00:00Steve North, the federated, lowering his year-end price target on the S&P to 7,500 and writing this.
00:05The sell-off was overdue given the violence of the last few weeks.
00:09We remain cautious on software names as many are potential value traps.
00:14Steve joins us now for more.
00:15Steve, welcome to the programme.
00:16I've been looking forward to catching up with you, sir.
00:17Really interesting note.
00:18I think we should start from this.
00:20You are not bearish.
00:21You still think earnings are going to be OK.
00:22This seems to be a call on valuation, Steve.
00:24Just share with us your thoughts about how your thoughts on valuations are developing
00:28and comparing now to maybe where we were a few decades ago.
00:32Jonathan, actually, the piece you cited was really inspired by a conversation
00:37you all were having on surveillance a couple of weeks ago about the confusion around
00:42the macros seem to be pretty good, yet the market is having trouble.
00:48And I think what we're saying is the reason the macros are pretty good.
00:53But the problem with the market right now is that there's a whole hunk of it
00:58that was dependent on two different arguments for why it should have a higher valuation.
01:05One is the MAG-7 were giant free cash flow generators with big moats around them.
01:12And free cash flow is worth more in terms of a dollar earnings than an asset-heavy company
01:18because the dollars that come right back to the shareholders are supposed to have to be
01:23reinvested in the ground or a big piece of a big asset.
01:25And the MAG-7 are no longer free cash flow generators, at least for the present, because
01:31they're spending 80% of it, 90% of it on AI.
01:35And the debate around NVIDIA versus the MAG-7, the rest of the MAG-7 is, is this going to
01:41go on forever or is this a one-off?
01:43And that debate's really not settled.
01:44So you've lost the free cash flow.
01:47And then on top of that, you've got all these asset-like businesses, Block being a perfect
01:52example, that a couple of guys in a garage coding software, and they were all the rage
02:00for the last 10 years because you didn't need any assets at all to generate earnings.
02:05It's all intellectual capital that you're selling at very high margins.
02:10And the question is, can those margins hold up in a world where your competitor is now
02:17AI, not a software engineer?
02:19And so those businesses are under pressure and the valuation is a question mark.
02:25And so when you put the two together, the valuation, I give a fair valuation on the S&P, we
02:31think
02:31is lower than it was six months ago.
02:34So we've cut, you know, we've increased our earnings forecast, actually, we're at four
02:3910, three years out now on earnings, which is ahead of the street a little bit, because
02:44the macros look good.
02:45But a lot of that acceleration in earnings is coming outside of the set of stocks I just
02:50talked about.
02:51It's coming in, lo and behold, the asset-heavy businesses, you know, that are actually doing
02:57pretty well, which, by the way, includes Europe and Japan and Asia and Korea, which I know
03:04you guys have also been talking about.
03:05But a lot of those businesses are the very businesses that are enjoying part of this pickup.
03:11They're beneficiaries of AI, and they're less prone to being cannibalized by AI.
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