Latest / The PhilStockWorld Investing Podcast / 🤖 Q3 Mark-Up: Tariffs, AI, and Policy Risk

Transcript

🤖 Q3 Mark-Up: Tariffs, AI, and Policy Risk · The PhilStockWorld Investing Podcast

• 0:00
  Penny: Welcome to the deep dive. We've got quite the stack of sources you sent over financial reports, trading desk notes, analysts takes all zooming in on the, really explosive end to q three twenty twenty five. We saw major indices hitting new all time records, a period we're calling the markup.
• 0:16
  Roy: Exactly. And our mission today really is to unpack whether this markup has legs.
• 0:21
  Penny: Yeah.
• 0:21
  Roy: Is it built on solid growth or is it more like what some of these sources are hinting at a fragile macro mirage? Because while this euphoria we're seeing now is such a stark contrast to the first half of the year which is all about tariffs and turmoil.
• 0:37
  Penny: It's a really dynamic picture. Market policy, these policy cliffs looming ahead, and of course, the AI super cycle just keeps accelerating. It's complex. So maybe let's rewind. Let's start with q one because that really set the stage with all that turbulence.
• 0:49
  Roy: Oh, q one was a rough start to 2025. Definitely. Traders were calling it the tariff terror. We saw these big sweeping trade policy changes just drop and bam, they hit global supply chains almost immediately.
• 1:00
  Penny: And the market reaction was, well, pretty violent, wasn't it? S and P down 4.6%, but the Nasdaq, which is always more sensitive to global stuff, it just got hammered down what, 10.4%? Devastating.
• 1:12
  Roy: Absolutely cratered, and the scary part, the economic data actually backed up the market's fears. That first official Q1 GDP number, it showed an unexpected contraction, minus 0.3%. Now that was the first economic shrink we'd seen since what, early twenty twenty two?
• 1:28
  Penny: Right, and a contraction plus higher costs from tariffs. Yeah. That's basically the textbook definition of stagflation risk, isn't it? Slow growth, sticky prices.
• 1:37
  Roy: Precisely. It put that risk right on the table from day one. A really defensive mood took hold. But then, almost as fast as it dropped, q two arrived and boom, this huge reversal. Yeah.
• 1:46
  The melt up mirage.
• 1:47
  Penny: Yeah. That's where the policy whiplash really kicked in. You have the administration doing that ninety day tariff pause for some allies, a bit of temporary relief. But what really drove that q two rally? Was it the whole economy bouncing back?
• 1:58
  Roy: Not really. No. It wasn't broad based at all. It was almost entirely powered by a handful of mega cap tech stocks.
• 2:05
  Penny: Mhmm.
• 2:05
  Roy: You know the names. Microsoft, Meta, and especially Nvidia. They were just posting these monster earnings all driven by AI hype. They pretty much single handedly dragged the market back up from those April lows.
• 2:17
  Penny: But even with that tech surge, wasn't the underlying economic picture still showing some serious strain despite the official q two rebound number?
• 2:25
  Roy: Oh, absolutely. The headline q two GDP figure bounced back sharply. Yeah. Plus 3.3%. That was great.
• 2:30
  Right? Right. But dig into what companies were saying. The tariffs were still biting hard. General Motors, for example, specifically called out a massive, $1,100,000,000 negative hit to their operating income just from tariffs.
• 2:43
  Penny: So headline screams growth, but manufacturers are feeling the margin squeeze. It it really shows that split, doesn't it? The AI giants can maybe absorb or pass on those costs, but old school heavy industry, they get squeezed.
• 2:56
  Roy: That's the key split from the first half. Yeah. Mhmm. A bifurcated market. Yeah.
• 2:59
  And tech was winning that fight clearly.
• 3:01
  Penny: Okay. So let's jump to q three. Because this is where things get really interesting, where the market narrative just completely flipped on its head leading to this record breaking markup. Indices soaring, but driven by, well, fundamentally bad news for the economy.
• 3:16
  Roy: This is the pivot. It's crucial to understand this. For months, right, the market was pinning its hopes on the Fed cutting rates. But the assumption was that inflation would cool down on its own.
• 3:27
  Penny: Which it wasn't really doing. Inflation stayed pretty stubborn.
• 3:30
  Roy: Exactly. So the real catalyst came in early September. The labor market finally showed clear signs of cracking. That August non farm payrolls report. A huge miss.
• 3:40
  Only 22,000 jobs added. And worse, they revised the previous months down so much that it actually wiped out jobs a net loss of 21,000 over the prior reports combined. The labor market basically stalled.
• 3:52
  Penny: And the market saw that and cheered. No recession fear, just euphoria.
• 3:56
  Roy: You got it. That weakness was seen as the final piece of the puzzle. It basically guaranteed a September rate cut, in the market's view. The thinking was, if the economy is slowing that fast, the Fed has to step in, right? Prioritize jobs over fighting inflation for a bit.
• 4:12
  Penny: It's completely backward, but it makes sense in a weird way. Bad news is good news because it means more Fed support, and that conviction sent everything flying, Dow blasting through 46,000.
• 4:22
  Roy: But here's the risk, and it's a big one. The market is essentially betting the Fed will just ignore how sticky inflation actually is. Remember the August Beige book? That's the Fed's own snapshot. It confirmed companies everywhere were getting squeezed by rising input costs, many linked back to tariffs.
• 4:39
  This inflation isn't going away easily, but the market is only seeing the rate cut side.
• 4:43
  Penny: Okay, so that macro tension leads us right into the structural risks people are worried about. Let's dig into the AI Supercycle Skepticism first.
• 4:51
  Roy: Yeah, the warnings are definitely getting louder. Yeah. And more specific. People are drawing direct lines back to the .com bubble excesses. The big concern is this idea of circular AI money flows.
• 5:02
  Penny: Circular money flows. Can Can you break that down a bit?
• 5:04
  Roy: Sure. Basically it means a lot of the perceived growth in AI might just be the big tech companies funding each other's spending. Think about it. Nvidia sells GPU's to Microsoft. Microsoft pumps billions into open AI.
• 5:19
  OpenAI needs huge server farms often from Amazon or Google Cloud. It's like a closed loop where they're buying and selling from each other inflating the sense of external demand.
• 5:29
  Penny: So when we read like Alibaba is dropping $50,000,000,000 on AI, is that real end user demand driving it? Or is it more like a strategic arms race fueled by investment dollars, not necessarily immediate profits?
• 5:42
  Roy: It leans towards the latter in many cases, yeah. It definitely pushes valuations up across the sector, sometimes without a clear link to broad sustainable profit growth outside that tech ecosystem. That said, you got to be careful not to paint everything with the same brush. Some AI players do have real substance. Google for instance gets mentioned a lot Gemini, DeepMind, TensorFlow, they have massive existing businesses throwing off cash.
• 6:03
  It's not just hype there.
• 6:04
  Penny: And that structural risk, the potential AI bubble, runs smack into the policy cliffs we're facing now. Like stubborn inflation.
• 6:12
  Roy: Absolutely. Let's look at the Fed's preferred number: Core PCE. Personal consumption expenditures minus food and energy. The latest reading. Still sticky.
• 6:22
  2.9% year over year. That's what, nearly 50% above the Fed's 2% target?
• 6:28
  Penny: And that number definitely lines up with some of the more hawkish things we've heard from Fed officials lately.
• 6:34
  Roy: It really does. Cleveland Fed President Hanna gave a pretty pointed speech recently. She highlighted that inflation pressures, especially in services think insurance, healthcare, those aren't just about tariffs, they're stickier. And she warned inflation will probably stay above that 2% target for another year or two.
• 6:51
  Penny: Which totally clashes with the market pricing in what an 89% chance of an October rate cut? Market thinks the Fed's going to fold way sooner than Hammock suggests.
• 6:59
  Roy: It's a massive disconnect. A huge gamble by the market. And then you pile on the Q4 policy risks, the tariff uncertainty isn't going away, and we've got this government funding deadline breathing down our necks.
• 7:10
  Penny: Right, the shutdown deadline, that's policy roulette, pure and simple. Funding runs out 12.01AM ET Wednesday, we're talking like thirty six hours away now.
• 7:20
  Roy: And this raises maybe the biggest immediate question mark for the market, the potential for a data blackout. The BLS, the Bureau of Labor Statistics, they've said point blank they won't release data during a shutdown. That includes the really critical Friday non farm payrolls report.
• 7:35
  Penny: So the Fed keeps saying we're data dependent but suddenly they could be flying blind without the key jobs number.
• 7:41
  Roy: Exactly. Total fog rolls in right when they need clarity. Yet despite that threat the market actually closed higher yesterday. Just shrugged it off. Confidence in that October rate cut held firm.
• 7:52
  It's like one source said, faith in the Fed is stronger than its fear of Congress. For now, anyway.
• 7:57
  Penny: But you still see the jitters intraday, right? That tariff tape bomb that hit yesterday morning showed how quickly things can move?
• 8:03
  Roy: Oh yeah, classic tape bomb. Nine point three seven AMET. A proposal hits the wires a 100% tariffs on films made outside The US. Specific targeted policy risk.
• 8:12
  Penny: And the market reaction was instant. Sell programs triggered across media and streaming stocks. Disney, Sony, Netflix, Warner Bros. Discovery really took a hit. It even dragged down the whole communications sector.
• 8:24
  Roy: Yeah. WBD got slammed. And that volatility makes the Warner Bros Discovery case study just perfect for illustrating this moment. It's where policy risk slams right into fundamental weakness, makes it a really interesting short candidate according to some of these notes.
• 8:38
  Penny: Okay. Let's unpack WBD then. The stock had that huge run up recently. Right? Up 75% near $20 a share.
• 8:45
  But that was all based on m and a rumors, wasn't it? Paramount, the Ellison bid, pure speculation.
• 8:51
  Roy: Pure speculation. And that hype completely masked the, let's just say abysmal underlying fundamentals. I mean, this company has been bleeding cash since the merger. Back in 2021, they made $2,000,000,000 on $12,000,000,000 revenue. Okay.
• 9:04
  Last year. Revenue ballooned to $37,000,000,000 but they lost $11,300,000,000 Lost.
• 9:10
  Penny: Wow. That's losing almost 30¢ for every dollar that comes in the door. One of the sources had that brutal quote, the best way for them to make money is to shut down.
• 9:18
  Roy: Sounds harsh, it's just the math. Negative returns at that scale are terrible. So then you layer on a potential 100% tariff on international content, doubling production costs outside The US. For a company losing money already, that's potentially catastrophic. It completely kills any M and A rationale.
• 9:35
  Penny: Destroys the premium. The whole speculative case just evaporates.
• 9:38
  Roy: It does. So the actionable idea here was pretty clear: Initiate a short position. You're betting against the fading M and A hype and this new, very real, tariff headwind. It's disciplined based on fundamentals meeting policy risk.
• 9:53
  Penny: Right. So while WBD is getting hammered, let's pivot to where the money was flowing yesterday, where the strength looks more genuine. We saw capital moving into those AI infrastructure plays the picks and shovels as they say. That big storage rally stands out.
• 10:07
  Roy: Yeah. This is a key structural theme. Western Digital WDC pops over 9%. Seagate STX up over 5%. This isn't just day trading, this reflects real investor belief in a strengthening cycle for hard disk drives driven
• 10:20
  Penny: purely by the massive data demands of AI.
• 10:22
  Roy: Exactly. The core idea is simple: data is the oil that runs AI. These AI models need absolutely enormous amounts of storage, persistent storage, and HDDs offer that bulk capacity relatively cheaply. It's a structural demand shift. And you see it reflected in analysts' conviction too.
• 10:39
  Morgan Stanley jacked up their price target on WDC from $99 all the way to $171 That's real belief in the cycle.
• 10:47
  Penny: And it wasn't just storage. The utility sector was strong too, linking back to that other huge need for AI power.
• 10:54
  Roy: The AI power narrative is becoming a really big theme. You're seeing reports about wholesale power costs spiking your data centers. The demand is potentially exponential and it requires huge investment. Look at PG and E out in California. They just announced plans to spend $73,000,000,000 on capital projects by 02/1930, largely to meet this expected AI driven demand.
• 11:14
  Penny: 73,000,000,000. That number alone tells you the scale, the tangible cost of building out AI. And it explains why certain utilities start looking like defensive growth plays almost regardless of the broader macro picture.
• 11:25
  Roy: That contrast is so important. WBD losing money hand over fist versus PG and E investing billions to meet verified future demand. It really clarifies the mandate for Q4. Stay disciplined. Keep hedges on.
• 11:39
  Focus on companies with that kind of defensive growth. Real fundamental underpinning.
• 11:44
  Penny: And part of that defensive stance involved holding a dual hedge. Gold was a big one yesterday, hitting a new record high $3,855.2 an ounce. Classic flight to safety move against all the political risk and that sticky inflation.
• 11:58
  Roy: But the strategy outlined in these sources was specific. It wasn't just buy gold, it specifically cautioned against chasing momentum in the gold miner ETFs like GDX.
• 12:07
  Penny: How interesting. Why avoid GDX if gold itself is rallying? Doesn't the ETF give you that broad exposure?
• 12:13
  Roy: It does, but the argument is GDX is already up, like 100% this year. It's had a huge run. If you pile in now chasing momentum, you might be buying a basket that includes a lot of miners that are actually now overvalued, just carried up by the tide. The focus instead was on finding individual mining companies that are undervalued based on their actual assets in the ground.
• 12:31
  Penny: Okay. So more of a value play within the gold space, like the example cited, Gold Fields, GFI.
• 12:35
  Roy: Exactly. GFI was highlighted as potentially being 331% undervalued just based on their proven reserves and production profile. It's about intrinsic value, not just chasing the hot trend. In a choppy market, that asset value provides a potential floor that pure momentum doesn't have.
• 12:52
  Penny: Okay. So wrapping this up for you, the listener, as we head into q four, it feels like the market ended q three on a high. Right? Driven by these two big hopes, fed rate cuts are coming and the AI infrastructure build out is real and powerful.
• 13:05
  Roy: But Q4 starts immediately staring down these policy cliffs. The shutdown deadline is literally hours away. The tariff situation is still messy and inflation isn't gone despite what the market wants to believe. It just screams caution, discipline, active risk management.
• 13:20
  Penny: And that immediate uncertainty, it really is fascinating. If congress doesn't get a deal done, if we get that data blackout from the BLS, the market's gonna have to guess what the Fed will do without that crucial Friday jobs report. What happens when a data dependent Fed suddenly loses its main data point? How does the market react to that uncertainty? That might be the first big test of October.