If I had to describe the global economy and markets in a phrase, I’d say it’s tense but getting by. Below are some updates and my takeaway on the state of affairs across consumer, equity, and debt markets, and how they’re related.
A Strong Consumer
Consumer confidence came out yesterday at 91.7, rising 7.5 points above last month. The previous level was the lowest in over a decade, but with a slight decline in oil, we saw it tick back up. It’s still on a downtrend overall, but it’s not changing overall spending habits. Spending actually grew according to the BEA despite the inflationary macro backdrop.
I’d presume that’s in large part due to how, outside of oil, consumers are absorbing other cost pressures well. The core CPI came out at 2.6% YoY. While that’s above 2%, the economy has been above the target for so long that it’s starting to feel like we should move it. Food (which is excluded by the core reading) grew at 2.5%, suggesting that beyond oil, the rest of the economy isn’t hot at all. Over 5 years of above-2% inflation means the target is becoming more obsolete.
We saw the same consumer trends with the bank earnings. Spending remains strong and broad-based as debit and credit card sales volume rose 10% YoY, according to JPMorgan. BofA, Wells Fargo, Citi, and Visa all reported similar jumps. Even with some of the increase resulting from oil, restaurants and other discretionary service spending remained steady.
The AI (or SI) Trade
This leads into equity markets. The macroeconomic backdrop has been anything but stable, but consumers aren’t showing signs of feeling the difference yet. That stability has prevented equity markets from experiencing a heightened level of volatility and panic. However, there’s some uneasiness building.
AI continues to be the headline story in the markets, but investors’ risk appetites are being pressured. To start, consumer staples, healthcare, and utilities are all up by high single digits this month, suggesting capital is flowing into less-risky assets. We’ve seen the same occur in investment-grade credit markets (which I get to below).
This means investors are positioning themselves for less risk exposure in the coming months. This is certainly due to the energy volatility but also due to more concerns over AI spend.
Google and Amazon have yet to report earnings at the time this is being written, but Meta, SpaceX, and Tesla have all reported. The recurring theme is the same: the lack of returns in the short term isn’t outweighing long-term promises and expectations. Meta and SpaceX’s capex estimates jumped to $135-145B and $35-45B (respectively; SpaceX estimate is for Q4 only). At the same time, Meta’s cash flows fell again. Tesla isn’t a pure AI company, but the stock still suffered on disappointment over Elon Musk pushing back Optimus robot production.
For the pure AI names, though, the disparity between capex and cash flows is the everlasting issue at this point in time. I don’t believe this is sustainable, and investors are having those same concerns. Regardless, the next litmus test for AI appetite is coming soon, as Anthropic filed its S-1 and is expected to go public by year-end.
Beyond AI, the median equity is down 10% this year. So even while AI names have kept the market looking fine YTD, broader trends across specific sectors don’t tell the same story. Depending on how things play out for the rest of the year, we might see the AI narrative change as well.
Credit Markets
Beyond derisking in equity markets, we’re seeing risk priced into credit markets. Investment-grade corporate bonds have looked very attractive, but the same can’t be said about high-yield ones. CCC risk premiums have jumped to over 1200 bps in some parts of the market. Inflation and higher yields are putting increasing pressure on companies. Even while capital inflows into credit markets haven’t collapsed, there’s been a clear shift into investment grade to avoid default risk.
However, investment-grade bonds are still showing stress. AI leads the way as big tech companies do massive capital raises to invest in the buildout. That risk is being priced in. Spreads on credit default swaps on Meta hit a record of between 114 and 119 bps after the company reported massive lease obligations and -$2.1B in FCF.
I’d expect to see similar stories play out with the rest of tech earnings unless real monetization occurs. These companies aren’t at the point of imminent default, but the risk is growing with each quarter.
Putting It Together
The three markets are telling one story. The consumer is holding up, and that’s what keeps the economy and equities steady. But investors aren’t fully buying the calm. They’re moving into safer stocks, and credit markets are charging more for risk, especially in high yield and in AI-heavy tech.
As long as spending holds, the pressure stays relatively quiet. If it cracks, equities and credit have little else to lean on. For now, the market is tense but getting by. The next tests are the remaining big tech earnings and Anthropic’s IPO, which will show whether investors still trust the AI story.
Disclaimer:
This blog post is for educational and informational purposes only. It is not financial advice. I am not a licensed financial advisor, and nothing in this post should be interpreted as a recommendation to buy or sell any securities. Trading involves risk, and results are not guaranteed. Past performance is not indicative of future results. Always do your own research and consult with a licensed financial professional before making any investment decisions. None of my statements or points of view are necessarily reflective of the views of Deep Knowledge Investing.
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