The Big Macro Force That's Been Driving Stocks Higher for Years

Joe Weisenthal (0:02)

Bloomberg Audio Studios, Podcasts, Radio, News. Hello, and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.

Tracy Alloway (0:22)

And I'm Tracy Alloway.

Joe Weisenthal (0:23)

So Tracy, one of the things that we've been talking about a fair amount, everyone's talking about it, I guess, is how the biggest, most profitable companies in America, they're still really big, they're still really profitable, but they've switched from throwing off tons of free cash flow to big investors spending a lot of money.

Tracy Alloway (0:40)

Yeah, that's right. So we've had years and years and years of big tech basically, I guess, generating infinite amounts of cash, it feels like. And now they're switching to actually spending some of that cash to build very expensive data centers and things like that. And you're right, it is kind of a change for the market, right? Like we haven't seen that scale of investment for a very long time, certainly not, I don't think in our lifetimes, have we?

Joe Weisenthal (1:08)

I don't know. No, it doesn't feel like it. I mean, I guess maybe we'll get into this in the conversation. You know, I think if you go back to like pre-GFC era, when a lot of the really big companies in the index were like, you know, Exxon was the biggest company in the world for a long time. So they would have always been having to like spend because you can't just sort of like passively collect oil, etc. But it does seem generally true that the big theme, both with financials and tech, is this incredible ability to generate huge returns with fairly modest capital outlays, whether we're talking about equipment, plants, or even human labor.

Tracy Alloway (1:44)

Well, the other big switch is just, if you look at it just at the tech sector, basically, which has been the dominant force in our equity markets for a while now. But for much of the 2000s, the investment was in sort of like intangible SaaS type stuff, and now we're switching to really like brick and mortar. They're paying to build energy capacity and they're paying for actual chips and actual buildings to house a bunch of air conditioners and servers and all of that.

Joe Weisenthal (2:14)

No, it's totally true.

The big theme is just this. So the question is like, okay, they're still making a ton of money. They're still very profitable. And maybe these investments will pay off in a massive way at some point down the future. But can investors expect the same level of returns that they've seen in the past if there's this big switch in terms of strategic decision making in terms of capital outlays and so forth, taking on debt? What does this mean for the markets? What does this mean for investors? And I don't know the answer, but maybe our guest.

Tracy Alloway (2:44)

Well, also, I mean, you and I, I think for the past 20 years, we have all gotten very used to everyone saying that the tech sector is overvalued.

Joe Weisenthal (2:51)

Right. Yes.

Tracy Alloway (2:52)

Even as it throws off infinite amounts of cash, everyone is like, so overvalued. The market's at a top, the market's at a top. That has been the case for pretty much like my entire mature investing age lifetime.

Joe Weisenthal (3:05)

Right. And so you bring up a really another important dimension of this, which is just that valuations by traditional metric. I mean, I remember early on, what was the Shiller-Cape ratio? And it's like, this has got to mean revert. We're at the 98th percentile of historical valuation, and it keeps going up and so forth.

Tracy Alloway (3:25)

Mean reversion is always around the corner, Joe.

Joe Weisenthal (3:28)

It's always coming eventually. But no, this is another question. Why didn't it mean revert? And why have just the multiples that we've seen on traditional price to earnings ratios, you look at them, they make it go crazy and they got to come down. Why haven't they? That's also an interesting question that we need to get answers to, even beyond the specific capital question.

Tracy Alloway (3:48)

Yeah, let's do it.

Joe Weisenthal (3:49)

All right. Well, I'm very excited to say we do have the perfect guest today because we are speaking to someone who's really done a lot of research on some of these exact questions, including he published a paper or co-authored a recent paper that really caught my eye back in January called A Macroeconomic Perspective on Stock Market Valuation Ratios. So it's good that you brought up the earnings metrics. We're going to be speaking with Jonathan Heathcote, one of the co-authors of this paper. He's an economist at the Minneapolis Fed. We're going to talk all about this. So, Jonathan, thank you so much for coming on Odd Lots.