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CIARAN RYAN: The JSE has hit another all-time high, as have the Nasdaq and the S&P 500. All of this is happening while [US President] Donald Trump has imposed tariffs on US trading partners, which could result in higher inflation. That hasn’t happened yet, but there appears to be an attempt globally to balance the books and bring government spending under control. It’s a messy scene with lots of moving parts.
To help us make sense of all of this, we’re joined once again by Adriaan Pask, chief investment officer at PSG Wealth. Hi, Adriaan, thanks again for joining us. What do you make of all of this? What are the major areas of concern impacting global markets in your view?
ADRIAAN PASK: Thanks, Ciaran. It’s good to be here. With so much happening at the moment, it can be difficult to separate the truly important issues from the noise – especially since everything feels important. What helps us in a research environment is stepping back and grouping the broader themes into key areas that are most likely to drive long-term outcomes.
Take tariffs, for example. While they are important, we view them as largely cyclical – something that won’t last forever. During Trump’s first term, similar measures were introduced, only to be rolled back when Biden took office, and now they’ve resurfaced. This highlights a clear cyclical pattern.
By contrast, the other factors we’re watching may also have cyclical elements, but their cycles tend to be longer, more impactful, and carry greater risk.
I see three broad areas of focus. The first is the US fiscal strategy, which is critical because it drives three key components of the financial system: the dollar, US bonds – which influence global bond markets – and gold. Whether [or not] the US continues running large deficits and expanding, its debt will have significant implications for all three, and, by extension, for other asset classes.
The second area of concern is the technology capital expenditure (capex) cycle. While much attention is given to the valuations of tech stocks – the so-called Magnificent Seven – what I find more important is the underlying capex cycle.
Valuation debates matter, but the bigger risk, in my view, lies in how this investment cycle evolves. So, what they are currently spending on capital projects has fundamentally transformed the nature of these businesses, and these things will have a significant impact on how they report going forward and what the results will be on free cash flow versus headline earnings. That’s where the debate gets a bit more complex, but we can delve into that in a minute…
The third area is investor behaviour. If a crisis is going to emerge, this is where it’s most likely to come from. We’re seeing abundant capital, relatively loose financial conditions, and a large amount of money in circulation – all of which create the potential for instability.
Asset prices are up. Everybody thinks that it’s quite easy to invest and find the right stocks because things are just going in one direction, there are lots of speculative products being launched, and these are all signs of excess. It’s not encouraging the right investor behaviour, and it’s creating pockets in the market that might introduce other risks.
We’ve sort of touched on private equity before, and private equity is not necessarily a bad thing, but there are definitely some areas that we need to take note of in terms of why clients are going there. Do they fully understand the potential risks out of that environment, and what a broader unwind could look like if we were to find some blowups in that space? I don’t think people have generally applied their minds sufficiently to those things.
These are the three broader areas that deserve closer attention, not only from investment professionals but also from the average person who may be distracted by day-to-day headlines like Trump’s tweets. If a crisis or market shock is to emerge – which is almost inevitable – it will most likely stem from one of these three areas.
CIARAN RYAN: And if you were to rank those three in terms of area of importance, which would be the biggest risk to your portfolio?
ADRIAAN PASK: I think the US fiscal strategy is a concern, but it’s been such a long scene. They’ve been in deficit for decades, and things just continue along that road. So, who knows how long it can continue? It seems like the bond market, the gold market, and the dollar are starting to wake up to the realities that this is not sustainable.
The continuous debate is: ‘It’s the reserve currency of the world. So what’s the problem? We’ve got blank cheques, effectively.’ The reality is, it just doesn’t work like that, and we can see some of that having an impact. Now we see higher bond yields, we see higher gold prices, and we see a weaker dollar. Those are all very direct outcomes of the US fiscal strategy and the concerns around that.
But that being said, I wouldn’t put that as my primary concern over the short- to medium term. I think what we see in the technology capex cycle is something that could come reasonably soon…. My view is that in terms of technology capex, it really is peaking at the moment.
If we look at some of the capex that’s being spent by these Mag Seven companies, it’s completely off the charts if you were to go back in time to see how the spending a few years back compared. For example, in 2014 total capex for the Mag Seven, which they spent on things like data storage centres and those kinds of things, was $23 billion for them combined. Meta has recently come out saying that they will spend $65 billion just next year.
So, if you look at what is being forecast, next year it’s around $300 billion that they’re going to spend on capex. But if you look at profits out of the Mag Seven at the moment, it’s around $600 [billion]. That’s going to create a significant headwind.
And I think at the risk of making things a little more complicated, the accounting here is really important. So, typically what happens with capex is you spend money off the balance sheet into these capital projects, you buy new data centres, or you spend money on chips, or whatever you’re doing, but then you depreciate or amortise that expense over time.
So, typically, the process would be something along the lines of: I’m buying a new chip from Nvidia, I’m spending X billion on these chips, but I don’t have to expense it in my income statement. I can take it off my balance sheet and appreciate the cost over a period of five years.
So slowly but surely, you can release that, and it doesn’t really impact your headline earnings; it impacts your free cash flow.
But if you take on too much capex, then you run into a problem where you’ve got to run multiple tranches of depreciation for the various elements of capex that you incurred every year – and that starts to build up materially into a depreciation cost that becomes a big headwind for headline earnings in future years.
So you’ve got to be pretty sure that, whatever you spend on that new infrastructure, you’re going to get commensurately a payment back or a gross [amount] back out of it. And, if you’re spending to the extent that these guys are spending at the moment, they’re going to have to make substantial, substantial profits to offset their associated depreciation cost.
In my opinion, they’re starting to stack the odds against themselves. But the reason this is happening is almost [because] they have no choice. If you don’t spend, you’re going to be left behind, and your fate is sealed in any event. The one who spends the most will likely succeed. But that’s a dangerous game to play, because inevitably some of these could fail, and some of these will over-allocate out of fear. So, there’s a complicated dynamic at play.
I think what we shouldn’t miss in this is that the whole argument for these businesses at the start of 2014 was that they were not spending on capital, they were capital-light businesses. They’ve got fantastic operating margins. They use network effects and subscription services, and other things, to be quite profitable. Now, all of a sudden, these are very capital-heavy businesses and over time, that erodes margins. That’s the part that worries me.
So, I think the concerns around tech valuations are valid, but largely because of what we see in the capex cycle at the moment. It is very elevated levels of capital being built out.
It’s not the first time we’ve seen this, actually. If you cast your mind back to the dotcom bubble, we saw similar things happening. Cisco was the largest company in the world at that time; it was incurring similar capex, and it ran into similar issues in due course.
So, we’ve got to be very careful that these guys don’t run into similar problems. It doesn’t make them bad businesses, but the business models are fundamentally changing. If you look at their financial statements, you can see these businesses are in a completely different space from where they were ten years ago.
And then on the last one in terms of speculation, I think that invites all sorts of other things to creep in, in terms of speculative behaviour. So we might see something in the private-equity space where we are seeing some of the larger endowments around the world trying to exit these private-equity investments, and that could have a significant impact on liquidity, which might lead to something.
To get back to your question in terms of how I would rank these, I would think it’s quite tight between the speculation and what we see in the capex cycle. I think both of those [factors] could be imminent, and the one could actually cause the other. If we see financial distress in the tech stocks, we might see more distress in private equity, or vice versa. There’s the chance that those might coincide.
And then more broadly in the longer term, unless the US can find a way to turn things around, they’re going to run into some debt problems. We can already see that the market is agreeing with that view in terms of where the bond price, gold price and dollar have been moving towards.
CIARAN RYAN: Yes, it does begin to take on a little bit of the colour of the dotcom boom that we saw 25 years ago, as you mentioned. But if you look outside technology sectors that we’ve spoken about, where do you see AI having the biggest impact? In pharmaceuticals? Is it in engineering, or is it across the board?
ADRIAAN PASK: I think it’s across the board. But what’s interesting to me is that, if you speak to the experts around us, they seem to think healthcare is the one area that could really materially benefit from AI spending. Yet it’s the one sector that really did not benefit from the AI sentiment change. That area of the market has been a laggard. That’s interesting.
And if you look at what most of these companies outside of the Mag Seven say that they will likely spend on AI, it’s about 3% of revenues. Will that be sufficient to drive revenues going forward? Given the amount of capex that is currently being spent, that’s not enough.
So, we’ll have to see whether there is another race developing in terms of the various other sectors that feel compelled to invest in AI so that they can stay ahead.
But it feels to me exactly like the internet situation, in that people invested in internet companies initially and dotcom companies, but the beneficiaries, if you think about it, also translated into, especially online retailers, for example. Those were beneficiaries because the infrastructure of the internet enabled consumers to shop online. So, you’ve got to really think carefully about how AI can help.
I think there are various applications around. Logistics, for example, is a big one. Security is another, even defence. There are arguments being made around how that could improve.
But for me, it’s almost more important to think about which management teams have exhibited a good track record for assessing opportunity and risk and have been quite nimble in their approach to adjust their business models proactively to benefit from changing market conditions – whether it be AI or anything else. Because if you’ve a good management team that spots these things early, I think you’re in a better position, because it’s still very possible that you find an area in the market that will benefit a lot from AI, but the management team is just not in a position where they [are] open-minded [enough] to absorb these new processes and efficiencies into their businesses.
If you think about our local environment, we know what happened between Shoprite and Pick and Pay, for example, through Covid-19, and how the two different teams operated very differently. That set the two businesses on very different courses into the future in terms of success and profitability.
So you’ve got to be careful in the sense that you don’t broadly assume that a specific sector will universally benefit from these changes. For me, the management team is actually more important.
CIARAN RYAN: Finally, Adriaan, let’s just wrap this up for investors. What is the optimal approach to building wealth with all these moving parts and all this uncertainty in the market?
ADRIAAN PASK: I think that probably relates to the level of speculation that we see at the moment. Especially in US markets, you can see investors are being lured into all sorts of things, investing out of the conventional sphere, and often it’s being masqueraded as democratising investment into sophisticated things.
But in reality, many of these products are not really suitable for a financial plan for the average Joe. Even where some institutions use it, they use it very sparingly and, in some cases, as I’ve mentioned, they try to exit some of these things because risks are starting to rise.
So I think when it comes to as an individual trying to take all of these things into consideration and managing for them, it’s very important to be clear on what you want to achieve with your capital and your savings because it is very easy to be lured into something that has a promise of higher returns but hasn’t been tested in a previous market cycle – or has an element of uncertainty attached to it.
So, despite all these new things being on the market at the moment, I think it’s actually a really good time to focus on the more conventional things that have stood the test of time – things like just conventional equities. People know how they work. They are fairly transparent. If you have a disciplined process, you use a skilled active manager, you are careful not to overpay, and you think about when and how you interact with your investment in terms of being disciplined around this investment policy – if you’ve got those things in place, I think you are fine.
So, to summarise, have a clear plan of where you want to go. Identify what your true risk appetite is and use things that are dependable and have been tested throughout time to ensure that you’re not lured into any speculative areas or overpay for things that haven’t demonstrated their true worth.
CIARAN RYAN: Sound advice there from Adriaan Pask, chief investment officer at PSG Wealth. Thanks very much once again, Adriaan, for joining us.
ADRIAAN PASK: Thanks, Ciaran. It’s been good to chat to you, and thanks to everybody listening. I hope you found it useful.
Brought to you by PSG Wealth.
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