beaten up as much as Microsoft has, but it's for PE. I think it dropped below 20 for a little bit earlier this week. And like you said, it's trading under the average forward multiple of the S&P. The fact that Nvidia is trading under or what Hershey's is trading out, it just blows my mind. And I wonder, and that's why I'm really curious to see how this earnings season is going to play out, especially from some of the big tech names. Like, how is the market going to react there? Meta was beaten up for the longest time. They finally found their mojo this on a rocket ship the last week or two. Exactly. I think that pivot to cloud might have done something. Chips cloud. Chips as well. And so, I think Google also been trading sideways, not really much mojo there. They feel like they're an afterthought now when it comes to AI. They had so much height with Gemini 3.5. Now no one's talking about them anymore. So I'm really curious to see where it goes, especially this earnings season. Do you have anything? Is there something that you're keeping in mind, keeping an eye on specifically when it comes to some of these names for this? Yeah, I mean, it's a great question. I think big picture is the free cash flow, as you mentioned, right? We've seen free cash flow come down dramatically given all the spend that's happening. We're seeing companies like Amazon, a couple days ago, go out on the market and issue massive bond offerings to underwrite a lot of the infrastructure AI infrastructure spending they're doing. And so there is a capital and a cash flow question that has to be addressed, I think, in this earnings season. But as I kind of back out and zoom out a little bit more and just look at what's happening at each one of these companies, I mean, we've been saying for some time that, you know, it used to be called FANG and then it was Mag 7 and it's still Mag 7. But this idea that they all trade as like a monolith to us never made sense because these are individual companies with individual headwinds and tailwinds and management teams and balance sheets and opportunities. And I think to your point on Google, it's just amazing how quickly sentiment on Wall Street changes, right? Because I think it was March, April of 2025. Forget the tariff ceremony. You can literally isolate those and remove them from the story. I heard so many people talking both just in conversations I have, but as well as out in the public square in the media talking about the death of the 10 blue links, right? Google's business was going to be disrupted and disirmeated by AI and chat GPT in particular. This was back when they were like the darling and the LLN space and that turned out not to be true. And so what happened is Google re-rated down to like 16 times earnings and then it went up to 30 something times earnings and that's why we've seen them more than doubling in the stock. So it's not that Google's business has slowed down or Gemini 3.5 is no good. There's going to be, it's a horse race. There's going to be some like at one moment, one LLN's better, the next moment, the next one's better. So I'm out of China look good. Like that's going to happen in any kind of like cutting edge technology phase and we're in one with AI. But when you look at Google's business, it's still doing very, very well. The stock just got way ahead of itself with like almost a doubling in terms of the PE. So I think that's more of the story at Google. But for the current earnings, we're earning season. We're just looking at growth, free cash flow and what companies are saying about spending rates of spend. What do you feel about meta entering the China sell some of their excess cloud capacity? There was a freak out that like, well, this might be an indication that we actually have a ton of excess. There's not a shortage of cloud compute like everyone thinks there is and it kind of broke the narrative that's been driving the market for the last few months. How did you think about that? I don't agree with that with that read because meta has never been a cloud computing company. It's not like they sell compute as a hyper scalar like AWS or Azure or Google Cloud. But instead, they've been spending massive amounts of money to create compute for their own internal model efforts. And we know that their internal model efforts have not fleshed out the way that Mark Zuckerberg would like to see them flesh out. It's been bad. Yeah, it's not been great. And there's a big question mark on Wall Street around like, okay, there's spending hundreds of billions of dollars to build out this internal model. And why are they doing that? They don't have the direct dollar for dollar revenue capture that the other that hyper scalers do, right? Jensen Wung's that they're talking about that all the time. And so I think what Mark Zuckerberg looked at as he said, we're spending a lot of money on compute. We probably don't need all of this right now, maybe in five years, but we don't need all of it right now for Mew Spark in our AI super intelligence lab. Let's take some of it and go get some revenue because Wall Street is demanding revenue given all this AI spend. I think it's the right move. I don't think it says much about the broader industry in terms of spare compute capacity as much as it says about AI, meta trying to figure out that their own AI strategy. Yeah, because it was very confusing to me because on one hand, you had and thropic buying compute from SpaceX. You had Google buying compute from SpaceX. And then all of a sudden meta is selling. I think they just realized there's a big market for computing. Big opportunity. Yeah, exactly. They can capitalize on it. And then that will kind of keep some of the Wall Street Wall Street off their backs for maybe another quarter or so, you know? Yeah, and they're not competing in my view with this spare compute approach. They're not competing against AWS. They're competing against CoreWeave. They're competing against NBS and like, and I think in their mind, Mark Zuckerberg's mind, he's like, oh, we can compete against those guys like with one hand tied behind our back. So I think that's where they're going with them. Yeah, and now they launch some models as well. We'll see how that, how the market takes to that. I mean, I've heard some mixed reviews so far, but that'll be interesting to watch. I want to pivot a little bit and kind of end talking some Fed stuff because I think that's the other big story that was that middle line headlines in June. Kevin Worsh, you know, took over as Fed Chair. He had his first meeting mid June and he came out hawkish, right? The market was like, this guy coming out hawkish, even though that's kind of been his MO forever, right? But the market was surprised. And now the market is pricing in, but multiple rate cuts this year. What was your take on Kevin Worsh's first meeting and how he's kind of approaching his first few months as Fed Chair? And do you believe that they're going to potentially move on rates this year, potentially hike rates this year? I will start back, we're working backwards. I do not think they're going to hike rates this year. You and I talked at the end of December about my view on the path of Fed policy this year. And I think I said zero cuts is probably what we're looking at as opposed to it. Back then it was the market was expecting two or three cuts. Now it's a couple of hikes. And I think the truth is in the middle. So I don't expect any hikes this year, just like I don't expect any cuts. I think inflation is going to settle down in the second half of the year, which takes the need from some committee members on potentially increasing rates, if you look at the doppelot. I think that sort of neutralizes that view. I also think that if you look at inflation expectations, which is really the signal and the inflation noise, we've seen inflation expectations, both survey based and market based look pretty stable. So I don't think there's any call for hikes in the second half of the year that said, looking at Kevin Warsch in his first meeting, we have a second meeting coming up, I think of the 28th and 29th of this. month. I think he did a pretty good job actually. I'm on the record with you saying, Kevin Worsher's not my favorite pick for the Fed. It's not who I would have selected, but let's see what happens. And I think he did a decent job during the press conference better than I was fearing perhaps. I don't agree with the idea of trying to strip the Fed of communicating to the markets. He took out forward guidance, of course. I think that comes with some serious challenges and could backfire. But I also sort of applaud him for taking this new approach of saying, hey, we're going to create some internal task force. We're going to staff it with economists and business leaders and technologists and technocrats. We're going to figure out how to improve some of the core functioning of the Federal Reserve. It's probably overdue. And so I think it've done well. There's a big opportunity to improve things there. And then the last point I'll make you mention that he came out hawkish and that sort of surprised folks. You and I had talked about earlier in the year how, and you had just made mention to it, this idea that Kevin Worsher, most of his career, indeed when he was at the central bank, you know, 15 plus years ago, he was a noted hawk. And so this is who Kevin Worsher is, I think, in terms of his default setting. I think the reason people were surprised is not because of Worsher's body of work, but rather who nominated him, Donald Trump, who wants lower interest rates. And so I think Kevin is doing what Kevin does. And he's looking at the day days, looking at the information and he's leaning a bit more hawkish right now because he's wants to see how inflation, both tariffs and energy, the war and the Middle East is not over yet. Where it feels like it's on again off again every day. He wants to see how that filters in. And so I think we are where we are. And he's going to continue to these core messages. We will get inflation back to target. So let's see if he does that. Do you think that the job market story at all could influence, could dictate the story for the second half of the year. I mean, the job market has been relatively strong, but like starting to see some cracks, do you think that plays a role at all in the second half of the year? Well, it has to because the Fed has a dual mandate of price stability, i.e. inflation, and full employment. In other words, the jobs market. Right now, the employment market looks pretty good. You're right. The June number was below consensus. But if you look at the three months prior to that, we are averaging, you know, 150,000 or so. And so as I look at the jobs market from from my perch, I think we've just been in a process of normalizing for a couple of years, post-COVID. I think that the immigration policy in this country has brought down the equilibrium rate of job creation, just given the supply side dynamics. I'm not the only one out there talking about that. And so I think we're sitting in this situation in terms of the labor market where things look pretty healthy. If you look at like initial claims, if you look at Jolts, which is jobs demand, like all of that looks pretty good. Wages are growing, you know, mid-the-high threes. And so keeping up with inflation. I think the jobs markets in a good position. But to your, the thrust of your question, I think the Fed is going to be looking at through the lens of, can we continue to see a stable jobs market and how is AI potentially going to impact it good or bad? Kevin Orsch has talked a lot about how AI might be a productivity boost to both labor, but also help camp down inflation. So we're going to see how both of those things play out over the near term. But if I'm right on inflation in the second half of the year and things kind of drift back to disinflation, then I think the jobs market will take more oxygen in the conversation because inflation will feel like it's moving in the right direction. If it doesn't move in the right direction, that's going to be the focus. Well, oil prices coming down definitely helps with that. But now the fear is like, is AI actually making the inflation problem worse? Because we've seen through these tech companies raise prices, Xbox, Apple products, you know, memory prices going through the room. So now it's supposed to be deflationary, but is it actually being inflationary now? And what does that look like moving forward? So that goes back to the bottlenecks. bottlenecks is the phrase of the day. It goes back to the bottlenecks we're seeing to your point and you're spot on. We're seeing a bit of inflation now in the system because of those bottlenecks raising prices. But the question if you're a central banker is, you know, and obviously, Worsh will say, we don't want to go forward guidance. We're not going to try to forecast. But at the end of the day, you have to have a view and a framework on where productivity takes inflation longer on outside of just like the short term bottlenecks. It all just reminds me of COVID when you had like lumber prices going like historic levels and all these different things because of toilet paper. Right. Toilet paper. All these supply bottlenecks cause crazy prices and then eventually things normalize. We'll see if that happens with memory. And if it does, how long does it take? Jason, I really appreciate your time. Love talking to you. Of course. Look forward to having you after Q3 so we can recap some of this stuff. Let's do it in the fall. Sounds good. Thanks again. Awesome. How are you going? Thank you too. Well, all right. Guys, hope you enjoyed that conversation with Jason. Where I gotta say it's great having him come on every quarter and I can't wait to revisit some of these topics in the fall. Let me know what you guys thought about today's conversation. Do you agree with Jason that the Fed will hold off on rate hikes? I think I'm starting to lean that way as well. David thoughts on Spotify and YouTube. And while you're at it, consider giving us a five star rating as well. You know, all that engagement really does help us out and it helps other people find the show. Thank you guys so much for listening, watching and commenting. Shout out to Mike for all the work behind the scenes. And we'll see you guys back here tomorrow.