Gold, Bitcoin, Dividends, A.I., Private Equity

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Is it chilly where you are, Alexis? Is it cold right now?

You know what? It is a little cold.

You know what that is?

What is it?

It's this cold open that I'm doing right now. That's— yeah. That just happened. We're going to talk just very quickly about earnings season, and then we're going to answer a few listener questions. We've got questions on, remind me the topics. There's one in there about gold and Bitcoin.

Gold and Bitcoin, right? We have a really timely one on AI spending, of course, one on dividends and one on private equity and private credit.

Those are crowd pleasers. That's a full lineup of crowd pleasers. Let me start by saying just a couple of quick things about earnings season. We're right at the start of the third quarter earnings season. When we say earnings season, what we mean— there's no formal definition for it. For one thing, companies don't operate on the same fiscal year. Some companies have fiscal years that line up with a calendar year and some don't. If you took the companies in the S&P 500 and you looked at a distribution of when throughout the year they report, you'd see that there were four main clumps of reportings and there were some stragglers in between. But we like to ask and answer the question every so often, how are earnings going? So we have to come up with some rough rules. We used to say that earnings season began with a report from Alcoa, the aluminum company. It was the first company in the Dow Industrials to report each quarter, but it got kicked out of the Dow and it split into two companies. And now we say that earnings season starts when the big banks report. And that happened this past week. And the numbers were good. All four of the big ones, JPMorgan, Wells Fargo, Citigroup, Goldman Sachs, they beat consensus earnings per share and revenue estimates. They had generally strong results on trading and investment banking. I'd say that bodes well. UBS estimates that third quarter earnings for the S&P 500 will increase 10%. When I say up 10%, I mean from the same quarter a year earlier. And when I say third quarter, I mean all of the results from all the different companies that we have decided to stuff into this third quarter review period. Doesn't necessarily have to be third quarter results for each individual company. Okay, the stock market looks expensive. The S&P 500 was trading recently at 25 times this year's projected earnings. So if prices are high, you want to see plenty of growth. I think 10% growth for the third quarter would do it. We got 8% in the second quarter. If we did get 10% in the third, that would mean that actual results beat estimates by 3 to 4%. Of course, I don't get to decide what number is good enough. The market decides that, and it's based on investor expectations. UBS writes, after a better than expected second quarter and healthy market gains over the last couple of months, there's been some debate regarding whether or not the bar is now higher for the third quarter. After all, consensus is expecting solid earnings growth at the aggregate level. Still, we think investor concerns have been mounting in a couple of key areas. First, recent weak data points in the lower end of the auto loan market are raising fears that cracks are starting to grow in consumer spending. So any data that suggests consumer spending remains resilient should be well received. They go on to point that we have already seen some trends like that, including improving credit card delinquencies from the big banks. They say another concern is credit quality following some bankruptcies like the auto parts company First Brands and the subprime auto lender Tricolor. But UBS calls these bankruptcies somewhat company-specific and not indicative of a substantial deterioration in credit more broadly. Okay, so they sound bullish. One more point that UBS makes here that I think is pretty interesting. It has to do with the Magnificent Seven, these big tech companies. They're spending lavishly to build AI infrastructure, so they've been a big source of earnings growth. Collectively, they grew by just under 30% in the second quarter. For the third quarter, UBS expects these Mag Seven to grow by 20%. That's a significant slowdown, which sounds like a negative thing. But remember, UBS expects faster earnings growth overall in the third quarter than the second, which means it expects the growth to be broader. It writes that for energy companies, oil prices still declined during the quarter year over year, but the comparisons will be a little more favorable in the third quarter than they were in the second. Banks, we already mentioned, are enjoying strong momentum right now. And companies with more international exposure can benefit from a weaker U.S. dollar. We've just started the third quarter reporting season, about 10% of the way in. The numbers we're seeing so far are healthy. Let's hope it continues. All right, Alexis, I'm ready to field some questions.

All right. Up first, we have a question from Federico, who I believe is in Italy. He didn't record his question, so I'll read it.

Please read it in English and Italian, if you would please.

Italian is a little beyond my skill set, but I can definitely do it in English. Okay. He asks, how can investors ensure that the value of their gold or Bitcoin investment is truly decoupled from the dollar? In other words, how are these assets fundamentally priced if their common benchmark is the US dollar? And he also says some very nice things like, thank you for your work on the show, et cetera, et cetera. To which I'll say grazie, because that is the only Italian I know.

Thank you, Frederico. You say that a common benchmark for gold and Bitcoin is the US dollar. What you might mean is that you commonly see their prices quoted in dollars. There hasn't been benchmarking between the dollar and gold for more than 50 years, and Bitcoin's never had it. You ask, how can an investor ensure that the value of these things is truly decoupled from the dollar? It's hard for me to think of assets that are more decoupled from the dollar. I mean, gold is an element that you dig up from the earth. It's been used as a store of value for thousands of years. That's not an accident. As I've talked about in the past in this podcast, if you use a process of elimination on the periodic table, you start with the question of which of these things should I use for money? You inevitably end up with gold and silver. And gold is the one that doesn't tarnish. These are the only elements that are not poisonous or not radioactive or not highly reactive with other things or not too rare or not too common, are not gases or liquids at room temperature. In other words, these are the things that most lend themselves to use as money. That's why they've historically been stores of value. Now, being decoupled from the dollar isn't the same thing as saying that US policymakers couldn't do something that would affect the price of gold. For example, you could say that gold is running higher now because of concerns about inflation, but you could also make the case that after Russia invaded Ukraine in February of 2022 and the US and its allies froze Russia's foreign exchange reserves, that central banks around the world, especially China, saw that as a reason to begin holding more gold. So on one hand, US actions may have affected the price of gold. On the other hand, the reason these central banks are buying up gold is because they view it as out of reach of US policymakers. Bitcoin doesn't have nearly as much history to call on to guide us, but the whole point of the currency is its decentralization. It's that the rules are not made by central banks. I want to touch on one thing that you didn't ask about, which is how gold and Bitcoin have both been rising a lot this year, but just over the past week or so, Bitcoin has shown some weakness. Gold has kept moving higher. The economist Ed Yardeni, who we've had on the podcast before, put out a note on that subject. His target for gold was $4,000 an ounce by the end of 2025. It has already gone over that mark. Now he's predicting $5,000 by next year. And he writes, if it continues its current path, it could reach $10,000 by the end of the decade or sooner. Ed writes, the recent weakness in cryptocurrency prices, particularly for Bitcoin, in response to another dose of Trump tariff turmoil, all capital T's there. May have contributed to the price increase of gold. Bitcoin was among the risk assets that sold off last Friday when President Trump escalated the US-China trade war by announcing an additional 100% tariff on US imports from China and new export controls on critical software. Okay, so Ed writes that gold is acting like a hedge against not only inflation but also mounting geopolitical risks, whereas Bitcoin is behaving more like a risk asset. In other words, it sells off at the same time, let's say, high-flying stocks are selling off. Ed writes, Bitcoin has been described as digital gold, but we would describe gold as physical Bitcoin. Risk-off investors may increasingly be concluding that gold is a better protection for geopolitical risks than is Bitcoin. Interesting take. We'll see if it pans out. Okay, Alexis, what's our next question?

Next, we have a question from TJ about AI and who benefits, and I'll read it for you. He says, you would think the biggest beneficiaries of AI would be the customers of the Mag 7, those who would leverage AI to build new products and services or cut costs, but that is not happening. What gives?

Thank you, TJ. Excellent use, by the way, of what gives. I'm not hearing that one nearly enough lately. There's a question behind your question, and I think it's an important one for the US stock market. The largest hyperscalers, these big companies who are spending most of the money on AI right now, they're expected to boost their CapEx, capital expenditures, the investments they're making on all these big data centers, by about 30% over the next 2 years to a rate of $500 billion per year by 2027. That is an enormous amount of spending. However, 2 things. First of all, it would represent a pretty steep slowdown actually from the rate of growth that we've seen over the past year. Also, it's a big number in a pretty darn big economy. So $500 billion a year on CapEx by hyperscalers, that's half a trillion dollars, but that's in the context of about $4 trillion of business fixed investment. And that is just one part of a $30 trillion US economy. Barclays writes recently, most of the impetus to aggregate demand growth from this spending is already behind us. What it means is what matters most from here is not the dollar amount being spent, but what's the growth on that spending. And that growth is decelerating. So what we would like to see if we're going to have decelerating spending growth on the infrastructure is increasing spending, as you say, TJ, by the customers. European strategist for Deutsche Bank published a report this past week on ChatGPT. They call it the poster child for the AI boom, but they write, it may be struggling to recruit new subscribers to pay for it, according to proprietary transaction data from DB Data Insights. That's a sample of anonymous transaction data from third-party financial institutions in some big European markets, the UK, Germany, France, Italy, and Spain. Deutsche Bank writes that European spending on ChatGPT has stalled since May. Most consumers know ChatGPT as a free service. But there's also a Plus version that costs $20 a month, and there's a Pro version for $200 a month. The CEO of OpenAI, the company behind ChatGPT, says that it has over 800 million weekly active users. That's up from 500 million at the end of March. So it's great growth in users, but Deutsche Bank writes the number of paid users may not be keeping pace even as spending gradually approaches the likes of Spotify and Netflix. This is interesting to me because we often hear AI spending discussed as this big amorphous topic where you have a hard time kind of benchmarking the amounts you're hearing about to things you're already familiar with. So this Netflix comparison is maybe useful. OpenAI is a private company, so you only really get a price or value on it when it does some kind of transaction like issuing shares., but it did that recently, and the transaction put a value on the company of around $500 billion. That's pretty close to the value of Netflix, which we know to the moment because it trades all day long in the stock market. So the two companies are valued similarly by investors, but they don't bring in nearly similar amounts in revenue. OpenAI is projected to bring in $13 billion this year. For Netflix, that figure is $45 billion. Now, OpenAI has grown quickly from a small base, but for it to continue to grow into its valuation, it's going to need to either bring in a lot more paying customers for ChatGPT or to roll out new products that customers want to pay for. But other companies are doing the same thing, including Anthropic, which is more focused on these big enterprise users. Deutsche Bank writes of OpenAI, it needs to show rapid revenue growth to prove that the technology is more than just hype and can pay for itself. And it points out that there are a number of free competitors. And it writes, meanwhile, concerns about the financial sustainability of AI investments and talk of a bubble are mounting amid a flurry of multibillion-dollar capital expenditure and circular financing deals. I think we talked about some of those circular deals last week. Okay, so this is one piece of data, and just because Deutsche Bank has seen evidence that some of the spending by customers on AI has slowed or stalled in Europe, that doesn't mean that's going to continue or that that's going to have implications for the broader market. We don't know yet, TJ, the answer to your question, what gives? We have to see whether that spending by end users materializes. If it does, we might end up saying that the stock market got it right and the run-up in the stock values of all those AI companies was totally justified. And if it doesn't, we might end up saying that the market got ahead of itself, that the spending boom by end users related to AI ultimately came years down the road. That's not to say at all that AI is a flop. Deutsche Bank finds in its European sample that spending on OpenAI subscriptions has reached almost half as much as Spotify brings in. That's the most popular music streaming service. It's also at a quarter of Netflix's levels, and as I said, headed to about a third. It's overtaken Disney+. If it continues at this growth rate, it could overtake Spotify in May 2027 and Netflix in February 2028. So everything really hinges on whether this fast growth in paying customers and not just an investment boom continues. By the way, I just asked ChatGPT whether AI investments will be justified by customer spending on subscriptions. It didn't really take sides. It said the investments will be justified if there's clear value delivered to the customer and the prices align with that value and there's high retention and low churn. And their scalable use cases. And it said the investments would not be justified if AI features feel gimmicky, or if there's a low willingness to pay, or if the high compute costs eat into the margins, or if competition commoditizes the tech. It's a pretty good answer. Let's take a quick break. When we come back, we'll talk about dividends and private equity and private credit.

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Welcome back, Alexis. Who do we have for our next question?

Next up, we have a question on dividends. Here is Machik from California.

Hi, Jack. I just listened to your most recent episode about dividend investing. One of the things you mentioned about how dividends are advantageous versus stock buybacks from the tax point of view, but also from the point of view of being more predictable. I happen to invest in Intel stock, and Intel was for many years paying dividends. And I think 2 years ago, they started decreasing the dividend, and then when their problems started getting bigger and bigger, they just stopped paying dividends altogether. So the question is, are there any rules about dividends? Is it as predictable as you said it is? Thank you so much. I'm enjoying your show and hoping to get an answer.

Thank you, Maciek. If there's a tax advantage between dividends and stock buybacks, it's probably with stock buybacks because those are not taxable to the investor as income. There's a new small excise tax on stock buybacks, but that doesn't fully bridge the gap. I still think dividends are a good idea. Maybe I'm old-fashioned thinking that when we discuss total returns, it should mean that something is literally returned to the investor. But I also think that having a steady stream of cash rolling in gives investors something to hang on to during price downturns for the market, gives them something to reinvest into more shares at lower prices. And as we discussed in an earlier episode, despite appearances today where the dividend yield for the S&P 500 is only around 1%, dividends have historically played a large role in total returns. And the longer time period you look at, the larger that role grows because of the power of compounding. But you were disappointed by Intel suspending its dividend as a cost-cutting measure. That happens sometimes. It's always disappointing. And you ask, Are there some rules? The answer is not really. There are more rules if we're talking about a different type of share called preferred stock, but even there you only pay if you're able to pay. The rules really have to do with which type of dividends have to be paid first. For common stocks like we're discussing here, companies can really cut or stop their payments anytime they want. Why wouldn't they do that? One reason is it tends to be bad for their share prices. I'm looking as we speak at a disgusting chart published recently by BofA Global Research. It's titled Stocks Tend to Meaningfully Underperform the Market Following a Dividend Cut. And it has a line and it starts out high and it goes steadily lower. And that line is labeled cumulative relative median performance versus S&P 500. The chart goes out to 60 months following a dividend cut. And in total, it moves lower by about 15 percentage points. In other words, this basket of stocks in the S&P 500 that had cut their dividends they underperformed the index by 15 percentage points over a period of 5 years. What's notable about the shape of this line is it's not just a sudden drop. There's no cliff and then steadying. The performance for these stocks continues to stink for years after the dividend cuts. I don't think most companies want to bring that on themselves. I think that more than anything provides a disincentive for managers to cut their dividends. But sometimes companies have to. The best way to protect yourself from that is to study company finances carefully. You can look at the cost of a company's dividend and take that as a percentage of some measure of financial output, profits, or cash flow. You just have to make sure you ask yourself, if you're using cash flow, what level of cash flow is normal? In other words, has cash flow been declining? Should we expect it to continue to decline? Have the past couple of years been better than usual? So make sure you're just trying to work out some level of normalized cash flow for the company and ask whether that makes the dividend payment easily affordable with all of the other obligations the company has, the spending and investment it has to do to run its business. The other way to protect yourself, of course, is to invest in a basket of dividend-paying stocks. I think last time we talked about dividends, I mentioned a couple of ETFs. There's one from Vanguard if you don't need so much current income. The ticker there is VIG. There's one from Schwab if you want more current income. The ticker there is SCHD. There are many other examples besides these. Look for low fees and an approach that prioritizes the sustainability of payments and the growth of payments over time. Thank you, Maciek. Alexis, we have one last question.

Yes, we have one last question from—

Listeners who have submitted questions are on the edge of their seats right now. Is it going to be me? Is this my moment in the sun? I've crafted a crackerjack question, and I know that Jack and Alexis have picked mine.

The lucky listener is Peter.

All the other questions are great too, by the way. I'm sure we'll do our best to get to many of them, but this is Peter's moment.

Go ahead. Yes, we love all our questions, but this is Peter's moment. He writes, could you possibly consider discussing the topics of private credit and/or private equity? Suddenly these buzzwords are frequently mentioned in the media as if they've always existed, and we're all supposed to understand what they mean and why they have suddenly appeared out of the ether. I am 74 years old and a pretty good stock picker. I had to get a professional brokerage manager to take over my account because I just don't get it anymore.

Thank you, Peter. This is a, this is a question with a long and complicated answer, but I'm going to make it a short answer because we tackled this subject in a previous episode on private equity versus stocks. So Peter, that episode has some of the details about private equity and how it works and how you should regard it as an investor. I'll just quickly say a few things. First of all, if you don't know, private equity is kind of like the stock market, but without the daily liquidity and trading. In other words, you're investing in stakes of businesses, but those stakes are not listed on exchanges. You don't get daily pricing. You get pricing every once in a while when a stake is sold. There could be years in between those transactions. And so you have accountants who do their best to estimate the value of these businesses and stakes in the meantime. Some critics of this practice say that private equity claims lower volatility than it really has. In other words, if a private equity company says we're able to get these returns, they're similar to what the stock market gets, but we do it with much less volatility, then you might want to ask, well, how do you know if you don't get the same daily pricing that I get in the stock market? You don't really know what your volatility is. Okay, fine. But when it comes time to spend some of your money as an investor, you're not going to spend your theoretical or even your actual volatility. You're going to spend your returns. So what are those like? Private equity has been around for a long time and there have been a lot of studies of how it does versus the stock market. I don't really find compelling evidence that it reliably beats stocks. The best evidence I've seen suggests that investors can do just as well with a low-cost stock index fund. I like two things about a low-cost index fund. First of all, the low cost. I'm controlling one of the things I can control ahead of time. Fees in the private equity world can reach levels that would shock and astonish mutual fund investors. The second thing, of course, is that in the stock market, you get liquidity. You can sell when you want. You probably shouldn't sell often if you're a long-term investor. The private equity industry says that they achieve what they call an illiquidity premium. In other words, they say, yes, you have to lock your money up for years in private equity, but that inconvenience is more than compensated by surplus returns. It's an elegant theory. I just haven't seen it reliably backed up in research. Private credit, by the way, is something similar. The same firms that offer private equity investments have taken over some of the roles that were traditionally performed by banks in their commercial lending. They're making loans to companies, they're selling these loans to investors. So just as private equity gives investors an alternative to stocks, private credit gives them an alternative to bonds. Peter, you say you're hearing a lot about these all of a sudden. That's not coincidence. There's always been some gatekeeping that has gone on in private equity and private credit. You have to be what's called an accredited investor to participate. You have to have a certain net worth and level of sophistication. And as I've written in the past, that gives the industry something of the status of, let's say, the American Express Black Card. People aren't quite sure. What are the benefits? How much does it cost? I don't know. Very few people have it. It must be wonderful. Ultimately, it's a company selling something for a little bit more than what they're giving you in return. I mean, that's how you make a profit. And often when you're buying into prestige, the deal is worse, not better. There's a big push by private equity to gain access to 401(k) accounts. Investors may find down the road that they have the opportunity to not just allocate their money to stocks and bonds and money markets, but also buy a sleeve of private equity investments. As private equity ends up with more money to put to work, you have to wonder if the investment opportunities will be as lucrative as they have been in past decades. Now, let me not overstate the case here. There are some private equity funds that have achieved spectacular returns. I just think it's hard to tell in advance which ones are going to be those funds in the years ahead. At the time of that last episode we did on private equity, there were a couple of books out that were highly critical of the industry. A lot of the concerns were social in nature, private equity buying up key parts of the economy, let's say doctor's offices, and how that might affect the experience of patients. I'll leave the social implications to others. This podcast is about the returns. There are big sophisticated investors out there who invest regularly in alternative investments, including private equity and private credit. Some of them are able to negotiate much lower fees for themselves. Some of these funds had fantastic returns in past decades. But again, I don't find evidence that these same pension funds are consistently knocking it out of the park now. Peter, I hope that helps. If you don't have private equity or private credit, I don't think you're necessarily missing out. If you want more on the subject, you can listen to that earlier episode. If you want entertainment on the subject of private equity, I would refer you to an Instagram account with a fellow named Johnny Hillbrandt. He calls himself PE Guy. I don't know anything about him. He makes a weird face. I hope so. Otherwise, he has a weird face. I'm pretty sure he's making a weird face. Is that safe to say? He gets very toothy when he talks and he Seems to do his videos from a different town each time, and he talks like a PE guy doing a lot of posturing about his lifestyle.

The kiddos, we pulled them out of school, um, for all of September. So they're at the Green School in Palm Beach. Yeah, yeah, one of the best. Um, but yeah, we're actually using a state-of-the-art tutor. Yeah, we got her through Mariah Carey.

I like when PE Guy talks about his kids. I know that Tarantino is involved in youth soccer, and, uh, the youngest is named Ibotta. That's a great idea, actually. I should have named my kids Gap and 10K. I want to thank Fredrico and TJ and Maciek and Peter, and thank all of you for listening. If you have a question you'd like played and answered on the podcast, you can send it in. Could be in a future episode. Just use the voice memo app on your phone and send it to jack.hough@barons.com. Alexis Moore is our producer. You can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen. If you listen on Apple, please write us a review. Thanks and see you next week.

Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks.