Why The Stock Market Just Won't Crash Even With This Oil Shock

The stock market just broke a brand new all-time high. It has been up for 11 days in a row. To what do you ascribe this incredible 11-day streak for the Nasdaq? And a record-setting day for U.S. equities. Yeah, pretty amazing. What, we're looking at five, I think, is it, up days for the S&P 500, a weekly gain of maybe four and a half percent, about 13 days. Yet the United States is in the middle of a war. They have no Navy, they have no Air Force, they have no leaders, they have no nothing. They wanted to close up the Strait again, you know, as they've been doing for years. And they can't blackmail us. Oil has been up over $100 for the last 36 out of 42 days. Some AI layoffs have started. 24 percent in extended trade after the company announced plans to lay off almost half its workforce. CEO Jack Dorsey pointed to AI, saying intelligence tools have, quote, changed what it means to build and run a company. And that within a year, most other companies will reach the same conclusion. Gas prices are up 30 percent. In every single historical stock market crash other than COVID, it's always been preceded by high oil prices. And yet today, the stock market knows this, and it keeps going up. If you're new here, I'm Alice, I am an accountant, and I used to work in corporate finance, and I'm also a business owner. As an investor myself, I've been watching this market very closely. I've heard a lot of different reasons from different people why they think the stock market isn't crashing. And today I want to give you my take on why I think the stock market is refusing to crash. A lot of people think that the stock market reflects the economy, and to some extent, it's supposed to. It's also based on what investors believe is going to happen in the future. So the stock market is a forward-looking machine that basically prices in the future earnings of companies that trade on the stock market. And right now, there are some very specific reasons why investors are looking past the war. They're looking past these oil prices, past the Strait of Hormuz closures, past inflation risks, and past rising gold prices. Yet they are still buying into the stock market. Now, we all know that the stock market isn't always logical. In the short term, it actually tends to be more emotional than logical. Specifically, those emotions are greed, aka the pursuit of money, and fear, being scared of losing money. Fear tends to override greed, or what we call loss aversion bias, which is why a stock can take months and months for the price to climb up. But when a sell-off happens, that sell-off can basically wipe out months of gains in just a few business days. In the short term, the stock market is basically investors placing bets. And investors are not always rational. And sometimes the stock market is wrong about individual stocks, and it can take years for the market to reprice a stock correctly. And right now, all of the money and all of the bets are basically being put into one area, artificial intelligence. And this is because of the AI productivity thesis. According to JP Morgan, nearly 40% of the S&P 500 is directly or indirectly impacted by perceptions of the AI market. With the AI investment thesis, or what some people call the productivity thesis, basically says that right now we're in this once-in-a-lifetime technology build-out that's going to revolutionize commerce and labor markets. Markets can also stay irrational for longer than what rational people expect, which is what I think is happening a little bit right now. Back in 1999, everyone sort of knew that dot-com valuations were insane, or they were overvalued. But the market actually kept going up for an entire year before the whole stock market crashed. So that's why we say it's almost impossible to predict crashes or when the markets will eventually reprice themselves. So I think one of the reasons why the market is shrugging off the war, shrugging off $100 oil, I think that basically investors have learned how to live with this war and maybe even optimistic in thinking that the light at the end of the tunnel is here. And I think that the AI productivity thesis has become basically so dominant that the impact of AI is far exceeding the negative economic impacts of the war. So if we look at where actual cash and money is flowing right now, all money is being poured into things like data centers, power grids, these pick and shovel companies. The whole hyperscaler CapEx thesis is basically a bet that for every knowledge worker and what we can get out of a knowledge worker, we can multiply that two times, three times, four times, even up to 10 times through AI tools. And of the $700 billion that Meg-7 and these hyperscalers have poured into AI, it's all priced in on the expectation that knowledge work is going to be more productive per unit of labor. And if that thesis pays off, then the productivity gains and the money flow is going to trickle over into other areas of the economy. Okay, so this is things like software, finance, healthcare, and to their owners. And in the worst case scenario that the CapEx thesis or the AI thesis does not pan out the way that it's supposed to, it's basically $700 billion of money that has been misallocated, which is obviously not good. If you look at most AI stocks right now in the AI value chain have grown significantly in the past year or two, and they're all elevated. Some of them are actually significantly overvalued by traditional metrics. But what the market is telling us is that investors don't care because again, they think that AI actually will reshape the global economy more profoundly than the internet did. And the impact of that will far exceed what's happening with this war. And if that's true, then investors basically think that current valuations would be fair. Right now, there are basically five companies, five to seven companies that are carrying the entire S&P 500 and like ballooning the economy. And when these companies report strong earnings, the S&P 500 will continue to go up no matter what's happening anywhere else. And the S&P 500 is dominated by companies whose primary input is knowledge work. And these companies are the main beneficiaries of the AI buildup. And you can see why investors are still excited. The question is whether the returns justify the valuations. And again, what about the impacts of the war? I think that until there's some sort of indication that the AI bet is possibly wrong, the market will just keep going up. The other alternative is that what happens with the war continues to worsen, becomes even more catastrophic to the economy. And maybe then investors will balance out AI economic growth with the negative impacts of the war. And that will then be priced more into the market. The really interesting thing is that basically all previous recessions were preceded by elevated oil prices. Gasoline is up 30% right now in North America. Inflation print came in at 3.3%. The consumer sentiment right now is at an all-time low. And professional economists are projecting that inflation could go up to 4%. And right now there are some similarities of what the US experienced in the 1970s with stagflation, which is inflation, what we have right now, rising unemployment, which is also what we have right now, and AI layoffs are not going to help that number at all. And also weak economic growth outside of the AI cap expending. Let's talk about earnings. Despite the fact that we are in a war, despite these oil prices, despite everything, earnings are still strong, especially earnings for the MAG7 companies. You know, you look at the US economy and you look at what's, you know, I heard at the beginning of the show, we're talking about the economy's weak, economy's strong. Actually, the parts of the economy and the primary drivers are doing quite well. You look at tech. I mean, you look at some of the numbers yesterday that you cited and you look at these earnings growth. I mean, I was looking at some of the semis. You're talking about 97% earnings growth year on year. I mean, like unbelievably powerful numbers. So all of the MAG7 companies are going to be reporting Q1 earnings later this month. So it's going to be interesting to see what actually comes out because thus far earnings for the stock market have been pretty strong. And again, the stock market is ultimately driven by earnings. Companies generate profits, those profits justify valuations. And right now, despite the war, despite oil prices, earnings overall are still pretty strong. The S&P 500 is currently trading at 20 times forward earnings right now, which is elevated compared to the historical average of around 16 to 17 times. S&P 500 is heavily skewed towards MAG7. So if we had to break that number down a little bit more and just looked at MAG7, they're trading between 28 to 31 forward PE, while the rest of the S&P 500 is trading at 10 times forward PE. Part of what we do and a big part of what we have to really be focused on is looking through the noise because it's been changing so much. So overall, we've been looking at fundamentals. We've been looking at a lot of the macroeconomic data that's been coming out. We've been looking at earnings. Throughout the war you've been looking through the noise? From the beginning. We entered the year constructive. The context is that during the 2001 crash, the market was trading at 28 times earning. And in 2008, it was trading around 25 times. And at 20 times overall, the market is expensive. The MAG7 is definitely expensive, but the overall stock market is not at the extreme valuations that we've seen before the dot-com bubble crash, for example. So Amazon's AWS is still growing. Google Cloud is growing. Microsoft's Azure is still growing. Meta's ad revenue is still growing. So these companies that basically drive the market are generating lots of real cash flow. So while oil prices are expected to hit trucking, transportation, food, agriculture, airlines. Again, what I think is that investors are basically pricing in the fact that these hyperscalers are still propping up the rest of the economy and basically carrying the weight of the entire economy. So the Federal Reserve has not actually raised rates in response to these forest spikes. Right now, the Federal Reserve is frozen. They are not in a position to either raise or decrease rates. They are holding steady while monitoring the situation of what goes on with the war. And they basically have two mandates, which is to control inflation and also maximize employment. We're at a transformational moment in U.S. economic history. AI is going to make almost everything cost less and the U.S. can be a big winner. Interest rates are a huge catalyst to the stock market because when there are lower interest rates, this basically makes stocks worth more today. Lower rates leads to higher valuations. They have an inverse relationship. The tension here is oil being over $100 a barrel because every single U.S. recession other than COVID was led or pre-led by an oil surge. So if inflation stays elevated, the Fed cannot cut rates. So if oil prices stay high, gas prices stay high, the overall inflation stays high, then the Fed cannot do anything to cut rates and rates are one of the key pillars that support the stock market. And so I would say that this is the most important tension to watch closely as an investor. And it seems like the market is still hoping or pricing in a potential rate cut. But the counterintuitive part is that the oil market tells a completely different story. Eventually, both cannot be right and one of them is going to have to be wrong. And if the market decides that that's going to change, that's when we're going to see a repricing. So as an investor, if you have to pay attention to one thing, I would say that the tension to watch is interest rates. Gold and silver up to right now, gold is at $4,800 a barrel and silver as at $80. This is also a little bit strange because usually precious metals, specifically gold and equities are usually inversely related because gold is usually seen as a safe haven. And so when stocks go up, usually gold goes down. But right now, both of them are holding strong and actually going up simultaneously. So when both of these go up together, it actually could be a signal that investors are hedging. And what that means is that they're possibly buying AI stocks for the upside while also simultaneously buying gold as an insurance against the scenario where what happens with AI completely goes wrong. So it could be a sign here that investors do realize that this whole AI thing could go terribly wrong. Gold prices are also partially driven up by central bank demand as well. But right now it seems like smart money is playing both sides. Both precious metals and AI stocks. So given that the stock market is clearly not concerned about the war, I think there are a few scenarios that if it does worsen, then the rally could possibly end. The first is if inflation actually goes above 4%. This happened during 2022 when Russia invaded Ukraine. Inflation went up to like 9%, which led to like a whole year and a half of rate hikes. But right now, economists are saying that possibly 4%. So the ball case is that you look through and you look towards an eventual peace between these two sides because both sides are motivated to get there. The ball case is, well, the ball case is also that valuations are looking more attractive. The ball case is the growth earnings expectations are pointing higher. The question is, are those earnings expectations and the growth we're looking at S&P 500 for the next quarter, looking at growth expectations of 20% earnings growth expectations. Is that factoring in the kind of inflation and growth shock? If that scenario were to happen, then the Fed might not have a choice but to raise rates. And if the Fed were to raise rates in an environment like this, then that in theory is supposed to put downward pressure on the stock market. The second is the Strait of Hormuz. So what's going on there right now? It's closed. It's not closed. European and some other leaders that this is going to take months to negotiate is a fair call that raises the risk that the disruption to all of these supplies causes significant long-term damage when markets are busy pricing for the idea that the worst is behind us. If it stays closed for more than six months, if the conditions with the war worsen, if oil goes up to even $150 or $200 a barrel, which doesn't seem likely as of today, but if it were to, then that supply shock would be very devastating to a lot of sectors, even worse than what it is right now, which would then drive inflation up even more. So again, these are things like transportation, manufacturing, consumer goods, energy costs for data centers. Another thing to mention is that this AI CapEx boom is actually heavily driven by debt as well. A higher interest rate environment does not help with all that debt and combined with extremely elevated oil prices or prolonged effects of war, then that could change the stock market dramatically. But as of today, it doesn't seem like investors are worried because they still think that whatever is happening with the AI productivity thesis still exceeds all of these negative effects. And then the third thing here that would definitely crash the economy is if there are signs that this AI CapEx boom is going in the wrong direction or really isn't generating returns at what was expected. Why do you think that investors are beginning to lose patience with the amount of money, the amount of debt that is concerning AI and data centers and the investments here? Part of the problem has to do with a reliance on single customers. So Oracle has really become the poster child for why debt might be problematic. And that has to do with the fact that the vast majority of its backlog comes from a deal with OpenAI to the tune of $300 billion. And so they are committing to this kind of infrastructure build-out before any of this capacity comes online and before OpenAI has paid its bill. The Mag7 overall has put in $700 billion into AI infrastructure. And that is huge. So is AI actually going to replace knowledge workers? And is AI going to reshape labor markets? Or will that $700 billion basically just turn out to be a huge misallocation of capital if something goes poorly wrong? If you think about it, back in 2008, when there was a financial crisis because of subprime mortgage loans that defaulted, that actually made up a very, very, very small part of the entire housing market. It was something like 4% of all loans. And that was enough to crash the whole system. The financial system is quite sensitive, actually, to these small cracks. If we go back even further, back to 2001, the whole reason why the dot-com bubble burst was because it started to become clear that these internet companies were overvalued and they were not generating returns that their valuations implied to their shareholders. So if AI earnings do end up disappointing, which we're going to see play out for the rest of the year and for the next couple of years to come, then that will definitely significantly impact the stock market.