Plain English with Derek Thompson - The Big 2025 Economy Forecast: AI and Big Tech, Nuclear’s Renaissance, Trump vs. China, and What’s Eating Europe?

Episode Date: January 7, 2025

Happy new year! And what better way to celebrate the freshly torn calendar page than by welcoming one of Derek's favorite writers to the show to tell us what's in store for the 2025 economy. Michael Cembalest is the chairman of market and investment strategy for JPMorgan Asset Management, and the author of the truly spectacular newsletter, 'Eye on the Market.' Today, we start with stocks and describe the truly historic—and historically unprecedented—dominance of the so-called Mag-7 tech giants. Then, we draw the connection between Big Tech’s historic run and the surge of AI spending. After a discussion on the history and future of nuclear power in America, we do a pit stop on the European economy, where we evaluate the continent’s tradeoff between safety and growth, and move on to China to disentangle that economy’s slowdown. Finally, we connect it all back to a Trump agenda that is a fascinating brew of old-fashioned Reaganite deregulation, newfangled crypto enthusiasm, mid-19th century tariff obsession, mid-20th century industrialization policy, and ... a bunch of other ingredients that I think I’ll just let Michael tell you about. If you have questions, observations, or ideas for future episodes, email us at [e-mail]. Host: Derek Thompson Guest: Michael Cembalest Producer: Devon Baroldi Learn more about your ad choices. Visit podcastchoices.com/adchoices

What's up everybody? Chris Vernon here and welcome to a new season of the NBA and the mismatch. And huge welcome as well to my new co-host, Dave Jacoby. I can't wait to link with you twice a week every Tuesday and Friday right here on the mismatch to break down everything that's happening in the league. Who's playing well, who we loved, who we loathed, trade rumors, team dysfunction. We've got you covered right here. So follow us, subscribe and hit us with those five-star ratings on Spotify or wherever you get your podcast. And also don't forget to follow us on social media. That's at Ringer NBA and check out

the full mismatch episodes with the two handsomest podcasters in the history of podcasting right on the Ringer NBA YouTube channel. Today, a chocka block economic forecast featuring everything from stocks to big tech, AI, rumors of a nuclear power renaissance, Europe's growth trap, China's liquidity trap, and finally a Trump agenda that could affect all of it. But first, happy New Year, folks. I, for one, am thrilled for the flipping of the calendar page. I have a ton of exciting news for you in the next few weeks, but we're going to start with this. Plain English will have its first ever live show coming up next month in Washington, D.C.

We'll be live from Union Stage down by the Wharf on Wednesday, February 12th. Tickets will be available beginning this Thursday, January 9th, and you can find more if you check in later this week to the ringer.com slash events. Ringer.com slash events. So more details to come, but here's your headline. Plan English, live show Wednesday, February 12th in Washington, D.C. at Union Stage. Tickets available this Thursday at the ringer.com slash events.

Second, we are finally back to a two episode a week schedule. Twice the plain English in your feed. And I say, thank God. We're going to use this doubling up to experiment with a few different show templates, including a feature I'm excited to launch probably next week or maybe soon thereafter, which we're calling plain history. I've been on a history book reading jag the last few months, mostly American history. I had the feeling more than a few times in the middle of those pages,

I was like, hey, it'd be really fun to talk to this author. But my podcast isn't really a huge. history podcast and would anyone want to listen to that? And I was talking this over with our producer, the wonderful Devin Beraldi. She's like, Derek, it's your podcast. Just do some history episodes. And if people hate it, you can just stop. Brilliant advice. So that's what we're going to do. Plain History will be sort of a feed within the feed. If you subscribe to this show, you don't have to do anything. We're just going to number the episodes in the feed, you know, Plain History, episode one, Plain History, episode two.

So if there are folks out there who say, enjoy 19th century presidential history and otherwise do not care for my work, they can just search the feed for Plain History and listen that way. And this is also a nice reminder that if you listen to the show and you don't subscribe yet,

please subscribe. And if you have a spare half second, tap that five-star rating as you do. So, summing up, if you live in D.C., come hang out with us at the war February 12th, And if you're partial to history, especially American history, I hope you enjoy this product of my descent into cliched fatherhood. Today's guest is Michael Sembalist.

He is the chairman of Market and Investment Strategy for J.P. Morgan Asset Management and the author of the truly spectacular newsletter, I On the Market. We draw the connection between Big Tech's historic run, to the surge of AI spending, to the hopes for a nuclear renaissance. We do a pit stop at Europe's economy where we evaluate the continent's tradeoff

between safety and growth, move on to China to disentangle that economy slowdown. And finally, we connected all back to a Trump agenda, an incoming Trump administration agenda that is a fascinating brew of old-fashioned Reagan deregulation, new-fangled crypto-enthusiasm, mid-19th century tariff obsession,

mid-20th century, industrial policy, and a bunch of other ingredients that I think I'll just let Michael tell you about. I'm Derek Thompson. This is Plain English. Michael Sembalist, welcome with the show. Thank you. It's a real honor to have you on the show. I've been reading you for years and years, and your eye on the market newsletter is, as I've told you before, I think just about the single best economic primer that ever hits my inbox.

So thank you for elucidating your analysis right here on the show. It's a low bar. It's a very low bar. There's so much ground that I want to cover here. I think we should start with AI and stocks. And we should begin where you do in your report with a close look at the tech giants. Apple, alphabet, Amazon, Microsoft, Meta, Navidia, Tesla, aka the Mag7. I generally knew that big tech was in the middle of a sensational run before I read your report,

but I did not understand just how historically unusual their dominance has been in the last few years. So why don't you start by educating us? How does the dominance of the Max 7 today compare to previous eras? It's not, I mean, there's nothing comparable to it. If you look at things like the share of market cap from the top seven or ten stocks, we have blown through, long since blown through the heights of 1999. share of profits, share of market cap, contributions to year-to-date return were kind of off the charts. And the reason why we pay so much acute attention to it in the investments industry is it's wreaking havoc on traditional active money management, right? I mean, the premise going, you know,

the Graham Dodd approach to investing going back over 80 years has been about diversification. And all of a sudden, you have this club. of stocks that are doing so well and generating such high returns that, you know, if you haven't been at least market weight those stocks as an active manager, it would be practically impossible for you to match or outperform the index that you're benchmarked to. So the whole active management industry is intensely focused on what's been happening with these stocks. And anybody that's been dared to underweight them over the last couple of years has generally gotten wrecked. They are, they're generating unprecedented amounts of free cash flow.

And we had our, the document that you're referring to is the eye and the market outlook. And it came out January 1st. And we had a meeting this morning at JP Morgan where we had some internal discussions with our investors. And what I was trying to explain to them was we've had profitable stocks before. But the free cash flow of these Mag 7 stocks are way higher than the free cash flow as a percentage of revenue of all of the market leaders that have preceded them going all the way back to the 1950s. They make oodles and rules of money, which is why they can afford to be pouring hundreds of billions of dollars of capital spending each year into, you know, AI-related R&D and infrastructure. So you're looking at a set of stocks that is dominating the economy, unlike any other set of publicly traded companies, have dominated the economy in the U.S., going back basically as long as we have good records. Your records go back to the 1960s, 1950s. I mean, you might have to go back to like the Gilded Age of Rockefeller Carnegie to look at a time when a handful of companies so bestrode the entire U.S. economy.

what would be like your, you know, we've talked about the statistics, you know, free cash flow, what would be your sort of plain language analysis of what it means for an economy where a handful of companies so dominate public returns? I think bestrode is the right word because it conveys this image of a colossus lumbering across the landscape. And I think that's right. I mean, what was allegedly going to constrain this was a more activist antitrust policy. And while Google has lost some lawsuits here and there against Epic Games and things like that, related to the Google Play Store and the amount of money that it pays every year to Apple for being the exclusive search engine on Apple devices,

so far the teeth in the remedies that have been applied in these antitrust judgments have been de minims. So, so far that hasn't really changed the landscape. There have been two periods before where either one company or a small number of companies, like a handful, garnered 15 to 20 percent of all the capital spending taking place in the economy. Happened in the late 60s with IBM and a couple of other mainframe companies. Then it happened with the fiber buildout in 1999-2000, and it's happening again now. and where you have a small group of companies, and Nvidia's projected 2026 sales would represent something like 15% of all the capital spending taking place in the economy.

I mean, that's just kind of remarkable to think about. And there's this explosive arms race of the big hyperscalers, which we can talk about, to acquire these GPUs. I don't have a question about Nvidia's order book. I have questions about the people comprising Nvidia's order book, and that's why it's also important to focus on. And just before we go on to the next segment, because there is a very clear way, as you've indicated, that this story connects to the AI story. What do you mean when you say hypers? And just for folks that aren't deep in the weeds here, what do you mean when you say GPUs as well? Okay.

So a hyperscaler refers to, you know, Google, meta, Microsoft, Apple, and some other companies, Oracle at times, that are hyperspending on AI-related infrastructure, you know, data centers. And somewhere between 50 to 70 percent of a data center is the actual GPU, the GPUs. And GPUs are these chips combined with software to make these accelerating computation devices, which allow for these incredibly complex language and other models to be trained. Right. And it can take 70 days to train a model running computer full time, where you're just feeding it, the history of everything you're finding on the Internet and having it self-teach about how language is used

and how numbers are used and how things fit together. So the success of the MagS7, I think, is really important to foreground the artificial intelligence splurge because other than Navidia, which makes the graphical processing units that you talked about, the GPUs, the Mac7 bucket holds these major spenders on GPUs and the data centers they live in, right? Microsoft, Google, Meta, and so on.

We're talking about hundreds of billions of dollars being shoveled into AI infrastructure. That's right. And by the way, meta's doing this two years after pouring a similar amount of money into the Metaverse, which mostly got incinerated. Right? So I think there are some valid questions to ask here

about, here we go again. The hyperscalers are spending hundreds of billions of dollars. Now, I think the promise of the promise of a good return on all this AI infrastructure is vastly better than the prospects for the Metaverse were at the time. And that's why we spent so much time in the report looking at how do companies like J.P. Morgan intend to use and pay the hyperscalers for access to all this infrastructure because that's the only way they're going to earn it back is if all sorts of companies say, well, you know, Right now, I'm using humans to solve tax, accounting, fraud identification problems, identifying new customer bases, where should I put my stores. I'm vastly relying on humans and some simple machine learning tools to do that.

I think instead, I'm going to use some generative AI applications, which are much more complex, but maybe quicker, more efficient. And depending on how efficient they are, I might be willing to spend quite a bit of money to use them. That's the play. Now, so far, the killer app is not here yet. But I think it's a little bit too soon to expect that. I do think it'd be good to look at what data points you scrutinized to understand if AI is in the process of paying off. Because right now, the big pictures I see it is that the biggest companies in the U.S. are historically profitable,

Gilded Age 2.0 profitable. They had these huge piles of cash to spend. And those cash piles just happened to materialize as artificial intelligence, this fantastically expensive technology, enters its prime. And so it's sort of like this historic kismet moment. Right. And to be clear, that pile of cash,

they're not making that money on AI. Right? Just to be clear, they're making that money on their core businesses and they're spending it on AI right now. And for the most part, The vast majority of their inherent profitability is not coming from AI. But that's the big question and the expectation over the next decade is how they're going to earn a return on this stuff. And it's funny, because there's a narrative that the dawn of AI will, in the future, create an era of unprecedentedly profitable companies.

But you could just as easily say, spinning that around, that the era of unprecedentedly profitable companies is what made this AI moment possible. But eventually AI has to pay off. That's absolutely true because JDS Uniface and Lucent and Global Crossing and the big capital spenders of 1999 were not profitable enough to keep it going. So as soon as pressure was put on the capital markets environment, those companies all collapsed and folded. This time around, you've got the big tech leaders much more profitable. They can keep this capital spending going for another couple of years.

before you and I will have an answer to the question of what's the killer app and how much is the corporate tech they're going to pay to get access to Gen.A.I. Applications. Now, you ask the question, where are we in the process? Unfortunately, early. And at this stage, what you tend to get are these surveys that you'll get from McKinsey or BCG or someone else, where they'll go and ask a thousand chief technology officers of the Fortune 1,000 companies, are you using Gen AI? How's it going? Was your experience positive?

Did it meet your expectations or exceed them? That's what's happening. Most of that news is very positive, but they're surveys and not a reflection of how much people are willing to pay for access to this infrastructure. But if you take people's general vibe-like temperature, about Gen AI, everybody says they love it. And so that's where we are. And it would be very difficult to, I mean, there's a few specific examples where Klarna has come out and said that Gen AI applications have allowed them to, to vastly reduce their amount of customer support agents. some

companies using co-pilot for coding have reduced their programming staff and increased their output but it's the hard concrete data on the productivity and revenue gains from Gen.

I'm still really early innings. I want to make sure that I understand your point here because I know there are two camps listening to this podcast right now. There are folks in the Sam Altman camp who think that this is the beginning of the last invention, and we are on the cusp of some utopian future, and there are other people

listening who aren't just AI pessimists, they fundamentally think that this is something akin to the metaverse, that while generative AI is kind of cool and ChachbyT certainly allows high schoolers to cheat on their English essays, this is not something that's going to be throwing up half a trillion dollars in new revenue for the MAG7 anytime soon. I want to pin down to your position here, which I take to be, the answer to the question, will AI pay off, is fundamentally unknowable today, Monday, January 6, 2025. Is that your position or is it something else? I would say I'm a little, you know, you've described two end zones on a football field. I'm a little, I'm past the 50-yard line on the way closer to Sam Altman than the pessimists. Let's use Gary Marcus, right,

who is a widely cited, you know, LinkedIn-based AI pessimist. I'm a little bit past the 50-yard line on this towards Altman, a little, because I've seen within JP Morgan, it's very effective at fraud determination. If you're dealing with large databases of customers and you're looking, you're trying to find patterns and fraud detection that it might be difficult for humans or simple tree search-based Monte Carlo processes to determine. I've seen the successes that some of these models have had in drug development. There's something called MRSA, which is an antibiotic-resistant bacteria.

Some people at Stanford used some of these new models to determine and to work on a new, the first new class of antibiotics in decades came out of some research that was being done using some of these new tools. So there are instances of where all of this power is being leveraged and harnessed to accomplish things that haven't been done before. So I'm seeing instances of it, but, you know, like B2B software, it's going to have to kind of proliferate in a major way across health care, tax, accounting, law, et cetera. And, you know, if you read, if you read Goldman had a piece last year where Goldman's just assuming a 15% or so increase in corporate profits over the next few years because of AI,

but when you dig into why, you kind of don't end up anywhere. And so there's just a lot of faith-based accounting taking place with these AI projections. And yeah, I spend a lot of my time tracking down actual data so that we can figure out what's actually happening on the ground. I love the way of thinking of it as a football field. I would say that I would plot myself at the 45-yard line on the Sam Altman side of the field. I think that it is both possible that we are in an AI bubble and that artificial intelligence is by far the most important technology. of the century. Yeah.

I think both of those things can be true. Some of our large-cap portfolio managers did not like this metaphor, right? But in the outlook, I showed what happened to Corning, where in the year 2000... Say what Corning is. Corning basically was the market leader in fiber optic cables technology during the dot-com bubble. almost every single piece of fiber that they put in the ground eventually got utilized. But it took almost 20 years for that process to play out, and a lot of pain was felt by investors along the way. So it's an example where even if the infrastructure ends up having a full eventual utilization rate,

it can be very painful after a period of overbuilding for all of that infrastructure to eventually be absorbed. You know, the most extreme example are all these dead, empty cities in China where it's unclear if some of them will ever be occupied. I think this AI infrastructure is much more like the corny example, where it's all going to get utilized. It's just a question of when and by whom and who's going to own it by them. And that's the question. The next lily pad I want to hop to, which is very much related to what we've been talking about, is nuclear power. I think we're very close to a conventional wisdom that AI policy, especially at a federal government level, is fundamentally energy policy. And because these tech companies, which you call the hypers, are going to need a ton of energy to power their data centers,

there's a lot of enthusiasm at the moment about a Renaissance nuclear power. And I want to set us up a bit before you give your take on the nuclear renaissance. So America built a ton of nuclear power plants in 1950s, 1960s, and there was enormous optimism in that era that we were on the path to super abundant cheap energy, too cheap to meter, in the words of Lewis Strauss, aka Robert Downey Jr. in Oppenheimer. And then the 1970s and 1980s, we all but stopped new construction on nuclear power entirely and cost skyrocketed. Today, the dead arising from the grave, and plants left for dead seem to be coming back to life. Three Mile Island, infamous Three Mile Island will reopen to power Microsoft data centers,

which themselves were power AI. It all comes together. If we had a nuclear tech optimist here on the horn, they'd say, look, it's not just the old plants coming back. Look at the innovation pipeline. Look at all the money going into, and I don't even know what these terms mean, but like sodium cooling and gas cooling and molten salt and small modular and all these little pieces of the constellation of nuclear innovation. Michael, are you buying the nuclear renaissance storyline? Are you buying the story that nuclear power is about to have a big bounceback that contributes meaningfully to U.S. energy?

No, not at all. And I say that as somebody that has written a deep-dive energy paper for the last 15 years where Vaklov-Smill, for most of that time, was our technical advisor. So I spend more time on energy than any other topic as it relates to my employment. And I love nuclear power on paper, just like everybody else. On paper, it's fantastic. What's happened in the West is that the level of redundancies that are required for licensing purposes, including the level of redundancies required to withstand a plane crashing into the plants,

have made the capital costs of building nuclear plants prohibitively expensive. There have been four, just four, count them on one hand, four plants completed in the last 25 years in the West. One in Finland, one in France, Flamanville, Hinkley in the UK, and the Volta plant in Georgia. all years late and billions of dollars over budget each one. Now, commission after commission has studied why are the costs three to four times higher than they are in China, Russia, Thailand, Pakistan, why can't we do it faster? Why can't, you know, and a bill was passed in Congress to try to accelerate this. This is really hard stuff.

So in terms of bringing the cost down on traditional boiling water reactors, I'll believe it when I see it. Okay. Number two, all these next gen types have been tried before and were abandoned either for safety reasons, you know, molten salt, gas cooled, thorium, all these things have been tried before and abandoned because of safety risks or concerns about nuclear proliferation. If the nuclear regulatory position is going to change their view and accelerate some of this stuff, great. it'll take at least 10 to 15 years to commercialize. Small modular reactors during the SPAC boom in 2021, which was one of the most ill-advised exercises in the history of capital markets, new scale went public.

They projected that their small modular reactor project in Utah was going to cost around $3 million a megawatt. when the cost hit 20, six and a half times higher, the offtake agreement, you know, clients pulled the plug. At times you have people in the nuclear space that are talking about what they want to believe rather than the facts on the ground. There's this great scene in Oliver Stone's JFK movie where Nixon looks up at a portrait of JFK and he says, when people look at you, they see who they want to. be. And when they look at me, they see who they really are, right? If you're going to focus on nuclear power, you've got to look at the Nixonian reality of where we are. As it relates to small modular reactors, nuclear power is the most capital intensive project on the planet

earth. You can't find a more capital-intensive project. I have never believed that you can take the most capital intensive project and make it more efficient by shrinking it. It goes against the entire concept of capital intensity, which is why most regular boiling water reactors are gigawatts big. So I'm very skeptical. The first Western small modular reactor project may start to put a shovel in the ground in Canada next year. Let's all follow it and see how goes. I want to hold on the cost concern for just one more beat, because like you, I love nuclear on paper,

and like you, I see the data, and it's a bloodbath. I mean, there's a Danish academic who, I believe you quote in your report named, I'm going to butcher this horrendously, but I believe it's something like Flivbjerk, thank you. And so, Flivberg studies the average cost of megaprojects around the world.

And megaprojects are, you know, big, large-scale construction projects, airports, dams, skyscrapers. This is amazing. There's only two categories where the average cost overrun for a megaproject is over 100%. Only two types of megaprojects in the world. When someone gives you the quote, you should immediately double the quote in your head. One is hosting the Olympics.

And two, is nuclear power and storage. I mean, there is nothing like this in the world. And I wonder, just going a level deeper, like at an existential level, What is it about nuclear that makes this category of construction so impossibly expensive to deliver on time and under budget, not just in the U.S., where people can hate the NRC or they can hate Alara or all sorts of regulatory gunk that has accreted to the mast of nuclear? What is it about this megaproject throughout the developed world that makes it allergic to learning curves and cost declines? at the risk, right, I'm going to go to some red lines here, okay, in the way I describe this, right? But when you look at the fact that China can build one of these plants in six years at a quarter of the cost, it really kind of challenges an industrial engineer to figure out what's really going on. Because it's not the people have done the work. It's not just materials. It's not just labor. Those are

pieces of it, right? There's a lot of capital equipment that the Chinese can build more cheaply, but there's also regulatory issues and redundancy and safety issues, which are different as well. And I think a lot of the people that are most aggressively pushing for more nuclear in the U.S. would not live within, you know, a hundred miles of a Chinese nuclear plant. nuclear power is a fascinating and terrifying thing. Imagine a bunch of vertical rods. If you space them apart, too far apart, nothing will happen. If you cluster them too close together, nothing will happen.

At the proper level of spacing, these rods will interact with each other and create heat of hundreds of degrees Celsius. And that's just inherently a very delicate technology. And those rods can't ever be exposed to the air. They have to be submerged in water once they are no longer being used in the reactor. And part of the problem that you had in Fukushima in Japan is what happens if there's a leak in the spent fuel pool storing the old rods, all of a sudden you get nuclear materials kind of spewing off into the atmosphere and into the aquifers. So there's a reason that Western Judeo-Christian societies have a different approach to cost redundancies and protections. Indian Point that's north of New York City got shut down because it's got a natural gas pipeline running either underneath it or right next to them. And in a Western society, that was deemed by the Union of Concern Scientists who prevailed upon Governor Cuomo to Shodd

down as a risk that was too great to bear. And, you know, what I think most people miss is you can believe that increased production and that you, essentially there's a learning curve, but learning curves and solar panels and wind turbines and lithium ion batteries kick in when you're making hundreds and thousands and tens of thousands of something. There's no learning curve benefit to building four things instead of one thing, right? If I've never, if I've never built something before, I'm not going to know that much more on the fourth one. And even in the heyday of nuclear power in the U.S., we were building five to ten plants a year. So I would, I would, I would, I'm, I would like to see what a nuclear focused

department of energy would be able to come up with. But I think we all need to be, very realistic. Let's talk about one last thing on nuclear before we move to the next topic, which is reopening of old plants. So so far there are two firm reopenings. One is a Palisades plant in Michigan. The other one, as you mentioned, is the Three Mile Island reactor that didn't get shut down. But these two plants were on the docket for decommissioning, but didn't make it. right they haven't started yet so yes a plant that has been shuttered but not decommissioned you can turn back on but there's only two or three more plants like that in the united states once you begin decommissioning a plant it doesn't make any sense at all to try to turn it back on and so i i think you're we're going to

those two got mentioned because they're the two that make the most sense maybe there's one or two more but that's about it i'm going to hold on everything you said and also echo what I imagine in my head to be the objection from nuclear fans listening who say, but nuclear power is so clean that deaths from Three Mile Island accident are overrated. There's some evidence that no people die. I don't take you to be, right, I don't take you to be arguing against it. I just, I agree with everything that you said, and what's difficult about nuclear power is, I think you put it well, the threat of something bad happening in a low regulatory environment,

hanging against the fact that overall, in a high regulatory environment, nuclear power does not cause the kind of accidents that many people fear is a hard thing, I think, to cash out in terms of the average residence anxiety. I think nuclear is just, it's just unique in that way. Solar panels tend to not scare people. I think the market should decide, right? In other words, and we're seeing that, right? How much are the data center hyperscalers willing to pay for either in front of the meter or behind the meter nuclear plants compared to some combination of gas, wind, solar storage? And, you know, nuclear will experience a revival if the levelized cost of providing it is competitive versus some of these other. sources. And for the most part, that's not the case. And, you know, when you're turning old plants back on, it's much cheaper than if you have to build a new Greenfield project. But I think the government should do everything they can to try to facilitate it. People need to be realistic

about the timetable, you know, on 10 to 12 years that it's going to take for that nuclear renaissance to even begin to provide power to the grid. I want to save the far-reaching Trump agenda for the end of the show. And first, I want to do a really quick global tour, starting with Europe. There's a phrase that comes around every so often. I believe it originated with the Ottoman Empire that is the sick man of Europe. And typically, the sick man of Europe refers to a country within Europe that's experiencing troubles or decline. These days, it feels like the sick man of Europe is the continent of Europe.

Like, compared to the U.S., Europe's energy prices are higher. Its productivity growth is much lower. Its labor mobility is lower, as your report showed. in the biggest picture, Michael, what's wrong with Europe? Am I wrong or is this a relatively extraordinary period of history where Europe is falling behind the U.S. in almost every single major economic indicator? You know, I think, yes, I mostly agree with that.

Essentially, Europe is different than the United States and the people that live there often make different cost-benefit decisions. Europe allows 44 chemicals in the food supply. I think in the United States, it's over 700. That's why the food tastes so good in Europe, and people are generally skinnier. Europe has decided that it's willing to pay a higher price for electricity and wear some extra sweaters in the winter in order to achieve certain climate targets. and has been in favor of fuel taxes in ways that the United States would never support. The society, there's actually more homogeneity of belief in certain kinds of things as it relates to food, climate, socialized medicine, and Europe has made certain choices.

Another choice Europe has made, they don't want the ratio of CEO salaries to the salary of the average worker to exceed certain levels. There is no such concern, at least one that's implemented in the United States, where sometimes those ratios, a la Elon Musk, are close to infinite. So Europe makes certain decisions that work for them culturally and socially. They then have implications economically and for market investors that are sometimes negative. But I would never go so far as to deny Europe the agency to make those decisions and to understand that it's making certain cost-benefit tradeoffs. The venture capital environment there is terrible compared to what it's in the United States. But they would describe themselves as not having nearly as rapacious a corporate culture as you have in the United States. So now, as it comes down to my job,

as chief investment officer, I began underweighting Europe relative to the U.S. 15 years ago. And on my tombstone, you know, they're going to write, Mike, here lies Michael Semblos, he was underweight Europe because I've been writing about this for 15 years. And I have all these models that show that the ROE and ROA, you know, return on equity and return on assets by sector, like, you know, industrials and basic materials and financials and tech and consumer discretionary, consumer staples, are all much higher in the U.S. compared to the European counterparts. And that's the major driver of European equity underperformance. And now you have this overlay where European energy prices are much higher. And you're having deindustrialization

because you're having ammonia factories, smelting plants, fertilizer plants. Those are very energy-intensive businesses in places like Germany. And they just can't compete. so they have to outsource. Not all of this is from renewables. It's also from the cost of transitioning from Russian pipeline gas to imported LNG increases the cost per molecule by a factor of three. I think that's a very judicious answer. And I take your point that certain economic differences between the U.S. and Europe might speak

to cultural differences that underlie certain economic policies. And it's an incredibly fair point to make. it's interesting at the same time that deciding as a people that we want to have fewer artificial chemicals in our food shouldn't on its own have anything to do with say the tech startup rate but when you look for example at maybe this is in your report the number of new companies in Europe that are large and publicly traded and in the tech sector it's fairly astonishing how few of them there are. I mean, we're talking on Spotify, which is a publicly listed European tech company.

You have ASML in the Netherlands. There's a handful of tech companies in the valuations of a couple hundred billion dollars. But it's really striking that we're in like a 40, 50 year period where communications technology is probably the most important sector in the world. And all of the largest tech companies are either in the U.S. or I guess number 11 or something is in Taiwan. Do you feel like the cultural preferences that you were just listing are the same things responsible for the lack of European tech strength? Or is there something else in the water and air that's happening here? They're obviously connected because you can't just do an unadulterated startup in Europe.

and then just see where it goes, because it may run afoul of all sorts of different rules and regulations and restrictions that people have voted for. And so I think all those things are connected. I read the other day, the Europeans, in spite of the position they're in, just passed a new corporate directive that any entity doing business in Europe that doesn't comply with its climate and labor, labor laws are subject to taxes of up to 5% of their global revenues payable in Europe. So it doesn't matter how much business I do in Europe. It could be small. But if I run afoul of their labor laws, I might have to pay 5% of my global revenues, including business I'm doing in Indian, Thailand, payable in Brussels.

Qatar immediately came out and said, this is from Mars. No LNG for you. No LNG for you. Right? Now, I expect this regulation to be watered down, but it's an indication that at least the European regulators and European politicians are taking their mandate very seriously. And we're seeing pockets of revolt against that in France and in Italy. But as things stand now, the statists are, you know, digging in their heels. and are sticking to this European model, you know, and with the Trump administration coming in, is going to be quite a contrast in terms of the U.S. versus Europe. Speaking of contrast, I want to move from Europe to China. You say China suffers from two different traps, a liquidity trap and a Thucydides trap. What do you mean? Well, by the way, I'm referring to investors in China. I have to watch for those two traps. So let's talk about the first one. A liquidity trap is a general term people use for when you invest in a country and things are going wrong and no matter how much liquidity they add, it just keeps getting worse because there's an underlying problem that they're not solving. And when you invest during a liquidity trap,

in spite of stimulus, asset prices just keep falling, which is what's been happening in China. Everybody knows the story by now, you know, too much real estate, too much industrial investment, not enough focus on profitability. And so far, we're not seeing a bottom in residential real estate. And interest rates keep falling, yet corporate activity doesn't pick up. Now, in principle, if interest rates fall at some point, the corporate sector springs into action because, of course, the capital is so low that why not start a new business? But what we saw in Japan in the early 1990s is interest rates can fall and keep falling and actually go to zero, and the corporate sector still won't respond because you're stuck

in a deflationary environment. And the debate right now is the Japanification of China. And Japan's, by the way, turning the corner for reasons that we wrote about separately, but in a positive way. But, you know, China is seeing interest rates come down, yet the money supply is shrinking, and there's no bottom in real estate markets. And so they announced this giant stimulus package in August. I don't think it was a coincidence that they announced it at a time when Trump. Trump started to rebound in the polls because I think they're trying to front run whatever damage she may do to them. And it's a fairly sizable package of monetary and fiscal stimulus. I just am not convinced that it's going to be enough. And so I don't think China is particularly cheap right now. if the equity PE multiples fell from where they are, which are, let's say, 12 to 14, down to 10x, then I think you're being paid to take risk in China. The other trap that I refer to is the Thucydides

trap, which refers to this Graham Allison book from a few years ago where he talks about 14 or 15 examples over the last few hundred years of what happens when you have an ascendant power, challenging and incumbent power, and most of the, you know, 10 out of 14 times it ended with war. And he's wondering whether or not we're in the world's in a Thucydides trap where there's just this undeniable,

unavoidable, eventual conflict between the U.S. and China. China and the U.S., as things stood a few years ago, had really extensive economic ties that argued against the eventuality of conflict because unlike all of the other conflicts of the last few hundred years,

there were never two potential adversaries that owned trillions of dollars of each other's debt had bilateral trade of hundreds of billions of dollars and foreign direct investment of hundreds of billions of dollars. Those ties are now weakening, right? Trade's coming down, cross-ownership of debt is coming down, and foreign direct investment is coming down.

So part of this Thucydides trap for investors is as we watch the Chinese U.S. economic ties start to shatter. And you watch Jake Sullivan, who I think has been the most effective member of Biden's cabinet in terms of implementing his goals. And his goals are to wake up every day. and how do I make life more difficult in China for them to achieve their overall technological and military objectives? That suggests that investors have to be very wary of increasing tariffs and other policies that are going to eat into profitability. And China recently announced a new set of restrictions on the export of rare earth metals and certain related technologies to the U.S. We don't know what Trump's going to do yet with China. It's definitely going to be something, not nothing.

And this was a controversial part of my report, and I got a lot of complaints from certain quarters on it. But the pace of Chinese espionage against the United States has accelerated to an agree that I personally see the chance of a reproschement as extremely low. I mean, at this point, China has infiltrated the United States infrastructure. They've hacked into the Fed. They've hacked into the largest industrial companies in the United States. They've hacked into the Defense Department. And the frequency and the intensity. and the intensity of this activity has become unprecedentedly high.

And so for an investor's perspective, I don't think you're getting paid for the risk right now. And I don't want to be an alarmist about this, but the alarmist narrative is not particularly hard to spin up here. You have all these indicators that you've listed showing that Chinese growth is slowing down, interest rates are coming down, they're pushing a bunch of fiscal into the economy to try to shore up what they see as a weak labor market, and in particular really weak labor opportunities for young Chinese workers. This is happening at the same time that there's a lot of concern about the relationship between China and Taiwan, which, among other things, makes the chips that Navidia relies on, which makes the GPUs that all the hypers rely on. There's a lot still of really gnarly interrelated things here.

And it's all happening just as Donald Trump is about to become president. And one policy from his upcoming administration that we actually have to talk about here are the tariffs. Let's assume, for the purposes of this question and answer, that Trump's tariffs are not a bluff. They are a policy promise. And sometime this spring, we are going to have a 15% universal tariff on everything imported into the U.S. with a higher tariff rate on things imported into the U.S. via China. When you think about the macroeconomic or capital investor-related implications of a policy like this, inflation, retaliation, even something like the relative distribution of goods imports

to the U.S., what would you expect to be the economic effect of a universal Trump tariff? A universal tariff that is sloppily applied would be very negatively received by economists

and by markets. The reason the markets are kind of holding back from that judgment right now is

when you look at people like Scott Besant there are incoming Treasury Secretary there are reasons

to believe that someone like that would argue you in favor of highly precise sculpted tariffs that are different according to how much the U.S. imports, where are we imported from? You know, does it come from allies or not? I mean, there's, do you provide export rebates to certain parts of society like they did with the farm bill? I mean, you can be kind of neurosurgeon level precise, or you could be, you know, like,

like Dr. Nick on the Simpsons and do it very sloppily. And, you know, the Dr. Nick approach is what is the one that you're describing. I'm going to kind of just take a deep breath and wait to see because that's what makes the most sense. But an across-the-board universal tariff in conjunction with cutting corporate and personal tax rates would be a policy mix that we haven't seen in the United States in 100 years. and is something that just hasn't been tried in a really long time and is potentially very disruptive

since the United States still runs a fairly large trade deficit. So we're waiting to see, but I, you know, when I'm part of a group of people that meets with our chairman intermittently on market issues, and we have a markets meeting. And Jamie is more inclined to view some of the things that the Trump people say as vague attempts to indicate policy direction and preferences, but not to be taken at face value. So Jamie thinks that I overinterpret some of the tea leaves

and, you know, puffs of smoke that come out of the Marlotto Vatican. We'll see. I think more of that stuff is real, but we'll see, you know, fairly shortly, you know, how much is carnival barking and how much is real. Your 2025 report is called the alchemist. This is your term for Team Trump, the motley team Trump, which includes, you know, everything from tech optimists like Elon Musk to tech skeptics like RFK Jr. Who doesn't like any technology or invention in the field of medicine in the last 50 to 150 years. taking this group seriously, because, you know, I guess I threw a little jab there to RFK Jr., but taking them seriously, in the biggest picture, what do you think the alchemists are trying

to change about America? Okay. I take this all pretty seriously. And I'm, I have a very charitable reading on what the alchemists are trying to do. So let me describe what I mean by that. I call them the alchemists because they're trying, you know, the cover of our outlook was a guy and he's in a middle-aged outfit. It's got a MAGA hat on, but he's in a middle-aged lab and he's got all these vials and he's mixing them together. And there's nine different components, okay? And it's tariffs, deregulation, oil and gas, deportations, tax cuts, cost cuts,

crypto, medical freedom, and agency purchase. I mean, that's a fascinating mix. The markets are really going to like some of it. They're really going to hate some of it. Some of it they won't care. But it is unquestionably the most unorthodox mix of policies that I've seen in my career and I joined J.P. Morgan in 1987. Why are they doing this? this. They're responding to the very first chart that we had in the piece, which is that for the better part of 80 years, GDP in the United States, consumption and industrial production all went up together. So all the different parts of American society, from 1930 to roughly the year 2000, all participated at roughly the same pace. In the year, in the year,

2000, China joins the World Trade Organization. It was a bipartisan thing. Both parties were behind it. And at that point, the title of the chart is the silence of the plants. It's a Clarice Starling reference. But GDP and consumer spending keep going up. Industrial production is completely flatlined. And the other things that got real bad right then were things like manufacturing jobs, job losses, the labor share of profits, rising suicide rates of the United States, opioid addictions, and rural poverty rates all substantially started to deteriorate once that happened. I'm viewing and have been for several years that divergence between consumption and industrial production as a chasm that has reached such a big gap that it's unsustainable for American

society. There's too much of a windfall for consumers relative to people that work in manufacturing and production. There's a guy named David Autor, who's an amazing economist at MIT. You've probably seen some of his stuff. He's shown that the counties that had the highest degree of competition of Chinese import were the counties that had the highest opioid addiction rates at the beak of the opioid crisis. So the alchemists are saying, we have a way to bring those two lines.

We're going to close that gap. We're going to bring the production numbers up to consumption. Is it going to work? I have no idea. And the conclusion that I make is that I think these people are going to break something. Now, by the way, they've played. They want to break something. The deep state, the FBI, vaccine policy, Medicare, the IRS.

They've come out and said they want to break some of the old ways. I think they're going to break something in markets. I just don't know what it is. And so I think we're going to have a pretty volatile year. And so I've advised our clients to kind of be prepared and have some liquidity in case there's a correction of some kind. But that's the story, which is they're responding to their read that somehow this gap has to be closed. And they are going to close it through deportations, strong-arming other countries to invest in the United States and not simply to sell it goods. some of that's already happening,

repatriating certain supply chains, you know, running large budget deficits. One of the things that's getting in the way of the alchemists is there wasn't a red wave in the House. You can argue there was in the Senate. Once you take away the three seats, Walt Stefanik and Gates, and eventually there'll be special elections for those seats. But the GOP is starting the year 217 to 215.

One guy sleeping in takes away the GOP majority, right? So I just think they're going to have a lot of trouble implementing parts of this alchemist agenda. And here's the irony that I think a lot of Democrats will end up appreciating and in a good way, which is the Trump-dominated. Supreme Court, which throughout the Chevron deference standard is all of a sudden going to make it harder for Trump's agencies to unilaterally promulgate whatever rules they want. Because the end of Chevron deference essentially is let's lower the importance of what the

government agencies can do. Congress has the final say, and if they're not clear about it, it goes to the judiciary. And so that's the irony here, which is the, the, major roadblock in the Trump agenda might be that his own agencies can't go out and do his bidding quite as simply because of all of his judges throughout the Chevron deference. I really want to end here by sitting in the grand narrative that you just described, because there's a way in which I think the story you told is actually much more bipartisan than it is team Trump. And tell me if you disagree with this, read, you know, if the story you're telling is that a new group of people in Washington are trying to sew together these two threads of

American economics that were torn apart in the last 25 years, right? These threads of consumption and production that they were torn apart in the last 25 years and this tearing apart coincided with China being admitted to the World Trade Organization in the early 2000s. Isn't that a narrative that Jake Sullivan would sign on to and people in the Biden team would sign on to, aren't they also trying, or weren't they also trying, they're on their way out, to repatriate supply chains and invest in American production with inflation reduction. Yes, not only that. This is this is the tragedy for them, which is they spent 75% of the energy bill in Republican counties in red and purple states. They believed in this effort too. They just did.

what I consider to be the worst marketing job in the history of politics. I'm older than you. If you lived during the 1990s, you couldn't turn the corner without hearing or seeing Bob Rubin talking about the successes of the Clinton administration and the Clinton recovery. He was everywhere. Same thing with James Baker, who did it during the Bush presidency. These people understood that part of the job of the Secretary of the Treasury is to trump but the successes of the administration.

In that context, Janet Yellen was the most invisible Treasury Secretary of the past hundred years. And when I went on to Google Trends to compare her digital recognition footprint to Steve Manukin, who most of our clients couldn't identify in a police lineup, she showed up as having a lower digital footprint than him. And amazing Fed Chair, in retrospect, not the three. right person to tell the Biden story because it didn't get told. And more people own that than one person. But yes, in general, those are bipartisan efforts. And by the way, you've got a lot of

Republican senators and governors quietly going to the White House saying, please don't kill this piece of the chips bill, a lot of which is being spent in Arizona, or this piece of the energy bill, which is building these battery assembly plants from Louisiana all the way up through Michigan, or this piece of the infrastructure bill, which is benefiting states like Oklahoma and Texas. So the irony is the Trump administration will probably end up reaping the benefits of the job creation and economic reinvigoration of some of the communities that were left behind from the World Trade Organization, what I consider it to be a mistake. And I don't, when you roll back the clock, I think we should have some degree of forgiveness for the people who worked on that.

There was no way to know what it would be like to add a billion people into the World Trade Organization. And there was also no way to know that China was basically going to abrogate almost every agreement that they had agreed to as conditions for joining that WTO. And China became what is widely understood as the most mercantile country in the history of commerce. And there was no way to know that that's how that was going to play out. You know, the Clinton people and the Bush people just didn't have any visibility on that. And that's the way it's turned out. And so now we as a country are in this rear, you know, retrograde movement to try to repair some of the damage that was done by that. Michael, it's a fascinating place for us to land.

the story you're describing, the story that America has in the last 25 years, fallen out of love with building things, from houses to high-speed rail, and the idea that we need a new politics of building, I see that not only is the story of Trump's rise, I think it's one of the major stories of this political moment. I think it was a motivation of Biden and Bidenomics. I think it's a motivation of some of the folks behind Trump and what they might call Trumpinomics. I think it's a part of something bigger than one party or another. And I feel obligated to say it is a major, major theme of the book that I co-wrote with Ezra Klein, which is called Abundance Out in March.

I'm a few weeks away from being totally insufferable on the point of going into full sell, sell, sell mode on this book. But suffice it to say that the theme that you just articulated, this pendulum swing from production to consumption and the costs of deindustrialization, this is very active in the So much more to come there, and most importantly for the moment, thank you, Michael, for this grand tour. I really appreciate it. Thank you for having me. Many thanks again to Michael Sembalist.

So one new feature that we're going to try out in 2025 is, well, look, a few of you have written in the last few months, and you've said something along the lines of, why doesn't this show have a final beat? Like a final button, some editorial routine to close out the show. And I think it's a good point. I think we should have a final button. So we're going to experiment with a few things, I think, this year, because this is a wide-ranging show. The show's themes sort of dance along the beat of my dilettante brain. I thought it might be useful for the audience, and maybe most useful for myself, to record something like a summary of the most important thing that I learned in the previous 30 to 60 minutes. Sort of like, if you only remember one thing, right, or one thing to remember.

I don't know if that'll be the official name, but that's how I'm thinking about it right now. So here's today is one thing to remember. The 2020s really are Gilded Age 2.0. There is no decade on record when the richest companies in America were this profitable. The 10 largest U.S. stocks today have higher profitability than the 10 largest publicly traded companies of any decade going back at least in 1950, and possibly before then. Today, seven companies, the Mag 7, which is Apple, Amazon, Alphabet,

meta, Microsoft, Navidia, and Tesla make up one-third of the total market cap at the S&P 500. That means the other 493 companies in the S&P 500 are just twice as valuable as the Mag 7. 493 versus 7. So why does that matter?

Well, as Michael said, it matters for at least three reasons. First, if you're a diversified investor, that is to say, diversified away from the Mag 7 toward the Not So Mag 93, it means you've been missing out on a lot of capital gains. Second, it tells us that a handful of firms, and by extension, a handful of individuals like Elon Musk, really do bestride the economy like a colossus in a way that just doesn't have modern historical precedent. Now, you could say, that's a reason to break them up. You could say, that's a reason to praise them. I say it's a reason to pay attention. Bigness isn't necessarily bad, but it does deserve our scrutiny because the potential to do bad scales with bigness.

And finally, the bigness of the max seven matters because most of these companies are hyperscalers. They are the companies driving the AI spending boom. And if you want to know, how can the private sector afford to spend hundreds of billions of dollars on chips, on data centers. How can the private markets bear the weight of an Apollo program for our age? This is why they can support a tech project without precedent because their cash piles are without precedent. Talk to you Friday.