Oracle and Oil Refiners. Plus, Pyramid Scheme or Nah?

**Greg Hall** (0:00)
Hi, I'm Greg Hall, Pimco's head of Global Wealth Management in the United States, and the host of the Accrued Interest Podcast. Accrued Interest is built for financial advisors and their clients.
In each episode, I sit down with portfolio managers, economists, and industry leaders to discuss the issue shaping markets and portfolios. As you listen to Streetwise, you'll hear excerpts from my recent conversation with Pimco Group CIO Dan Ivison on the themes explored in our latest secular outlook, Rupture and Resilience.

**Jack Hough** (0:33)
Can you feel that excitement in the air, Emily? It's electric. What do you think that means? This is a different kind of episode right now. What do you think is coming up here?

**Emily** (0:43)
I don't know, but I'm nervous and excited.

**Jack Hough** (0:48)
Crap, my timer went off.

**Ace** (0:49)
Hold on. Timer for what?

**Jack Hough** (0:55)
That killed the suspense, but folks, it's a listener question special, all right, with a guy who forgot to mute his phone. Come on.

**Emily** (1:02)
That was the thing we didn't see coming.

**Jack Hough** (1:06)
We've got four top shelf questions. What are the topics we're going to be covering? I know one is Oracle, and we're going to hear from a Barron's pal about that one.
What are the other topics?

**Emily** (1:18)
We're going to be talking about potential pyramid schemes, oil crack spreads, and you try to dodge the dad humor allegations.

**Jack Hough** (1:28)
Well, that's a separate matter. But yeah, let's get into it. Emily, who should we start with? I understand that we have a How, and I'm a How, so maybe, but this one is a first name How.

**Emily** (1:47)
Yes, we're going How for How for our first question. So he says, Hi, Jack, I have enjoyed listening to your podcast since COVID. I'm about your age, so I enjoy your dad humor.

**Jack Hough** (1:58)
Let me just point out for the record.

**Adam Levine** (2:01)
Well, I appreciate that.

**Jack Hough** (2:03)
And I don't want this to sound like sour grapes. Dad humor has a specific meaning. Those are, if you're out there telling growners, am I telling growners? Is that what's happening here? If you're a dad who makes jokes, those are not automatically dad jokes.
I feel like I'm shouting into the wind here. Maybe we should just continue.

**Emily** (2:22)
Howe was reading an article in the Wall Street Journal entitled Earnings Forecasts Are On Steroids. And he says that a handful of companies, Alphabet, Amazon, and Nvidia, had their operating income boosted $69.2 billion by an obscure accounting rule, which made their other income, normally a minor item, increase quarterly earnings in the entire S&P by 12 percent. Now, Howe is an index fund investor and is trying to stick to that. But how worried should he be about the rise of the entire index from this obscure but huge boost to earnings?

**Jack Hough** (3:01)
Thank you, Howe. You mentioned a story by our friends at the Wall Street Journal. I think the one you mean is from June 29th by Spencer Jacob, and it is indeed called Earnings Forecasts Are On Steroids. Here's the issue that it talks about. A publicly traded company can own a stake in a private company. Companies like Alphabet, Amazon, and Nvidia, they can invest in companies like Anthropic and OpenAI. And those private companies, we don't really know how much they're worth until they have their next fundraising event. And often at those fundraising events, we learn that they're worth a lot more than they were the last time they raised money. And so when that happens, the publicly traded companies that hold these stakes will mark up the valuations. And that can count as a gain for earnings. And that, as the story points out, has given a big boost to S&P 500 earnings all year. So you ask if we should be concerned about that. I think so. Anything that's providing a one-time boost to earnings like that, it raises the possibility that if we're saying that the S&P 500 is, let's see, 21.7 times this year's projected earnings. That's a little bit higher than its long-term average. But maybe it's even higher than that because maybe the earnings themselves are overstated. Overstated might not be the right word here. Let's call it flattered.
Flattered in a way that might not last. And there are some other observations that go along these same lines. I pointed some of these out in an April story in Barron's called Stock Market is More Expensive Than It Looks. One of them is Profit Margins. They are incredible right now. They've recently been about twice as high as profit margins have been on average since the end of World War II. Now, I know that sounds like a good thing and it is. The problem is that historically, profit margins have been mean reverting. They tended to come back to their average. Maybe that won't happen this time. Maybe we've entered some new era of everlasting profit nirvana, where margins are structurally higher. I say that a little tongue in cheek, but there really have been some structural changes. Companies are more asset light today.