Catalyst Watch
Freely Flowing Cash
Welcome to Catalyst Watch at The Transcript, a report for paid subscribers that highlights investment themes from this week’s newsletter.
1. There’s Robust Activity Across the Economy
This week’s earnings call commentary suggests that there’s increasingly robust activity across the broad economy. We saw positive sentiment in every sector that we cover and very few, if any, pockets of weakness.
It’s well understood that the Tech, Financial and Consumer sectors are all strong. Quotes in this week’s industrials section helped reinforce that that sector is also seeing increased activity. We noted positive data points from freight, defense, aerospace and automotive industries.
The flipside of the current environment is that robust demand also creates strain on supply chains and inflationary pressures. The Tech sector is clearly dealing with these challenges thanks to unprecedented capex for the AI buildout.
Inflationary pressures could creep into the broader economy too, especially if the Strait of Hormuz remains blocked. Honeywell expressed that it is planning for stubborn inflation.
“So essentially, we’re able to cover inflation with price, but inflation is stubborn. We see a lot of inflation in electronics, memory, obviously, copper, and we also see inflation in labor. So I think this is the environment we’re in. We’ll continue to price at that level and continue to manage things with our customers.” - Honeywell International (HON 1.81%↑) CFO Mike Stepniak
2. Hyperscaler CapEx isn’t Slowing Down
In recent weeks we’ve covered growing concerns about whether enterprises will be willing to continue to support exploding spend on AI services. This has spooked the stock market and led to increased skepticism about Hyperscaler capex plans. Google’s stock fell last week as it raised capex projections and produced negative free cash flow for the first time in its history.
Google’s earnings call suggests that hyperscalers aren’t pulling back on investment any time soon, though. Google indicated that, if anything, it is more bullish on AI demand.
“So I would say from an ROIC standpoint, I think we are taking a full stack approach. We are seeing momentum across consumers and enterprises and developers and so on. So it feels like, if anything, over the past year, we’ve gotten more bullish on the opportunities ahead.” - Alphabet (GOOGL 0.20%↑) CEO Sundar Pichai
No doubt this is reinforced by a large and growing backlog for cloud services:
“Google Cloud’s backlog increased by more than $50 billion sequentially, reaching $514 billion in the second quarter. The increase was driven by strong demand for our Enterprise AI offerings. The majority of the backlog is related to typical GCP contracts for a broad mix of customers, and we expect to recognize just over 50% of the total backlog as revenue over the next 24 months..” - Alphabet (GOOGL 0.20%↑) CFO Anat Ashkenazi
The broad AI industry was as bullish as ever last week. Jensen Huang was quoted as saying that the semiconductor industry would need to expand by 5-10x over the next 10 years. Intel was also talking about “unprecedented demand for AI compute.”
While there are concerns about AI bubbles, the frontier models are continuing to get better. Elon Musk captured the expected path of development:
“I do think it’s going to be a bumpy road because AI will be able to do any job better than any person can. That will be true very quickly of digital jobs, or really anything involving a computer or phone. AI will be able to do all of that very soon. For software engineering, we already have a situation where AI is better than at least 90% of professional software engineers at writing software. It’s getting to the point where it’ll be better than 99%, and then there’ll be no way to compete. It’ll reach what I call Stockfish level. Stockfish is so good at chess that it can easily beat Magnus Carlsen, or anyone else, even running on a small computer. I suspect you could run Stockfish on your phone and beat Magnus Carlsen. That’s how good it is at chess, and that’s how good AI will be at writing software.” - Spacex (SPCX -2.50%↓) CEO Elon Musk
If you believe that this will happen, it’s hard to bet that handwringing over the scale of investment will be much more than a short-term blip.
3. How Close is China to Taking the Lead in AI?
Musk also had some noteworthy comments about the state of the Chinese AI industry. While China is currently chip-constrained, the country may be closer than people realize to closing this gap. Once that challenge is solved, China has an infrastructure advantage in electricity production, which many people view as the long-term bottleneck for AI.
“Since the US has banned exports of the latest AI chips to China, China is somewhat chip-starved. I also think China is closer than most people realize to solving the lithography problem, which would enable it to produce AI chips at very large volumes. The current constraint outside China is electricity. In China, the constraint is chips....Given that Chinese AI companies are doing as well as they are with a relatively small amount of compute, it seems that if they had a lot of compute, there’s a good chance they would be the leaders. At some point, they probably will have a lot of compute, so there’s a good chance they will become the leaders...China has far more electricity than the United States. In fact, China has more electricity than the United States, Europe, and India combined already, um, and is heading to... And my guess is China gets to four times the electricity production of the US, which is roughly proportionate to the population.” - SpaceX (SPCX -2.50%↓) CEO Elon Musk