Beyond the hype, the nascent AI boom in the equity market offers hope that technological breakthroughs could provide a spark for the nation’s productivity crisis, according to Schwab’s chief market strategist, Liz Ann Sonders.
Sonders said in an interview yesterday that today’s market and the tech bubble of the 1990s were simply not comparable eras when you look deeper at key financial profitability metrics such as return on equity. Twenty-five years ago, the market was led by unprofitable dot-com companies. But today’s so-called “Magnificent Seven”—Apple, Amazon, Meta, Nvidia, Microsoft, Tesla and Alphabet, are very profitable. While lucrative tech stocks are performing very well, “unprofitable tech [companies] aren’t,” she said.
While she acknowledged that there was a lot of hype surrounding artificial intelligence, the term “bubble” again doesn’t really apply. The reality is that most of the early winners in the AI race are big companies that already enjoy vast data sets that they can mine for relevant information.
Those benefits will accrue to giant companies, “at least for now,” Sonders said. How long AI takes to migrate from the tech industry into the mainstream economy remains to be seen.
The productivity bust in the U.S. and much of the developed world, which began in the 1970s, is a very real problem that reduces economic growth and ultimately people’s living standards. In the 1990s the advent of PC technology and the internet triggered a brief uptick in this critical measurement, but it quickly fell back to well below 2.0% for most of the last two decades.
In 2022, as companies struggled to persuade workers to return to the office, nonfarm private sector productivity actually fell 1.2%. That’s one of the reasons (along with the unprecedented rise in interest rates) that leading economists like Evercore ISI’s Ed Hyman haven’t abandoned a hard landing scenario for the second half of 2023 or 2024.
Many economists and ordinary Americans have been anticipating a recession for a year or more. Sonders maintains her view that there’s already a rolling recession that was sparked by the unique cycle driven by the Covid-19 pandemic. Even if a broader downturn hasn’t materialized, Sonders cautioned that it might be too early to celebrate a soft landing.
History shows that economic data, particularly employment figures, often looks quite healthy during the first few months of a recession. “Out of 12 of the last 14 recessions, payrolls were still going up in the first month,” she said.
It’s always possible that a potential productivity boom from AI could propel the economy to dodge a downturn, but that could also take years to accelerate business activity. “It may not come soon enough for companies to avoid layoffs,” Sonders said.
Many businesses are currently experiencing weak real revenue growth (growth adjusted for inflation) and they are cutting employees’ hours back rather than starting cutting jobs, partly because they worry about labor shortages. With wage increases accounting for a big chunk of sales gains, companies are struggling to protect profit margins. “Now we’ll see who has pricing power,” Sonders said.
In some interest rate-sensitive industries like housing, the Fed already managed to engineer a short-lived recession last year with its dramatic increase in interest rates. Housing sales collapsed in 2022 because many potential sellers didn’t want to give up the low mortgage rates on their existing homes.
There’s another byproduct of what Sonders calls “a really funky cycle,” and that’s the creative response of many economic players. Recently, home sales have started to recover, she said, thanks to imaginative, favorable off-bank lending terms offered by home builders to offset mortgage-rate shock. Buyers are also becoming resourceful, using everything from stock market gains to loans from relatives to make all-cash or mostly cash offers, sidestepping banks.
Sonders said that just because housing has displayed surprising strength so far doesn’t mean it won’t “succumb” to the laws of gravity, whether there’s a hard or soft landing.
She’s now looking most closely at the labor market to discern future signs of weakness. One major difference between the current cycle and previous ones is that the bulk of layoffs so far are hitting workers at the high end of the wage spectrum in industries like finance and technology.
These are people who don’t always head straight to the unemployment office when they lose their jobs, she explained. If layoffs start taking a toll on workers on the lower and middle end of the income ladder, the effect on consumer spending could be more dramatic. Already the excess savings built up by these workers during the pandemic has been mostly depleted.
Ironically, Sonders says that if the economy were to suffer short-term pain in the second half of 2023 it could work to the advantage of the economy and markets over the longer term. That’s because an economic slowdown would take the pressure off both inflation and the Fed.