1. The war for AI tech talent. Big U.S. tech firms are using their financial clout, and the attractiveness of the U.S. as a destination for tech entrepreneurs, to snap up talent in critical tech disciplines — often by buying entire companies. In spite of the rise of coding bootcamps and the apparent spread of tech skills throughout developed economies, the fact remains that true tech expertise — top-flight academic candidates with the engineering and entrepreneurial orientation to bridge academics to the real world — is in very short supply. Either through acquisitions, or through the attraction of venture funding, the world’s best tech talent is continuing to concentrate in U.S. firms and in tech-focused U.S. cities. This “brain drain” from the rest of the world helps to firmly cement the dominance of U.S. firms in the race to develop and deploy the most advanced, transformative, and lucrative new tech.
2. Buybacks will continue to support stocks in 2019. Buybacks have driven much of the U.S. stock market’s performance in the post-crisis era, and are set to continue to be supportive in the rest of 2019. Some critics have claimed that buybacks can create dangerous distortions, but we see them simply as a tool in a company’s toolkit to return capital to shareholders — one that can afford a company more flexibility than accomplishing this goal with a dividend. Whether a buyback program is healthy or unhealthy should be judged on a company-by-company basis. In aggregate, buybacks from S&P 500 companies are on track for another strong year, according to analysts potentially reaching a trillion dollars. This activity will continue to support price appreciation for U.S. stocks.
3. Market summary. Although the U.S. market remains strong, it is also somewhat anxiously focused on the Federal Reserve and on trade developments. We believe that the fundamental supports of the rally are still firmly in place. Our favorites in the U.S. continue to be big-cap growth stocks supported by significant technological, social, and economic tailwinds. For our clients who are more focused on income, we also like select dividend-yielders who can grow their dividends reliably. The U.S., we believe, continues to be the best game in town. Tactical opportunities may present themselves elsewhere, but for now we will not regard them as enduring opportunities. Europe will remain challenged by slow growth and nationally divisive politics. Brazil has continued its strong stock-market rebound, which has accelerated as President Jair Bolsonaro has gotten closer to pushing through the critical pension reforms that could put Brazilian finances on a better footing. Gold continues to look technically and fundamentally positive as it consolidates after its recent breakout. Global monetary policy and central bank easing will, we believe, be supportive for gold during the second half of 2019.
The War For AI Tech Talent — and How the U.S. Is Winning It
In early July, as reported in the Financial Times, a group of British computing scientists decamped to Silicon Valley to form a new quantum computing startup, PsiQ. Quantum computing, as our regular readers will recall, is a computing technology which seeks to exploit aspects of quantum mechanics in order to build computers that are orders of magnitude more powerful than anything currently available. When and if fully functional quantum computers are built, they will reshape all the flagship technologies of the “third industrial revolution” — especially artificial intelligence and machine learning.
The CEO of PsiQ, Jeremy O’Brien, was educated in Australia, and then spent 12 years as a professor of physics and engineering at the University of Bristol in the UK, heading the Center for Quantum Photonics. (PsiQ’s approach is to use photons, rather than electrons, to build the “qubits” that are quantum computing’s answer to classical transistor architecture.) Many of his colleagues at PsiQ were also British academics.
We’ve written before (back in 2015) about the positive academic technology environment in many British universities (leading to tech clusters with monikers like “Silicon Glen” and “Silicon Fen.”) So why did this group of cutting edge researchers leave for the U.S., and why do we think it’s important?
How the U.S. Has Networked the World’s Scientists
One simple answer is that there is more capital available in the United States for would-be entrepreneurs making the leap from the academy to the marketplace, because that financial capital understands the real value of intellectual capital in a world where growth is increasingly driven by technology. U.S. financial capital also exists in a legal, political, and cultural framework that is favorable to its development, and fundamentally hospitable to the human capital that it attracts. This process has been underway for decades, and the U.S. has already built up a formidable lead — indeed, one that may now be close to insurmountable.
PsiQ secured funding from a venture firm founded by the creator of Android, Andy Rubin. Rubin himself sold Android to Alphabet [NASDAQ:
Big tech’s competitive landscape has highlighted network effects that can become intensely favorable to big incumbents. A company whose network gets past a tipping point can create very difficult barriers to competition; in essence the network itself becomes a moat.
“Winner Take Most” In the Talent War
A similar dynamic seems to be at work in the war for tech talent, and it is abetted by the small pool of really top-level talent in critical disciplines. Those U.S. firms who can afford to win the bidding war for this talent secure it, and in securing it, they intensify the tech status of the U.S. It becomes a destination where both financial reward and the excitement of collegial cooperation and competition are lodestars for a global intellectual and entrepreneurial elite.
How small is that pool? Take the case of artificial intelligence as an example. While there many be hundreds of thousands of scientists working on AI, most of them are the equivalent of “manual laborers” — they are not the ones making critical developments and innovations. A 2018 analysis using sophisticated data scraping from LinkedIn and analyzing academic conferences concluded that worldwide there are really only about 20,000 PhD-level AI scientists. Of these only about 3,000 are currently open to employment. Closer analysis suggests that only a quarter of these are really capable of top-tier work in which cutting-edge academic research is bridged to an engineering environment where it can effectively be put to work.
All of this is to say that the competition for real AI talent — the talent that will shape the new world AI makes possible and will fuel the growth of the world’s leading tech companies — is incredibly fierce. (Note to young readers: if you’re STEM-inclined, consider a PhD in an AI-related field.)
This competition is why U.S. tech leaders and venture capitalists are willing to pay so richly to acquire promising AI startups or lure them to American soil. Often (as when GOOGL bought UK AI startup DeepMind) it’s not so much the company itself, as the instant acquisition of its entire workforce, that really drives the decision. This is why critical tech talent from around the world ends up coming to the U.S. — and bolstering this country’s leading tech firms in their global dominance even further.
Investment implications: Globally, competition for critical tech talent is incredibly fierce– especially for academic entrepreneurs at the cutting edge of critical disciplines such as AI. The U.S. is winning that competition, because U.S. tech firms and venture capitalists have long understood its vital importance. Now, as global leaders, U.S. firms and funds are more able than ever to attract foreign talent, both because they can offer greater financial rewards, and because the U.S. academic, financial, and entrepreneurial environment is so hospitable compared to the more constricted and regulated environments elsewhere. Dominant U.S. tech firms are likely to continue winning this talent war in years to come, and that will provide them with a long-term tailwind.
Buybacks Will Continue To Support Stock Prices in 2019
We’ve often noted that one of the major facts of the post-2009 stock market rally has been the role played by companies buying back their own shares. By some analyses, company buybacks have been the largest net buyers of stocks over the past decade.
Source: Canaccord Genuity
From a company perspective, buybacks can be a way to achieve a return of capital to shareholders more flexible than providing a dividend, which once established can provoke a negative market response if it is lowered. Buybacks can also make sense to companies because of a persistent low interest rate environment such as the one that has obtained since 2008; they can fund buybacks in part from very low interest rate debt. It is possible for companies to issue debt and buy back shares in a manipulative way — for example, executives seeking to reach earnings-per-share targets primarily by reducing share count rather than by increasing earnings. Still, we disagree with the view sometimes expressed by progressive critics that buybacks are deceptive as such. They are one tool in a company’s financial kit, and analysts need to look at each company’s behavior individually to evaluate it.
From an investor’s perspective, in aggregate, buyback behavior is positive, and indeed has undergirded much of the market’s performance in the post-crisis period. Important to note now, buyback activity is continuing strong in 2019. A recent piece from Bank of America, analyzing their own corporate clients’ buyback behavior, suggests that the S&P 500 as a whole is on track for more than $1 trillion in buybacks in 2019. Financials and tech stocks have been the largest contributors thus far (comprising 35% and 27% of buybacks respectively). Buybacks accounted for 2% of the 3% year-on-year earnings per share growth for S&P 500 companies, according to Bank of America, and buyback spending accounted for 45% of companies’ operating cash flow. While buybacks have not materially accelerated from 2018, they remain well above their long-term average.
Source: Bank of America Merrill Lynch Research
We note that the U.S. is not the only market where buybacks are significant. They are increasingly so in Japan. Western-influenced shareholder friendliness of Japanese corporates — influenced by increasing shareholder activism from domestic and foreign shareholders — is leading to more buyback behavior, with companies announcing ¥2.3 trillion in buybacks for 2019.
Investment implications: Buybacks have provided support for U.S. stocks market throughout the post-crisis bull market, and that support is expected to continue in 2019. We do not see the conditions supporting buybacks — accommodative financial conditions, ample cash flow, and a desire to return cash to shareholders — threatened by any near-term developments.
The S&P 500’s June rally has extended into July. Although the U.S. market remains strong, it is also somewhat anxiously focused on the Federal Reserve and on trade developments. We believe that the fundamental supports of the rally are still firmly in place. The U.S. market is climbing a wall of worry, which a good sign.
Canaccord Genuity strategist Tony Dwyer, who has been a perceptive and accurate analyst of this bull market, likes to point out historical parallels. He observes similarities between the present and the bull market of the 90s, which also experienced periods of industrial slowdown and significant corrections such as the one we experienced in December 2018.
In Dwyer’s mind, the December correction, touching 20%, served as a refresh, and while the market may be slightly overbought after the rally year-to-date, that is likelier to lead to some near-term volatility than a repeat of last year’s close. With earnings growth positive, and critical financial conditions showing no stress, the stage is set for further appreciation of U.S. stocks this year.
Our favorites in the U.S. continue to be big-cap growth stocks supported by significant technological, social, and economic tailwinds. For our clients who are more focused on income, we also like select dividend-yielders who can grow their dividends reliably.
Within the U.S., we are cautious on industries and companies that are in the line of fire of politicians and regulators. Several bipartisan initiatives to attack high drug prices are working their way through Congress, and President Trump has telegraphed his intention (or threat) to act by executive order to conform the prices that Medicare will pay to the list prices in other developed countries. While the cost of drugs and other healthcare remains contentious and is being exploited for political gain by partisans on both sides of the aisle, we prefer to stay away, and watch for value to develop.
Europe and Emerging Markets
The U.S., we believe, continues to be the best game in town. Tactical opportunities may present themselves elsewhere, but for now we will not regard them as enduring opportunities.
Europe will remain challenged by slow growth and nationally divisive politics. Opportunities in emerging markets may become more clear as the global trade environment improves and the U.S. and China progress in negotiations. Brazil has continued its strong stock-market rebound, which has accelerated as President Jair Bolsonaro has gotten closer to pushing through the critical pension reforms that could put Brazilian finances on a better footing.
Gold and Cryptos
Gold continues to look technically and fundamentally positive as it consolidates after its recent breakout. Global monetary policy and central bank easing will, we believe, be supportive for gold during the second half of 2019.
Bitcoin has continued its rally, leaving many other cryptocurrencies behind. Several analysts have suggested that the bifurcation means the “end of altcoins,” which seems plausible to us as the digital currency mantle passes to tech giants, big banks, and the world’s governments; in this scenario, bitcoin may appreciate due to its network dominance as a decentralized digital asset, even if its stability as a store of value and usefulness as a medium of exchange are uncertain. On the other hand, the 2019 bitcoin rally has echoes of the “FOMO” fueled rally of 2017 (“fear of missing out”). As usual, we caution would-be speculators to recognize the opacity of the market; not invest funds they wouldn’t be content to lose; and deal only with regulated, secure, U.S.-based exchanges.
Thanks for listening; we welcome your calls and questions.
Equities Contributor: Guild Investment Management
Source: Equities News