Barron's Streetwise - Quantum Computing Stocks Are Going Nuts. Plus, the Outlook for Bonds.

Episode Date: December 20, 2024

Jack struggles to make sense of Schrodinger’s Cat and QTUM’s gains. And Schwab’s Kathy Jones talks fixed income strategy. Learn more about your ad choices. Visit megaphone.fm/adchoices

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Hello and welcome to the Barron Streetwise podcast. I'm Jack Howe. And the voice you just heard is Kathy Jones. She's the chief fixed income strategist at Schwab, and in a moment, she'll tell us what to do about bonds. But before that, I will bravely try to answer a listener question about quantum computing. I say bravely because I might not quite understand all of the scientific concepts involved. And when I say not quite, I mean not at all. And when I say all of the concepts, I mean any of the concepts.

Listening in is our audio producer, Jackson. Hi, Jackson. Hi, Jackson. Hi, Jack. I'm not afraid to tackle the, you know, the thick academic stuff. We've done deep dives on fertilizer in this podcast, right? We've talked about the Haber process, right? I mean, I'm not afraid to roll up our sleeves and really get in there. Yeah, you compared oil refining to the gin still

on the TV show MASH. That's right. You also talked about the difference between polypropylene and polyethylene recycling. Two of my favorite polys. But we might be getting in over our heads on this one. Let's give it a try. We have a listener question, right? Yeah, Remy wrote in this question, so I'm going to summarize it here. Okay. Remy notes that quantum computing stocks have been surging over the last couple of weeks, months, and asks, what even is quantum computing? And Remy's skeptical and worries that quantum stocks are part of a larger tech bubble. and worries that quantum stocks are part of a larger tech bubble.

Thank you, Remy. You have come to the right place, because while I don't understand quantum computing, I did just write a column for Barron's Magazine titled, How to Pretend You Understand Quantum Computing. This goes back to a book that I've mentioned on the podcast that my brother bought for me many years ago called, How to Talk About Books You Haven't Read. And I never opened it, but I still have it somewhere. And I like to think that I live by its principles. Does this mean you're able to talk about the new Kendrick album? I mean, as a matter of fact, I am familiar with a clip of one song that I heard and it said Kendrick and someone was shouting Mustang. So I went to my daughter and I wanted to show her that I know the new music. So I said, Mustang. And she said,

first of all, it's mustard and you're embarrassing yourself. So I guess if that, I guess that's what I know about Kendrick. Well, I'm totally not Googling right now, but apparently mustard is the name of a producer that's been sending rapper kendrick lamar beats every single day uh for the past six months and he finally made a song on that beat mustard i'm sure your stuff is great now i know so if you're wondering why quantum computing why now there are two good reasons the first is a recent announcement by google about their quantum computing chip called Willow. And there was a guy with kind of longish hair and a windbreaker and sneakers. And he looked like the kind of guy who can probably bend metal with his mind,

but has decided to use his powers for good or has been paid enough to do that by Google. And he said, for good or has been paid enough to do that by Google. And he said, Our logical qubits now operate below the critical quantum error correction threshold, a long sought after goal for the quantum computing field since the theory was discovered in the 90s. And I had a few questions about that statement, like what's a qubit and what's the error correction threshold and why is it so? And so on. But the upshot for Willow is that Google says it can perform a benchmark calculation in less than five minutes that would take today's fastest supercomputers longer than the age of the universe. Pause for dramatic effect. Jackson, I characterize that as a dunk, right?

That's not like a close call. That's not a photo finish. We do this thing in less than five minutes. It takes your machine longer. I think they said 10 septillion something. There was a number involving like 25 zeros. It takes your machine longer than the age of the universe. You just got dunked on. In your face, supercomputers. Tough week for supercomputers. And apparently they're being modest because the real figure is 14 times the age of the universe. Okay, so whatever we're dealing with is very fast, and it has potential in fields like drug discovery, but also in code breaking and cyber warfare. And the second reason to talk about this now is, as Remy says, the stocks are going nuts. And they've gone even more nuts since your column came out. One stock that you mentioned

went from $7. Now it's at $19.71. That's amazing because at the time that I wrote this last week, I looked and there was something called... I basically said that a good investment approach this year had been to buy anything with quantum in the name. There was something called quantum computing that was up 584% year to date. There was D-Wave quantum up 344%. And there was one called quantum corp that was up 154%. That last one, quantum corp, they don't even do quantum computing. That just has the word in the name.

And there were some others that don has the word in the name and there were some others that don't have quantum in the name but are involved in quantum computing there was rigetti computing that was up 547 percent this year and ion q up 148 percent and yes there is an exchange traded fund for quantum computing it's called defiance Quantum ETF, and the ticker is QTUM. I would not call it a pure play here because some of the stocks it holds are stocks that might benefit or some companies that are peripherally involved. So that one I checked was up 38% this year. But it was beating another fund called Global X Artificial Intelligence and Technology that was up 29%. In other words, quantum computing is doing

better than AI this year in terms of stock market performance. So let me jump right to my explanation of quantum computing. And since I don't understand it myself, I'm going to do what I did in the column, which is I'm going to explain how to pretend that you understand it. The first step is you want to explain to some colleagues at the office gathered around the water cooler that classical computing is based on bits, right? Data is stored in two possible states, zero or one. And then you tell them, that's why we call them bits. You say, it's a portmanteau for binary digits. And you should pause there because not everyone will know what a portmanteau is, so make a motion with your hands like two words being mushed together.

Now tell them that quantum computing is based on something called qubits, and tell them that's with the letter Q, so they're not picturing like the qubits that they talked about when they were building Noah's Ark in the Bible. That's different. A qubit is a unit of measurement that's based on what's called a superposition of multiple possible states. And the reason this is hard to understand is that it comes from quantum mechanics. That is the science of how subatomic particles behave. And it's

totally different from classical physics or how all of the objects around us behave. Some of the rules in quantum mechanics are bizarre. Particles can be in two states at the same time until they're observed. There was an Austrian scientist named Schrodinger who tried to explain this to normals by telling a story about a make-believe cat trapped in a box with an unstable radioactive material that may or may not decay, and that may or may not trigger a Geiger counter, which may or may not release poison, so that you're not quite sure whether the cat is dead until you open the box. As quantum mechanics would have it, the cat is both alive and dead in a superposition of both with a certain probability of each. As I wrote in Barron's, for me, this only raises more questions, including whether Schrodinger had pets.

This was in a movie. Jackson, you ever see that movie, A Serious Man? Oh, the Coen Brothers 2009 film. Coen Brothers are the ones who made Fargo and No Country for Old Men. I've heard it said that every other film they made is great. I'm not sure where this one fits in, but there's a scene that talks about Schrodinger's country for old men. I've heard it said that every other film they made is great. I'm not sure where this one fits in, but there's a scene that talks about Schrodinger's cat. In one scene, the subject of the movie, a professor is writing on a chalkboard.

And then the camera pulls out to show that the chalkboard is much, much bigger than you initially thought it was. And it's totally filled with figures. And the professor says, The uncertainty principle. It proves we can't ever really know what's going on. Later, there's a discussion with a student complaining about his grade. And he says, you know, he might not understand the math, but he says, I understand the dead cat. And the professor says, these are just stories that he tells during the class to illustrate things.

He says, even I don't understand the dead cat. Okay, so if the professor doesn't even understand the dead cat, what hope do I have? It's confusing to me how a thing can be two things at the same time, as long as you don't look at it. But these are some of the rules of quantum mechanics. This is superposition, and you can skip it when you're explaining the whole affair to your colleagues. You can also skip terms like entanglement and decoherence and interference.

If any of your colleagues chime in with questions that involve those terms, it means they know more than you do about the subject. I recommend you fake a sneezing fit and leave immediately. Here's the bottom line about using computers that are based on the quantum world. Classical bit-based computers, those are what they call deterministic. They have to solve problems by trying solutions one by one sequentially. That slows things down. Quantum computers can be probabilistic. They can start by thinking about the likeliest solution, which saves a lot of time. They're also massively parallel. You might say the

quantum computers are more human in their thinking, except they don't run on a ball of wrinkled fat in a skull. Now, when you're pretending to understand quantum computing, you don't want to give your audience more than they can handle. I recommend you wrap up with a gee whiz thought. You explain that since subatomic behavior forms the foundation of our universe, all systems are effectively built on quantum systems. And that includes traditional computers. They just don't yet use quantum properties in their calculations. And then you stare off into the distance to appear insightful, and you don't mention that you got that from this

podcast and that I got it from an IBM blog. That kills the mood. Okay, so back to Willow, Google's chip. The breakthrough for Willow is to exponentially reduce errors as the system expands. That's the opposite of what typically happens. What typically happens is that the errors increase as the system expands, and eventually the system loses the special properties that make it a quantum computer. But Google says it has solved this problem. Commercial uses for quantum computing could be years away. But B of A's analyst on shares of Google owner Alphabet,

his name is Justin Post, he writes that quantum innovation at Google is already building a significant technology moat for the company. And he says it's not reflected in the stock's valuation. If you want to know where we are on the cycle in this thing, I'd say we're at least five years too early for the meaningful cash flows that will one day flow from quantum computing. And we're also more than five weeks late on the rip roaring stock market gains accruing

to companies that don't yet make money from these pursuits. And if they do become commercially available, what are they for? I mentioned drug discovery and encryption. Quantum computing is also a natural fit for machine learning and artificial intelligence. We may discover more uses for quantum computing as the technology becomes more available. At the beginning of 2024, D.A. Davidson wrote that in five to ten years, the most demanding computing might already be done on quantum machines. And they wrote that that could make NVIDIA vulnerable.

But NVIDIA is not acting like a vulnerable company when it comes to stock market trading. Last I checked, the shares were up around 180% year-to-date in 2024. Computer scientists say that quantum systems are likely to be used only for some jobs in a hybrid arrangement with traditional computers. And NVIDIA has been announcing partnerships that use its chips to make quantum breakthroughs. That's about as much as I can tell you for now on the subject, Remy. I can't say whether quantum stocks are going to go higher or lower. It looks like a hype cycle to me. I think you would ask if it suggests that we're in a broader technology bubble. To that, I'd say some of the biggest U.S. technology companies look impressive enough to justify their valuations, but I do see

a lot of bubbly behavior around the edges. Running up shares of a company just because it has quantum in the name, even though it doesn't do quantum computing, I suppose that qualifies. Let's leave it there. Only let's put a call out for some listener assistance here, because I still can't tell whether Schrodinger's cat is alive or dead or both or what. So if you're the kind of person out there who understands it, and if you can explain it to a guy like me and you can do it in 30 seconds. Is that possible? Put 30 seconds on the clock. Tape a voice memo on your phone.

Email it to jack.how. That's H-O-U-G-H at barons.com. Tell me what in the heck the deal is with that cat and how it makes quantum computers so fast. We'll play the best explanation on the podcast. Unless they all stink. But I have faith in you people. There's smart people listening to this podcast. I know it. And now it's time for a quick break. We'll be right back with Kathy Jones from Schwab on what to do about bonds. Welcome back. We've been talking about quantum computing stocks and stock market hoopla in general

and whether stocks are too expensive. But what do we make of bonds here? I spoke about that recently with Kathy Jones. She's the chief fixed income strategist at Schwab. Let's hear some of that conversation now. So I want to ask you naturally about bonds. Here's one of your recent reports, and it says that the bond market is caught between the Federal Reserve's plan to cut interest rates, that sounds good, and the risk of higher inflation and federal debt levels, that sounds bad.

And there's a picture of a woman surfing here, which can be good or bad, depending on which way this big wave breaks. So which way is the wave going to break for all of us, Catherine? What do we need to know? Well, I think it's more like a series of waves we're looking for. So you've got to probably try and be a good surfer this year and ride the right waves and get back up after, you know, you've ridden one. The issue is, as you stated, we have the good news of the Fed's cutting rates, and that's generally positive for the bond market, but that has largely been discounted. And what doesn't seem to be discounted is the idea that there's a lot of headwinds ahead of us, things like tariffs and tax policy and rising deficit levels. And all those are potentially inflationary or negative

for the bond market. And so we've got kind of the good news, bad news in that rates are likely to drift a bit lower from here, but we've got a lot of things that could send them a bit higher. So is there anything that savers should be doing tactically with their bond portfolio, anything they should be doing differently? Should they favor shorter instruments or favor corporate versus government? Or what are the pockets

that look particularly attractive to you right now? We had been advocates for quite some time of extending duration and not just sitting in cash. But now we think that keeping it wherever your benchmark is or a little bit lower makes sense. By the way, the time of our conversation, just to give people some context, I'm looking at a 10-year treasury yield recently. Well, this is the other day. It was 415. And the shortest thing, like a one-month T-bill, 457. So just a little bit higher on the short stuff.

Yeah. And so people have been sitting in cash. And then when rates kind of moved up at the intermediate to long end, they started to extend duration, which we were in favor of. But now, given where we are, you don't have a lot of extra premium in there, extra yield in there to go much beyond whatever your benchmark is. So we usually use the aggregate bond index as our benchmark for duration and yield. That's around six years. We would say keep it that level or even a little bit lower.

And if we get a rebound in rates going into the year or in the second half of the year, which seems like a probability, reasonable probability, then we would think about extending again. And we also want to stay in higher credit quality bonds. You know, there's not a lot of extra yield in lower quality bonds like high yield bonds to compensate for the risks that you're taking. So the yield difference between a high yield bond and treasuries of comparable maturity is about the lowest it ever gets or even lower than the lowest it usually gets. And that means if something happens in the market that's not good news, you're probably

going to underperform with that. Not being adequately rewarded for junk right now. But what about inflation? You have to be a bond strategist. You have to be an inflation strategist. You have to have a view of what's going to happen. Is there anything that you see on the horizon that you think is going to catch people by surprise? What do you expect? Well, all of these policies are somewhat inflationary. And that's the tariffs. Now, that's more of like a one-time price level increase. If you slap a tariff on something, it's going to go up by that amount or close to that amount and probably get passed through. So if you have a 10% tariff on Christmas toys coming from China, then chances are those prices will be up close to 10% because the company importing

them will try to pass that along. So that's one risk. A second risk is that we just don't have as much excess capacity right now for the growth rate that we have. We have a growth rate running around 3% for GDP. That's pretty high relative to what capacity we have to meet those needs. So we'll probably see some just generalized continuing price pressures, but really housing is the one that's critical for most people in keeping inflation up. We do think it'll come down

over time, but there isn't a lot of downward pressure now on inflation. It's mostly just upward pressure on inflation. 2.6%, that was the latest inflation rate for the month of October. We're going to hang around 2.6% for a long time, even though maybe the Fed would like to see that moving even lower? Or are we talking about we could move from the twos back up to the threes and pushing four or something like that? What do you anticipate? So yeah, we could move from the twos back up to the threes and pushing four or something like that. What do you anticipate? So, yeah, we don't really look for it to go up a lot. I think, though, that there are areas where it's not going to come down and there are some vulnerabilities between besides the tariffs. You know, immigration reform could affect certain sectors of the economy more than others, like construction, agriculture, and housing

prices are already very high. It's already very expensive to build. So if you get a big decline in the number of people in that construction area, or you have to replace them with more expensive workers or search more widely to find those workers or simply can't produce as much because you don't have the workers, then that's going to push either some wages up or the cost of producing up. And that is something to watch for. So I would look at, you know, unfortunately, it's in areas that are very important to people that have been very difficult for people, food and housing. And those are pretty crucial. That housing is a real tough one. I feel for, you know,

young families out there that have been shopping forever and they can't find something affordable and they're probably watching that mortgage rate all the time, wondering when it's going to come down. What would you tell them? What do you think is on the horizon for the mortgage rate? I think it'll come down a bit because we will get a few Fed rate cuts. I think we get one at the meeting in December and then they pause, maybe skip a couple of meetings and get a couple more in 2025. So that should bring it down some and make housing more affordable. It's not going to go back to the we're not going to see those 3% mortgages again anytime soon, but we should be able to get south of 6%, which

will help the housing affordability to some extent. Now, you focus on bond strategy at Schwab, and your colleague, Lizanne Saunders, does stock strategy. But when it comes to the subject of people wondering, hey, the stock market's run up so far, is it time to take money out of stock? Should I put more money into bonds? How do you figure that out? Is it arm wrestling?

Do you two arm wrestle to figure out what the allocation should be? Who's in charge of figuring that out? And what would you tell people now? Yeah, we don't arm wrestle, but we do have a lot of conversations. And I think- Probably better that way, yeah. Yeah, it's probably better that way. I don't know that either one of us would be very good at arm wrestling these days. You know, we do have a lot of, along with all of our other colleagues

at the Schwab Center for Financial Research, we have a lot of meetings, a lot of conversations about how best to allocate. I think that right now, Lizanne is certainly seeing risks in the equity market, the narrowness of some of the gains, the valuations being very high. She's always quick to point out that valuation isn't a good trading strategy. Things can stay under and overvalued for long periods of time. I was saying the same thing in fixed income markets. When you look at credit spreads, that is the yield spread between, say, corporate bonds and treasuries of comparable maturity, those are very, very low, historically low. And that's a valuation measure that tells you things are pretty highly valued.

So our general philosophy is not to have people jumping from heavy overweight to equities, overweight to bonds, but to kind of stay with a plan that they might have, an allocation that they've already determined through their financial plan that works for them. So if you're a 60-40 investor, you may not have to change that. You may change under the surface, though, what's in that 40% or what's in that 60%. So if you're a 60-40 investor and you have 40% in bonds, our suggestion is if you are very heavy on high yield or emerging markets or some of the other riskier parts of the market, you might want to dial that back a little bit and focus on the higher credit quality. And similar story in the equity market. You may want

to shift around your allocation within the equity market to be less exposed to, say, overvalued equities. Is there something that explains on a big picture level, a societal or demographic level? You mentioned that stocks look pricey and in some respects that bonds look pricey too. And people are used to thinking about financial markets as, well, if this is expensive over here, I'll buy over here where it's cheap. But we go through these periods sometime where just everything seems expensive. What explains that? Is that a glut of people saving at the same time?

Or is there a demographic factor that explains that? And for someone looking ahead for like 20 years until retirement, do they have to be worried about any kind of change in that? Well, I think it's a combination of things. When everything gets overvalued, sometimes it's because policies have been in place that have allowed that to happen, right? We knew that before the great financial crisis. Everything was just going crazy on the upside because you could borrow easily and financial conditions were easy. There's some similarity now, although it's not nearly as extreme.

Maybe this is more like the late 90s where we got the economy running at a pretty good rate. So corporate profits are doing well. So, and there's a lot of money in savings. There's a lot of investors who have gains or who are saving. People have jobs. That means they often have a 401k or an IRA,

and they're putting money away. And that money has to go somewhere. And it goes to where the most attractive returns have been. And I think that that encourages the longer they keep going, the more people want to be in those investments that have performed well. And you can see that largely by the outperformance of the U.S. versus the rest of the world. You know, U.S. economy is doing better, more attractive markets. That just draws in a lot of foreign capital as well as domestic capital. Something would have to change for that. Either financial conditions would have to get really tight, which doesn't seem very likely with the Fed looking to cut rates, or we get some sort of negative economic news that

changes the outlook. And eventually, kind of a string gets pulled as far as it can go, and you get some sort of correction. But it doesn't seem like that's a huge risk right now. We're in this wave. There's a lot of demand for yield, certainly in a fixed income market, and part of that's demographic. But also, returns have been good, so people continue to do what works. We've talked about bond quality, bond duration, mortgage rates. We touched on surfing earlier. What am I missing here that you're seeing that you think investors should be paying more attention to this thing or something that they're getting or doing wrong right now? Yeah, I think there's a tendency. We've gone from a tendency to sit

in too much cash to a tendency to chase yield wherever it is, because we've had these kind of good returns now. And I would emphasize to people that right now, everything looks pretty rosy. Everybody's optimistic. And that's usually when something changes, right? When something comes along to change it. And then the other thing I would add in the fixed income market is liquidity. People don't focus maybe enough on making sure they have access to their money when they need it.

So there's a lot of investments out there right now that provide much higher income streams or returns look very positive, or they have looked positive over the last decade or so. And people are kind of looking at this and saying, oh, that looks fantastic. But a lot of them are not as liquid, meaning you can't access your money as quickly and easily as you might like. And that's something to really keep an eye out for. Thank you, Kathy. There have been some new developments since my conversation with Kathy. November inflation accelerated as expected to 2.7%. The Fed cut interest rates as expected, but it was described as a hawkish cut. Fed members raised their inflation projections for next year and reined in their rate cut expectations.

The 10-year Treasury yield has risen to around 4.5%, and the one-month Treasury yield has fallen to 4.3%. In other words, the yield curve is un-inverting. Thank you, Kathy. I'd also like to thank all the folks who helped out earlier in this episode with the quantum computing explanation, the Coen brothers, Schrodinger, the cat,

the guy from Google who was talking about that qubit stuff, and whoever wrote that IBM blog. And most of all, thank you, Remy, for sending in the great question, and thanks to all of you for listening. Jackson Cantrell is our producer. You can subscribe to the podcast on apple podcast spotify or wherever you listen if you listen on apple go ahead and write us a review merry christmas if you're christmasing and see you all next week