A Bifurcated Market on the Edge of a Correction

SPEAKER_1 (0:00)

All right, let's switch gears to what's going on in these markets and this economy. Joining us now, very pleased to say, is Jim Paulsen, who's the author of Paulsen Perspective Substack and a veteran chief investment strategist. Thank you so much for your time this morning. Jim, I mean, you've been doing this for a very long time. I'm just wondering what you make of this current market dynamic, and also in the economy, that so much hinges on just one theme right now, and that is AI.

Jim Paulsen (0:27)

Yeah, it's very, very concentrated, Sam.

If you look at the economy, 14% of GDP is made up by new era spending. That portion of the economy has grown about 13.7% annualized, average annualized in the last six quarters, but the remaining 86, 87% of the economy has grown at less than 1%, about eight-tenths of 1% average annualized growth. That's one of the biggest bifurcations I've ever seen in the US economy. We have a similar thing going on in the stock market. I've kind of divided the stock market this year into three parts. There's AI, and year to date that's up about 36%. There's IA, which I call inflation-assisted stocks, which are materials and energy. They're up about 32%.

And then there's the modest 7, which is the remaining seven sectors of the S&P, comprising about 360 of the 500 companies. They're up about 2.7% year to date, not even money market rates have they done this year. So it's really a bifurcated economy and a bifurcated stock market. Overall, I do question how sustainable is that long term? How much longer can they continue to be that bifurcated before it maybe caves in on itself?

SPEAKER_1 (1:55)

Yeah, it's interesting because you're not the only one that's kind of sounding the alarm right now. I mean, as far as some of the street warnings, you've had Ray Dalio, who's been coming out saying, this is a classic AI bubble nearing bursting point. You've had Temasek, the CIO, talking about an unwinding of AI trade being the biggest risk face in global markets. Barclays, some of their strategists also this morning are talking about the rising debt issuance for these AI companies. I mean, look, SpaceX is going back to the trough we're learning about this morning. So, it's a very interesting time. But Jim, as you point out, that other part of the market, you think about areas like materials, industrials, financials, utilities, they've all become this de facto AI trade. So, if you have a 401k in a money market, you're probably way more exposed to the tech trade than you think. Is there complacency in this market?

Jim Paulsen (2:53)

I think so. That might be, we talk about all the risks, like you say debt risk and AI and excess capital spending going on and those kind of risks.

Even the dystopian kind of problems with AI going rogue. I think the biggest risk, Sam, is just tech complacency.

If you look back, I look back over the last 100 years, back to 1926, and this is, well, we've been in the longest tech boom of any by a pretty big margin over this last 100 years. It's really relative performance, total return performance of tech is outperformed almost persistently over the last 20 years, from 2006 to 2026 There's never been anything close to that. I also looked on trailing 20 year periods, 240 month periods, how often percentage wise on average has tech outperform on a year on year basis. Over the last 20 years, it's outperformed 80 percent of the years of those 240 months. So I think the less biggest was in the late 60s, it was around not even 50 percent of the time. So the.com top was about 41 percent of the time in the previous 20 years. So there's been great success by just being overweight tech. And I think that a lot of investors, if you buy the S&P 500 over the last 20 years and just sit on it, you've been a hugely successful investor for 20 years running. I think they feel satisfied, they're rewarded with good results, they're a little braggiocious that they've done so well. I think there's a lot of complacency because of the length and the duration and also the magnitude of outperformance by tech stocks. And I just find historically that when one strategy gets very simple, you just overweight something and sit on it, and everyone does the same thing, eventually that spells trouble. And I just wonder how much longer that can go on.

SPEAKER_1 (4:53)

Yeah, and I think that's a conundrum for many investors right now, because to your point, I mean, when you've seen the returns that you have over the last few years, the decades, to your point, I mean, depending on how long you've been in this market, I mean, you sort of stick with what works. So you can understand the degree of complacency in this market right now. But if you're saying it's unsustainable, what cracks first? What's the outcome?