AI, shutdowns and shadow banks

Episode Summary

Executive Summary: In this episode of Unhedged, Katie Martin and Robert Armstrong discuss several topics that investors may be overlooking: the US government shutdown, which has halted critical jobs data; the AI investment boom and its potential for a bubble; and the growing shadow banking sector with $1.7 trillion in bank loans. The hosts also share their 'long/short' picks, with Robert shorting cyber attacks due to a Japan beer shortage and Katie shorting COVID as cases rise. They note that markets currently seem unfazed by these concerns.

Main Topics: US Government Shutdown (Priority: 5/5): Discussion of the ongoing US government shutdown, its impact on the release of critical economic data (non-farm payrolls), and the political stakes involved, including threats from Trump to permanently fire employees. AI Investment Bubble (Priority: 5/5): Analysis of the massive investment in AI and data centers, the potential for a bubble, and the concentration of economic and market growth in this sector. Concerns about returns on this investment and echoes of the dot-com bubble. Shadow Banking Risk (Priority: 4/5): Examination of the shadow banking sector, where non-bank lenders are financed by banks. The rapid growth of this sector ($1.7 trillion in bank loans) and its implications for financial stability are discussed. Market Indifference to Risks (Priority: 4/5): The hosts note that stock markets are at all-time highs, seemingly indifferent to the political and economic risks discussed. This suggests a disconnect between market sentiment and underlying concerns. Long-Short Segment (Priority: 1/5): Rob Armstrong shares his 'short' pick: a cyber attack causing a beer shortage in Japan, affecting his personal habit. Katie Martin shares her 'short' pick: COVID-19, as cases are rising again.

Key Arguments: The US government shutdown is very bad timing as it halts the non-farm payrolls report, the most important economic data point, at a time when the labor market is weakening. While AI investment is a major driver of US economic growth, there is a risk of a bubble if the business model proves unprofitable, potentially leading to a balance sheet recession. Shadow banking is growing rapidly, with $1.7 trillion in bank loans to non-bank lenders, and this accounts for all US lending growth. This raises concerns about hidden risks in the financial system. Markets currently seem indifferent to these political and economic risks, implying they may be ignoring potential issues. The circular nature of AI investment, where companies invest in each other's projects, echoes past bubbles. ADP payroll data, often used as a proxy for official jobs data, may become unreliable if the shutdown continues. Even if AI investment is somewhat bubbly, it leaves behind productive assets like data centers that can benefit the economy long-term.

Data Points: Impact of Shutdown: Non-farm payrolls report canceled - The US government shutdown has halted the release of the non-farm payrolls report, a key economic indicator. ADP Employment Change: Decrease of 32,000 jobs - The ADP private sector employment report for last month showed a decrease, significantly below expectations for an increase. Expected ADP Employment Change: Increase of 50,000 jobs - The expected increase in ADP employment was 50,000, making the actual decrease a significant miss. Share of GDP Growth from Tech: 90% of GDP growth from tech hardware and software in first half of year - Tech hardware and software accounted for a large portion of US GDP growth in the first half of this year. AI CapEx as Share of GDP: Equivalent to 1% of US GDP - The capital expenditure budgets of major AI companies are substantial relative to the US economy. Bank Loans to Shadow Banks: $1.7 trillion - US banks have significant exposure to shadow banks through loans.

Pivotal Quotes: "This is very bad. It's extremely bad." — Robert Armstrong: Commenting on the government shutdown halting the jobs report. "You know, markets are like, woo, all-time high, USA." — Katie Martin: Describing the disconnect between market behavior and underlying risks. "Yeah, they're nihilist, dude." — Katie Martin: Describing the market's lack of concern for various issues.

Implications: Listeners should be aware of potential risks in the US economy: a reliance on AI-driven growth, a government shutdown disrupting key data, and growing interconnectedness between banks and shadow banks. Markets' apparent indifference may lead to abrupt corrections if these issues escalate.