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We are back to the pre-war playbook of the AI datacenter boom and the manufacturing renaissance. While both fiscal and monetary stimulus are hitting the economy, the driver of growth remains the massive AI cap-ex boom. Large cap tech alone will spend over $700bn this year or nearly 2% of GDP. That’s a pretty good starting point for GDP. The risk to these numbers is to the upside. News of Anthropic’s Mythos marks an important milestone for AI’s progress (and raises significant concerns). It reinforces the point that AI agents are here. It will force executives to spend and to spend for a lot longer. Google’s Cloud CEO said, “I think for the next 10 years, there will always be more demand than supply...there’s always a shortage, there’s never enough.”
This spending is showing up by exploding demand for compute. OpenAI’s President sums it up well by saying, “I think we are heading to this compute-powered economy. There’s not going to be enough compute in the world to meet the demand.” Uber is a great example of this problem, the CFO said, “I’m back to the drawing board, because the budget I thought I would need is blown away already.” This was said in April and they already blew their whole annual budget! Google’s token demand is up 60% over the last quarter. The hourly rental rate for one of Nvidia’s most advanced Blackwell chips is up 48% over the past two months. Meta is extending the useful life of servers due to the significant supply deficit.
The supply side remains constrained across the value chain from energy to compute. GE Vernova reported that its order book is up 71%. They are sold out through 2028. SK Hynix chairman said that the chip shortage is likely to persist into 2030 with the short fall exceeding 20%. Corning’s earnings more than doubled. Teradyne reported 87% growth in its semiconductor business. Even Texas Instruments reported 90% growth in its datacenter business. ASML’s (an early cycle indicator) CEO said, “both our Memory and Logic customers are responding to this unprecedented demand by increasing capital expenditures and accelerating capacity expansion plans this year and beyond. Those investments are supported by long-term agreements with their own customers... I think I mentioned before, we see our customers having a lot less hesitation to really accelerate their capital expenditure.”
The stimulative impacts of OBBB are starting to hit the economy beyond AI. The longer-term impact will come from immediate expensing of capital expenditures. There have been $5.1 trillion in investment commitments to bring manufacturing back. While not all of it will come through, immediate cap-ex expensing from OBBB will serve as an incentive this year. Business investment is expected to increase by 5.5% this year. Commercial and industrial loans are up 7.4%, the biggest jump in years. This is a sign confidence is increasing among executives. United Rentals, which rents out various construction and industrial equipment, is a good bellwether for expanding manufacturing and industrial activity. United Rentals’ stock was up 20% post-earnings after beating earnings and raising guidance. Vulcan Materials, another early cycle indicator, reported 7.4% revenue growth. The manufacturing renaissance is starting to be reflected in the macro data too. Durable goods orders meaningfully accelerated last month. PMIs are now firmly in expansionary territory. The latest PMI Manufacturing Index hit the highest level in years. Certain regional manufacturing data is exploding higher. For instance, the most recent Philadelphia Fed's manufacturing index crushed expectations. Philadelphia, Richmond, and Dallas Fed’s index saw new orders hitting the highest level in years.
Industrials are at the intersection of the AI boom and manufacturing renaissance. They benefit from most major secular themes ranging from increased global defense spend, AI and infrastructure buildout, increased focus on domestic manufacturing, on-shoring / regional supply chains, and a new aerospace cycle. Industrials will have the second highest earnings growth next year, growing in the high-teens. These names benefit both from the AI buildout and margin expansion from AI implementation. Industrials outperform when PMIs bottom and turn up. In particular, when PMIs are less than 47 and turn up, the 12M forward return has historically been 22%, with a 95%-win ratio. Within industrials, transports are in a sweet spot. Capacity has been taken out of the system for years, while demand is growing with the manufacturing renaissance, leading to pricing power. JB Hunt’s conference call sums it up well, “what we’re seeing is a freight market that has fundamentally less slack than it did in prior cycles. Capacity has been steadily exiting for an extended period, driven by regulatory enforcement, rising costs, and financial performance that does not support capital reinvestment. Even if spot rates increase, capacity continues to lead the industry.” CSX for instance, not only has pricing power to drive top-line, but it is also seeing significant margin expansion through efficiency and technology. They grew earnings 26%, expanded margins by 560 bps, guided to another nearly 300 bps of margin expansion and 60% free cash flow growth. Similarly, Union Pacific reported that free cash flow margin was up to 24.2% from 7.8%. Old Dominion reported revenue per shipment up 5.9%. They trade cheaper than a market multiple for double digit growth. Positioning is light, as most investors are focused on tech. Hedge funds have net sold the group in 10 of the last 12 weeks. The net allocation is now in the first percentile. Norfolk Southern reported a mixed quarter, but the stock moved positive, an indication of the positioning within the group. Technically, they broke out of a nearly 5-year base, retested during the March correction, and are now breaking out. Historically, when we have had similar returns for transports, the forward return one-year out is 17% on average with a 98%-win rate. Transports breaking out and hitting all-time highs is one of the best leading indicators of economic momentum.
Looking forward the market will focus on geopolitics, earnings, the latest in AI, and the Fed.