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Written by: Samuel Rines
Key Takeaways
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When it comes to China, it was once an investment darling. Now, it is hard to find a positive.
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There are some strange winners in the AI investment cycle.
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The AI capex cycle is only getting longer.
Not so long ago, the juggernaut in the earnings data was China. It was a race for market share, and there was a palpable fear of missing out on the growth there. That dynamic has shifted. Instead of being a tailwind, China is now a headwind for companies from Starbucks and Estee Lauder to A.O. Smith and Otis Worldwide. Luckily, AI has taken the mantle from China as the investment and capex race that cannot be lost. And AI is not going away anytime soon.
Following the announcements of various measures to stabilize the Chinese economy, there was a sense of relief. But does it matter? So far, the answer is a resounding no. In fact—depending on which earnings release you read—sentiment has not only failed to improve, it is getting worse.
Starting with the consumer—
Estee Lauder
Source: Estee Lauder earnings release, 10/31/24 (emphasis added).
And
Starbucks
Source: Starbucks earnings release, 10/31/24 (emphasis added).
Source: Starbucks 3Q 2024 conference call, 10/31/24 (emphasis added).
And
Nike
Source: Nike earnings release, 10/31/24 (emphasis added).
To be clear, this is not a one-off statement on the consumer front. And the results and sentiment are spread across everything from skin care products to sporting goods and coffee. That is not an exhaustive dataset, but these are not small companies, either. It is also not a sign of broader weakness in the Asian markets. Japan was called out by both Estee Lauder and Starbucks as growing quickly. Not long ago, exposure to China was considered necessary. Now, it is becoming problematic. And it is not just an issue for consumer companies, either.
Trane Technologies
Source: Trane Technologies investor presentation, 10/31/24 (emphasis added).
And
Otis Worldwide
Source: Otis Worldwide 3Q 2024 investor presentation, 10/31/24 (emphasis added).
And
A.O. Smith
Source: A.O. Smith investor presentation, 10/31/24 (emphasis added).
And
Caterpillar
Source: Caterpillar 3Q 2024 conference call, 10/31/24 (emphasis added).
There is reasonable pushback against looking at the Chinese economy from a consumer perspective: the stimulus measures were not directly targeting consumption. But it is not as though the industrials have been seeing anything encouraging, either. Trane makes air conditioning units, Otis makes elevators, A.O. Smith makes water heaters, and Caterpillar heavy equipment. None has seen a shift in its business when it comes to China. Again, it is not bad news for all the growth markets. A.O. Smith called out India for its positive growth trajectory.
The drag from China exposure is not meaningfully improving. That may change in coming quarters, but—for now—the positive “vibes” coming from the stimulus measures are not flowing through to the revenue lines of businesses.
There is always another narrative. The Chinese economic juggernaut faltered as the AI boom began. And the AI capex boom shows no signs of pausing. If there is any readthrough from the numbers being reported, it is that the cycle is getting longer.
Mondelez
Source: Mondelez 3Q 2024 investor presentation, 10/31/24 (emphasis added).
As a refresher, the consumer packaged goods (CPG) companies spent most of 2022 and 2023 raising prices with little pushback on their volumes. That dynamic broke down in late 2023 and early 2024 as pricing had gone too far, too fast. To maintain their margins and some semblance of revenue growth, the CPGs needed to regain volumes. That dictates higher advertising spending, much of it online spending.
This “battle for volumes” could not have come at a better time for the major advertising platforms – Meta and Alphabet. The increased advertising spend not only helps with top-line growth; it also assists in financing their massive capex spending for AI servers and capabilities. How long can this last?
Meta Platforms
Source: Meta Platforms 3Q 2024 conference call, 10/31/24 (emphasis added).
And
Alphabet
Source: Alphabet 3Q 2024 conference call, 10/31/24 (emphasis added).
And
Corning
Source: Corning 3Q 2024 investor presentation, 10/31/24 (emphasis added).
The guidance from both Meta and Alphabet is more capex in 2025, not less. That is a setup from already elevated capex spending levels. That should not be ignored. There is no decline in AI spending coming in the near term. Even Corning (the company known for making the glass for TVs and smartphones) is seeing the multi-year tailwind for its optical communications division from AI demand. At some point, demand will wane, and capex budgets will revert to something more normal. But not soon.
Narratives and tailwinds shift. China was once the darling. Now, it is a headwind. AI was a nascent technology. Now, it is ubiquitous. And the investment around AI is only beginning.
Related: The Appeal of Agency Mortgage-Backed Securities in a Shifting Economic Landscape
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