Christopher P. Bloomstran, President of Semper Augustus Investments Group, presented a sobering, data-driven analysis of the U.S. stock market, arguing that a confluence of factors has created a secular peak that rivals the great market tops of 1929, 1966, and 2000. His conclusion is that passive, cap-weighted index investors face a decade or more of low single-digit returns, making active stock selection more critical than ever.
Peak Margins, Peak Multiples
Chris’s argument rests on two pillars: unprecedented corporate profitability and extreme valuations.
The Margin Story: For decades, as Warren Buffett noted in 1999, S&P 500 net profit margins were remarkably stable, oscillating in a range between 4% and 6.5%. However, a unique combination of factors in the 21st century—the rise of capital-light technology businesses, a secular decline in interest rates, and a significant cut in the corporate tax rate—drove margins to an all-time high of 13.3% in 2021. Chris’s core thesis is that this level is unsustainable and likely represents a secular peak.
The Valuation Story: This peak profitability is being capitalized at a peak multiple. The S&P 500 currently trades at 27 times earnings. This is skewed by the “Magnificent Seven” (substituting Broadcom (Nasdaq: AVGO) for Tesla), which trade at a collective 36-37 times earnings. Even excluding this cohort, the remaining 493 stocks in the index trade at 21-22 times earnings—still significantly above the long-term historical average of 16.5x.
The AI Capex Bubble and the Macro Debt Problem
Chris identifies the current AI investment boom as the primary driver of the market’s excess and a direct threat to the high margins of technology companies. He draws a parallel to the fiber-optic bubble of the late 1990s. Today, hyperscalers are spending an estimated $350-400 billion per year on AI-related capital expenditures, while generating less than $40 billion in corresponding revenue. The math is starkly unfavorable. As this massive capex begins to depreciate over the next several years, it will introduce hundreds of billions of dollars in new costs to the income statements of these formerly “capital-light” businesses, putting immense downward pressure on their celebrated profit margins.
This market-specific risk is compounded by a broader macroeconomic problem: debt. With total U.S. credit market debt now at 350% of GDP, Chris argues that the nation has crossed the threshold where leverage becomes a drag on economic growth. He points to the fact that real GDP per capita growth has been halved from its long-term 2% trend to just 1% over the past quarter-century. A slower-growing economy, he contends, should command a lower long-term valuation multiple, not a higher one.
The Stock Picker’s Response
Chris’s bearish top-down view is not a call to retreat to cash, but rather a directive to actively seek value in the areas of the market that the current mania has neglected. The market’s obsession with a single theme (AI) creates mispricing and opportunity elsewhere.
Focus Idea: Deckers Outdoor (NYSE: DECK): This high-quality, fast-growing consumer brand company saw its stock get punished due to market fears over a potential new tariff policy on goods imported from Vietnam, where 85% of its manufacturing is based. This overreaction allowed investors to buy a business with a pristine net-cash balance sheet and a powerful growth engine—the Hoka running shoe brand is growing at over 20% annually—for just 13x earnings. While the market chases AI narratives at 37x earnings, a tangible growth story became available at a deep discount because of a political headline.
Contrarian Cyclicals: Echoing Bob Robotti, Chris also sees value in out-of-favor cyclicals. He used the recent sharp sell-off in Olin (NYSE: OLN) to increase his position, buying the stock at a deep discount to its mid-cycle cash flow potential. He also maintains a position in gold miners like Kinross Gold (NYSE: KGC) as a pragmatic hedge against fiscal and monetary indiscipline, though he has been prudently trimming the position after its significant run-up.
Let’s go deeper.
Transcript
The following transcript has been lightly edited for readability.
John Mihaljevic: Particularly at this time in the markets, it’s very instructive to take the pulse and see where we are in historical context. If there’s anything I’d love for us to take away from today, it’s that we become aware of our own complacency after the run in the markets that we’ve had. It’s truly easy to be complacent at the moment, and that usually turns out to be exactly the wrong moment to be complacent. Chris has the numbers in his head. Maybe you can tell us where we’re at and what that means, generally speaking, looking at history for what may be to come.
Chris Bloomstran: What John’s asking is about a five-factor model I use for business valuation and looking at where historical returns are derived. Some of you who read my letter will be familiar with it. It breaks down the conventional change in earnings per share and the change in the multiple. I further break that down into four separate multiplicative components and one additive component: dollar sales growth, change in the share count, change in the margin, and the change in the multiple—those are all multiplicative—and then whatever dividends you get.
I presumed at around year-end 2021 that we were at a secular peak in the cap-weighted US stock market that rivaled 2000, 1966, and 1929. If you go back to the prior secular peak, Warren Buffett famously had an interview that wound up as an article in Fortune Magazine, and essentially said you’ve got this high multiple to earnings and you’ve got very high earnings. You’ve got record-high profit margins. With one aberration being 1929, you had an 8.9% net margin, but then you had several decades where, as he put it, margins were range-bound between about 4% and 6.5%.
At the secular low in 1981, you had washed-out margins. The profit margin was 4%, a record low with the exception of losses in the 1930s. You had a 4% margin capitalized at eight times earnings. Four times eight is 32% of sales. By the time you got to 2000, you’d had a bull market in stocks that had lasted 17 or 18 years, and Warren presumed that margins were on the high side. In fact, in ‘99 and 2000, you did wind up getting profit margins up to 7.5%, which was a full percentage point higher than the top of his range of 6.5%. Then you had a recession and a stock market sell-off, and margins came back down into the fives from 7.5%.
So he was correct. But what he didn’t get—what none of us would have figured out—was the capital-light nature of many of the big businesses that sit atop the stock market. You wouldn’t have presumed that long-term interest rates would trade into the twos and threes, or even the ones for a minute. The corporate tax rate, which had been historically as high as 45% or 50%, was 35% for a long time. In 1981-82 it was 35%. Under the TCJA, it got to 21%. The combination of all those drove the margin in 2021 up to 13.3%.
Then you had the sell-off in ‘22 and all the inflation post-pandemic, which took margins down to about 11%. The market got crushed in 2022; the S&P was down 18%, the Nasdaq was down 35%. But into year-end ‘21, I presumed—and I may be as wrong as Warren was in 1999—that we’d never see 13.3% again.
Well, here you are with Nvidia and Microsoft. Microsoft’s margins... Microsoft in 2000 was a bubble. In one of my letters, I spent six or seven pages on Microsoft predicting shareholders would lose money for 15 years. You had a business with a $620 billion market cap, but revenues were only $20 billion. So it was trading at 31 times sales, but they were doing a 37% profit margin. Microsoft was earning $7.5 billion. Over the next seven or eight years, margins compressed. Google became a competitor, and margins got down to 21%. The stock eventually traded not at 81 or 82 times earnings, but at single digits, and we bought it at single digits.
I still presume that around 13.3% is the most you’re going to get out of the aggregate profit margin for the S&P 500. In 2022, you had margin compression and multiple compression big time, and that’s what took the market down 18%. You’ve had a big recovery, and literally 80-90% of the recovery in the cap-weighted US stock market is about 15 companies. It’s the Magnificent Seven—not so much Tesla anymore—but Broadcom, even a Costco trading at 60-plus times earnings. You have this secular overvaluation in a handful of companies, call it 50 or 75.
Historically, if you look at periods following which the S&P 500 or the stock market earned outsized returns, well north of the Ibbotson classic 10.5%, when you had high margins capitalized at high multiples, you tended to have secular peaks. My premise is you’re not going to get much more than 5% out of the S&P 500, best case, for the next 10 or 15 years. If you run it from 2021, it’s running at about 8-9% right now. We’re below the 10.5%, but it’s taken this big run-up where you had back-to-back years of 25% returns, and it’s up 13-14% this year. You’re just now back to the fundamental valuation levels in the cap-weighted stock market that match where you were in 2021. So I think the picture for the passive investor and for institutions that allocate to the cap-weighted stock market is pretty grim, but there’s a lot of value underneath the surface.
This morning, we correctly heard that the long-term multiple on the stock market is 16.5, and that’s right. It’s taken the last 20 years of an outsized multiple to bring that long-term average up from 15x. Food for thought, and I had a note on this in my most recent annual letter: What if leverage becomes a hindrance to growth in real GDP per capita? Back to Buffett, he has talked about the tailwind he had over his entire investment lifetime, where you had 2% growth in real GDP per capita. Around 2000, the secular peak in the stock market, we had total credit market debt get up to 250% of GDP. Today we’re at 350%. A larger component of that debt mix is now government debt. There’s a lot of academic work that shows once government debt reaches a certain level, as Rogoff and Reinhart’s work shows, you begin to see a diminution of economic output. Indeed, for the last quarter-century, we’re not clipping along at 2% growth in real GDP per capita, but at 1%. So if the growth component that goes into stock market valuation is lower on a real basis than it’s been over the last 100 years, you could arguably say 16.5x or even 15x might be on the high side.
John: What I’m trying to wrap my head around is where inflation might be going. What we’re seeing from the government is a complete unwillingness to address the fiscal situation and even pressure on the Fed. Gold seems to be telling a very clear story. To me, when you have real inflation—and I think everyone in this room knows when you go buy a cappuccino in Manhattan that we haven’t been at 2% for the last 10 years—and you have the government running interest rates below the real rate of inflation, you’ve got the market in nominal terms. I agree very easily that in real terms, we’re going to be in trouble. But when it comes to the market in nominal terms, I think we’re at a point where all bets are off. If you look at the experience of Turkey recently, when Erdogan removed the central bank chairman, inflation went out of control. The market went down in real terms, but in nominal terms, it went up a lot. Do we have anything from the ‘70s that could be instructive if we were to get into that kind of environment?
Chris: You have the Venezuelan and Argentinian stock markets that have been up thousands of percent per year in nominal terms for the last handful of years. We’ve known for a long time that the demographics and the unfunded liabilities that go with it—the aging of the large baby boom generation—is upon us now. The question is, do the millennials replace themselves with more kids? Right now, we don’t have replacement rates anywhere near 2.1, neither in the US nor in the bulk of the world. That’s an issue.
We’re on the front end of this. At 350% debt-to-GDP, we have debt numbers pushing $95-100 trillion. That’s just on-balance sheet debt in the United States, split between government, households, and corporate. The unfunded liabilities for Social Security and Medicare are at least double, maybe triple or quadruple that, and we’re just on the front end of that.
There’s really nothing that we can do. We don’t elect politicians for their fiscal prudence. We don’t appoint central bankers for their monetary prudence. I’m not sure how you remedy this. Generally, the classical work-off of too much debt is deflation or ultimately depression. We did that in the 1930s. We had fairly high debt levels in the 1920s, but that gets skewed by the Depression. Nominal GDP was cut in half from $103 billion to $54 billion. So when you look at the spike in debt in the 1930s, that wasn’t aggregate debt growing; that was nominal GDP down 50%. Consumption and debt actually shrank. Debt was down 20%, but as a component of GDP, it spiked.
I think it’s untenable where we are. It’s not just the United States; it’s the entire industrial world that’s dealing with too much leverage and a population that’s not going to replace itself. The government’s not going to fix it. Do you have deflation or disinflation first? Ultimately, the endgame is probably high levels of inflation.
And to the ‘70s, a couple of years ago, I had a piece that equated where we might be over the next 15-20 years to what happened between the late 1960s and 1982. The notion is the Arthur Burns Fed screwed it up, never got ahead of the inflation rate, and Volcker came in as the white knight and saved everything in the early ‘80s. Well, if you look at where we set the Fed funds rate and plotted it against the CPI, you did have rolling inflation, but the Fed was moving interest rates up and down. The Burns Fed was not behind the curve. The McChesney Martin Fed was not behind the curve. They simply set the money rate to match where the inflation rate was moving.
They could be hard-pressed to get it down below the old 2% target. 3% might be the new norm. But from a capital allocator’s standpoint, you almost have to ignore it to a degree. Know that it’s coming and bake in inflation where it is. You’ll benefit from it in some ways. If we get hyperinflation, that’s no fun for anybody. But if you get rolling inflation like we had in the ‘70s, who won the 1970s? Capital allocators that had cash at opportunistic moments. Warren Buffett won the 1970s. He had cash on hand flowing in from the insurance operation and bought the Washington Post in 1974. From ‘66, you had a 20% decline; in ‘68, a 30% decline; and the near 50% decline in ‘73-’74, which was the Nifty Fifty. If you can be more active with your investment management—your buying and selling—you can take advantage of these rolling periods. I think Bob Robotti said it: It’s probably a time for stock pickers, and probably a time for more active stock picking.
That’s contrary to the notion of finding hundred-baggers, buying great businesses, and never selling them. It’s hard to get to a 17% compounded return and do that because you just don’t have that many businesses you can own for that long. John was short Costco earlier this year when it was trading at 65 times earnings. Probably shouldn’t have mentioned that, but it’s a closed meeting. Let’s move on.
John: I love the brand, don’t get me wrong. It was a purely financial decision, but it did feel wrong at some point, so I had to cover.
Chris: Sometimes you can short the best business in the world and be correct. Price does matter.
John: Where are you finding pockets of opportunity or bargains today, given where the market’s at? There are still areas that are neglected because they don’t fit into the narratives of the day.
Chris: This has been a fascinating four or five years. There are so many parallels to the late ‘90s. We happen to be up about 35% this year, which is great in our world. We own a couple of gold companies that have far more than doubled, and that’s on the back of the prior two or three years. We have a lot of money invested in dollar stores that until about three weeks ago were up a lot, and now they’re not up as much.
We’ve taken advantage of volatility in things like tariffs. In April, things went crazy, and Trump put out that list of tariff rates as they were going to apply to different countries, and the formula made no sense. You were going to take the deficit in goods (not services), take the dollar balance of your trade deficit against the country, and divide the number by two. So Vietnam shows up with a 46% tariff rate. I thought that seemed high. Vietnam immediately came back and said, ‘We’ll go to zero.’ Then the White House said, ‘Zero’s not good enough.’ How can zero not be good enough? Well, we run on the order of a $130-140 billion trade deficit with Vietnam. They send us shoes and coffee. They also send us Chinese-manufactured computer goods. So what the White House was getting at was, ‘Knock off the transshipping and stop saying you put a final solder or a final assembly on something and send it to the United States as a Vietnamese product instead of a Chinese product.’
So now we’re at a 20% tariff with Vietnam, except for transshipping, where it’s 40%. They’re trying to eliminate the China connection. Caught up in that are the shoe manufacturers. Two of the fastest-growing shoe brands are Hoka and On Running. Hoka’s owned by Deckers Outdoor. These companies got killed; they both declined in price.
We bought Deckers Outdoor on the news. The stock dropped from a high a couple of years ago of $220. My basis in it is $100. It’s trading down 5% today at $98. This is a business that was founded by a couple of surfers in the 1980s who made flip-flops and sandals. They were selling on beaches. They ultimately bought Teva, then Ugg, and went public. Ugg has grown in the low double digits, 10-15%, for a long time. It’s a big brand that does close to $3 billion in revenues. But Hoka, which was started by a couple of ultra-marathoners in France, began one year after On Running was started in Switzerland. Roger Federer is invested in On Running and, as I understand it, has made more money owning On than he made in his entire tennis career. You’ve got these two brands that in the last 10 years have each grown to $3 billion in revenues.
That’s $6 billion between the two of them. Nike, which is still the largest shoe manufacturer—Nike is two-thirds shoes, one-third soft goods. Shoes are where the margins are, not apparel. Under Armour, when they tried to knock off Nike, was the inverse of that. They were two-thirds apparel. They didn’t have the war chest to sponsor athletes and teams the way Nike did, and they got killed. Nike has seen their market share decline by half over the last 20-25 years, from 50% to 25%. Adidas is about half the size of Nike, at about $12 billion. So of Nike’s $50 billion in revenues, $30 billion are shoes. Hoka and On have $6 billion against Nike’s $30 billion. And you have other brands that have been growing.
The stock trades down. The business is run with no debt on the balance sheet. They have $300 million in capitalized leases, but there’s about $1.4-1.5 billion of net cash. They started buying back stock around 2009. They’ve taken the share count from 240 million shares down to 150 million. With the stock around $100 today, you’re at about a $14.5 billion market cap and a $13 billion enterprise value. You’re paying 13 times earnings for a business where the Hoka brand is still growing mid-teens to at least 20%. They had one quarter at 10%, and right around the time the tariff hit, the stock got cheap. They got hit by only 10% growth in Hoka. But in the most recent quarter, Hoka sales were up 20-plus percent. Ugg is still growing in the teens. I think you have a business that’s going to grow at least high single-digits, low double-digits.
They are very capital-light businesses. You can’t say they’re like Nvidia, but they contract-outsource manufacturing to Vietnam; 85% of manufacturing is in Vietnam. The sheepskin that goes into Uggs gets tanned in China. It’s a nasty, dirty process, and the Chinese like doing nasty, dirty things. But it’s basically a Vietnam story.
So, you figure they’ll pass some of the 20% tariff through to customers, squeeze suppliers, and generate some efficiencies, and probably have a bit of a margin decline. You can bake in 300 basis points of margin decline over the next five or six years, but you’re at 13 times earnings for a very fast-growing business.
That wouldn’t have happened... On didn’t get cheap enough to buy. I would have loved to buy On as well. But to buy a business that’s growing that fast with that good of a balance sheet... albeit it’s headquartered in the People’s Republic of California, so you have a little bit of that ‘woke’ element going on just because they’re in California. It was started by surfers, so that’s in the DNA. But things like this just come along, and you take advantage of crazy things like trade and tariff policy.
I should caution, though, with the caveat on Nike. We made a bunch of money with Nike, which I bought in 2016 or ‘17. I sold it down to a half-of-one-percent position. I thought I was going to own it for 30 years, but I didn’t want to own it at 30 times earnings, so I took it down to nothing. We sold all of our Nike to finance the purchase of Deckers. Nike’s had sales declines for the last two years as Hoka and On have picked up market share. Nike thought they were going to transition a lot of business through their apps—not their website, but their apps—and it didn’t work. Their DTC sales have flatlined over the last couple of years as these upstart brands have taken share.
Nike acknowledged that it didn’t work, so they’re going back to wholesale. They’re going back to Dick’s, Hibbett Sports, and Foot Locker, and they’re bringing the 800-pound gorilla—which is Nike—with them to negotiate for shelf space. In Nike’s most recent quarter, you saw they stopped the hemorrhaging of sales declines. They’re going to make it very hard on brands like Hoka and On for wholesale shelf space.
The beauty of Hoka is that a lot of sales are direct-to-consumer. I think 60% of Ugg sales and 38% of Hoka sales are DTC. I’m walking two hours a day now, getting all my joints replaced. I was a game-time decision on coming this week because I wound up with an infection in my most recently replaced hip three weeks ago. I was in the hospital for a week. But when I’m not in the hospital, I’m walking two hours a day, so I go through a pair of Hokas every two months, and they’re phenomenal.
As for the risk of brand diminution, I don’t think these are upstart brands in the way Crocs might have been for a while. I think they’ve got legs and some permanence. There’s no patented technology. They have a carbon fiber plate that goes with it, but I think it’s just consumer adoption, and athletes love them.
When I walk around the United States, the kids like my bright-colored Hokas. When I walk around Europe in my Hokas, I get frowns because in Europe, it’s all tan, brown, black, or white shoes. With multi-colored rainbow shoes, I get the ‘Euro look.’ They’re only 20% international, but they’re coming.
John: Europeans have style, what can I say?
Chris: Well, we have air conditioning and ice in our water. 😊
Audience member: I’d appreciate your insight on one of your largest holdings, GE, and whether the book ‘The Man Who Broke Capitalism’ had any influence on your investment.
Chris: We own a little bit of GE, but that was an inherited position from our anchor client. I’ve told the story on podcasts and in my letter: my original family client had over half their capital in GE in the late ‘90s. I thought the CEO had pushed the envelope on making the quarterly number and on the leverage that went with their finance businesses and the off-balance-sheet liabilities. GE declined by 80% over a period of time where we’ve now made 20 times our money. We’ve made about 12% a year since we started the firm in early ‘99. The S&P has done about 8% over that same period, but GE got killed.
They spun off and got rid of a couple of businesses, and the stock is up a lot, but we’ve never bought it. It shows up as a stub position. My basis in the shares that we have—which are in some generation-skipping trusts—is 12 cents per share. So I don’t touch it. Even though I would sell Costco at a price, you don’t touch a 12-cent basis. There’s a biography that came out more recently, in the last couple of years, and I’m drawing a blank on who wrote it, but it’s really good.
John: You mentioned Olin earlier.
Chris: Olin, yes. We’ve tended to be a lot more active over the years than I thought. Our turnover is 15-20%. It’s that 15-20% that comes from me trimming something that’s gotten expensive to finance the purchase of something else. I’m either adding to positions in the portfolio that are cheap or bringing in something new. But I always have to put sales tickets out. I have a list of seven stocks right now on my sell list, and we sell those down to model.
We bought Olin in 2019, right before the pandemic. It was trending toward an oligopoly. We got a basis in it of $12 a share when the pandemic hit. In a year and a half, we got through the pandemic, and Olin traded at $67. It was up to 15% of our capital, so I sold half of it. Regrettably, I didn’t sell the whole thing. But in the last few weeks, the stock traded down as low as $18, where we took it back up to a 5% position. I sold it down from a 15% position to 7.5%, and then because the stock dropped from $67 to $18, it became more like 1.5%. So we’re back up to 5%. The stock is back up to $26.
Relative to the purchase price that Warren or Greg is paying for OxyChem, you’re buying Westlake or Olin at a deep discount. You need Chinese epoxy to either be sanctioned or for them to close capacity. Those are real headwinds. But they’ve taken the share count down over the last five years from 165 million to 115 million shares. I bought it most recently at a market cap of around $2 billion. I’d say mid-cycle free cash flow is $1 billion, and mid-cycle cash flow is about $2.5 billion. So today you have a market cap of $3 billion, debt of $3 billion, so a $6 billion enterprise value on $2.5 billion of mid-cycle cash flow.
Warren, by the way, the reason OxyChem is such a great business inside of Berkshire is that nobody in the chlor-alkali world, at least in North America or Europe, is going to add any capacity. Olin has maintenance capex of $200 million, which matches their depreciation expense. Revenues are $7 billion. Against $1 billion in mid-cycle free cash, capex is nothing. And nobody is going to add capacity. In Berkshire’s case, they’ll take whatever free cash the business produces and send it to Omaha. They will not reinvest in that business, but it’s going to throw off a lot of money from cycle to cycle. He bought a good set of assets. Under the current White House, you may get consolidation in an industry that was already pretty oligopolistic.
Audience member: I wanted to ask about your gold investments. Are you investing in mining stocks? If so, do you focus on the big ones, like Newmont, or royalty stocks like Franco? Is that a macro call, or is it a fundamental thesis to sit with for a decade, as opposed to timing?
Chris: The question is, do we own miners or the metal? Is it a fundamental investment or more of a hedge against the macro? The answer is yes. I’ve long owned gold miners. We own two gold miners: Newmont, which has mediocre to poor management but has cleaned up its balance sheet. They’ve made some deals and gotten a little heavier into copper, which we liked for some of the renewables activity. Then we own Kinross, which has had some assets in tough places. They lost their assets in Russia after the invasion of Ukraine. They bought some resources in Canada.
For so long, the miners trailed the price of the metal. But here you are with gold at $3,900. You’ve got all-in sustaining costs that are $1,500-$1,600. These mining companies are minting money. They’ve taken leverage out of their capital structure. If they maintain this current gold price, the risk is they go out and start doing a lot of acquisitions using cash instead of their shares. Classically, they use their shares.
But I still think gold is a great hedge against central bankers and elected officials doing bad things. There’s no shortage of that. And to John’s point, we’re dealing with fiscal deficits that are unfixable. I think a big chunk of the hedge fund world chased cryptocurrency and other alternative hedge instruments. The large buyers in the last five to seven years have been central banks: China, Russia, and Turkey. The retail investor fled gold. So even though the dollar value of the gold ETFs are at all-time highs, they’re still about 20% below their peaks in terms of units or tons of gold held. The retail investor is just coming around to it. So we’re still pretty constructive on gold from here.
That said, my basis in Kinross is $3 or $4, and it’s trading at $25. So that’s at the top of my sell list. When I’m adding to Deckers, I’m trimming Kinross and taking some of that money off the table. I don’t know where this intermediate cycle is going to go, but we’ve made quite a bit and we may make more, but I’m okay using that as my primary source of capital today.
Audience member: When we look at some megacap tech companies, it seems some, like Google and Amazon, are investing in AI in a very insular way, where it operates within their ecosystem. They don’t seem to have these circular deals that Nvidia, Oracle, and OpenAI have. Could you give your view on this? Might these trends be better expressed through a company like Google or Amazon that can do it mostly in-house, whereas others have these circular and incestuous deals with one another?
Chris: If you go back to the late ‘90s and the fiber and communications bubble, this is that. But that was a retail frenzy. Today, I think everybody in the room can articulate what the capex number is for the hyperscalers—$350 billion? $400 billion in aggregate? We all get that you have to make money on capex, and these businesses that were capital-light are becoming capital-intensive. If it’s $400 billion in capex this year, AI revenues are not even $40 billion. To just cover your margin structure, if the depreciable life of a data center is five years, you have $80 billion of depreciation expense this year that’s going to come off that $400 billion in capex, and revenues are $20 or $30 billion.
To get a 15% return on the $400 billion, you need $60 billion in profit, and revenues are a third of that. This is not one year’s worth of capex; it’s $400-500 billion per year. You’re getting what the Ciscos, Lucents, and Nortels did, with the equity ownerships and warrant structures. There are no revenues to justify this, and you get these weird valuations out of private businesses. They do a funding round, and I think they take the cash and invest it in their own customers to make sure they have capital. I think this ends badly.
When you look at the cap-weighted S&P 500 now trading at 27 times earnings, if you take the Magnificent Seven (substituting Broadcom for Tesla), they’re trading at 36-37 times earnings. The remaining 493 stocks are trading at 21-22 times. So the cap-weighted stock market, excluding the Magnificent Seven, is expensive.
When you start putting depreciation on the balance sheet and start to see debt being used... I mean, Oracle has a lot of leverage because Larry Ellison has been buying the stock back hand over fist. He’s bought back something like 80% of the shares, so there is no book value, but there’s a lot of leverage. You’re starting to get leverage at Meta and some of the others. If and when the revenues don’t materialize, the high margin structures of these formerly capital-light businesses will compress, and you’re going to have earnings misses.
Could that be this year? Is it five years from now? I don’t know. But given the amounts of money being spent with debt coming into it... during the fiber bubble, there was a lot of debt. Williams Communications had $4 billion in debt; Global Crossing borrowed a bunch of money. You don’t have that kind of debt today, but these numbers relative to GDP are astronomically larger than the fiber bubble. I think this thing ends badly.
But who knows when? Will it end badly for all of them, or for certain players? We’ll probably have one or two winners. Microsoft won the last round, but the stock was down 80% over six or seven years because the valuation made no sense. So somebody’s going to win. There will be some productivity gains. But justifying $400 billion in capex—what may be $2 trillion in capex over a five-year period—I don’t know how you get the revenues out of that to generate the profits to justify the stock market caps. I could see business efficiencies being generated and nobody winning from the investment side, simply based on the valuations and the dollars being spent. Anybody in the room could articulate what I just said at least as well or better than I have because I think we all know the story, which is different than it was in ‘99.
Audience member: Could you comment on some of the craziness, like Palantir?
Chris: I would be the world’s worst venture capital investor because I don’t have that kind of vision. I can’t run revenues and theoretical profits 15 years into the future to justify the 30-40x multiples to current run-rate revenues, albeit revenues that are growing very fast. There are a lot of ways to make money doing that, but that’s not our bailiwick. I do like to look at them because of the craziness.
Audience member: You mentioned gold. Usually, in the context of gold, someone brings up Bitcoin, so I will. The other day I heard someone describe the dollar as having devalued relative to Bitcoin by 30%. That was the first time I’d heard someone comment on Bitcoin as a stable currency as opposed to a speculative asset. I’m curious to hear your perspective on that as a gold investor, given your views on the dollar.
Chris: Gold has millennia of history behind it. Somebody explain to me how Tether works with $175 billion in reserves. They won’t do an audit. Somebody, identify any single CUSIP for the Treasuries they own. They’re raising $20 billion. Why, if you have a 99% profit margin on the $4.5-5 billion of interest income you’re earning largely on a theoretical Treasury portfolio, would you raise $20 billion in new equity capital? I think there’s a Ponzi scheme element to some of this. We’ll see how it goes. I wouldn’t play that game.
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