AI is holding up the sky. The rest are back to earth

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Today's Points:

Europe's leaders left the White House with the Ukraine status quo intact. Next up, according to Trump, a Putin-Zelenskiy summit — we'll analyze tomorrow. Markets are staying aloft on the shoulders of AI. High-yield bond investors show no worries whatever about the economy. AND: Happy 275th birthday to Antonio Salieri!

Lucky Sevens

Newsflash: the US stock market is very concentrated. The performance of the equal-weight version of the S&P 500 — which effectively measures the average stock by weighting each constituent as 0.2% of the index regardless of their size — compared to the cap-weighted index has dropped to its weakest in 22 years: Previous extremes of concentration came with the bursting of the dot-com bubble in 2000, and then with the market crises of 2008 and 2020. This is as tight as the market has become in good times since the internet was taking off. The similarities, with a new technology promising huge gains in profits and revenues, are obvious. For the internet then, read artificial intelligence now. But the dominance of the very biggest stocks is new, and hints at at least one critical difference from the dot-com era. This is how the biggest 10 stocks' weighting in the S&P 500 has changed at five-yearly intervals going back to 2000. It's usual for a few winners to win big at any one time. That's the nature of capitalism. It's unheard of for 2% of the index's companies to account for virtually 40% of its value: It's also unusual for companies drawn from one sector to be so dominant. The Magnificent Seven tech stocks (in which Alphabet counts twice in the chart below due to its listing structure) plus another AI play in Broadcom Inc. take up the first eight spots. That's much greater dominance than in the wake of the pandemic in 2020, or after the internet implosion 20 years earlier: The eagle-eyed will also note that buying the biggest stocks and holding them is a dangerous strategy. Nortel Networks, eighth-biggest 25 years ago, went bankrupt in 2009 and no longer exists. Intel isn't in the shape it used to be. AIG's market cap has shed 80% since its 2000 peak, while General Electric, now on the way back, at one point dropped 92% from its peak. It's really not so unlikely that similar fates will befall one or more of the currently dominant group.  That creates a problem for passive investors, as buying the index no longer diversifies risk. These charts show the inverse Herfindahl-Hirschman index, a statistical measure often used by antitrust regulators to measure concentration in industries. It shows the number of stocks needed to match the diversification provided by the index. Now, only 100 stocks are needed to match the MSCI World: Meanwhile, for the S&P 500 that number has dropped below 50: A standard retort to complaints about market over-concentration is: "What does it matter?" It can be a sign of over-excitement about one portion of the market, as was plainly the case during the dot-com boom. But this time is more complicated because the Magnificent Seven stocks have registered very real growth in earnings per share in a way that leaves everyone else far behind. It's hard to say that there's a problem with overvaluation when earnings growth for the Magnificents has outstripped the rest to such an extent: This is not like the dot-com bubble, when hot companies hoovered up cash from investors. This time, a very small group is siphoning profits from everyone else. Rather than the market, the concern lies with the companies themselves. How can they make such big profits, and can they possibly retain them? The big tech groups have also been spending money far faster than ever before. This is a new development. Tech is usually "capital-light." Capital expenditures on the computing capacity needed for AI and the energy to back it have surged, so that the companies now invest almost as much of their cash as everyone else combined: Well-deployed capital expenditures pay for themselves with higher profits, but those still have to happen. Meanwhile, Big Tech's free cash flow yield (operating cash flows minus capital expenditures as a proportion of market cap) leaves little wiggle room for share buybacks or dividends: No end to this trend is in sight. With Nvidia, currently the biggest, yet to report, David Kostin of Goldman Sachs reports that the other Magnificents grew their earnings per share by 26% year-on-year in the second quarter, well ahead of expectations. For next year, their estimated earnings have risen 1% so far this year, while everyone else's have been written down by 4%. According to Kostin, the results prompted analysts to list their Magnificents capex estimates for next year by 29% to $461 billion. History suggests that not all of the Seven will be magnificent a few years from now. It also shows that their current dominance is unprecedented. AI, and their embrace of it, is a phenomenon of the age. All should be aware just how much the current positive perceptions of the market and of the US economy rely on it.

Where Credit Is Due

High-yield spreads are spectacularly defying President Donald Trump's expansive attempt to reengineer the global trade regime. Arbitrary levies threaten already thin margins, and tariff-driven inflation could keep monetary policy tighter for longer, raising refinancing costs and default risks. But the market is saying something else entirely. Far from pricing in distress, the spreads currently on offer suggest that an economic slowdown is nowhere on the horizon. US high-yield credit remains in strong health, as this Longview Economics chart shows. The implied default rate is close to zero: In the aftermath of Liberation Day, when the ICE BofA US High Yield Index spread hit 457 basis points and the yield-to-worst stood at 8.63%, Brandywine's Bill Zox argued that investors and allocators must learn to be "comfortable being uncomfortable." When volatility is high, he argued, the seemingly comfortable move rarely pays off over time. Twenty weeks later, spreads are barely recognizable, and inflows are once again unbridled. Here's how the index has moved since then: Another gauge of the credit market's pulse, which juxtaposes spreads between investment grade and high-yield bonds, comes to a similar conclusion. As DataTrek's Nicholas Colas points out in this chart, corporate bond spreads are nowhere near last year's highs, having retreated from the initial tariff shock: Corporate bonds' performance suggests investors are unperturbed about the possibility of a US economic slowdown, let alone a recession. Colas argues that corporate bond investors "are a much warier lot than equity investors." As they are preoccupied with getting their coupons and principal on a timely basis, he says: "There is almost no 'AI Trade' in US corporate debt. What we see is pure and substantial confidence in future US economic growth."  European performance has been just as strong, despite very different macro headwinds. Bank of America's Ioannis Angelakis observes investors piling into corporate credit at the expense of "risk-free" assets: High-yield funds recorded their 14th consecutive week of inflows; the pace has also accelerated week-over-week. European-focused HY funds registered their 15th consecutive week of inflows and the lion's share across European-domiciled funds, closely followed by US- and global-focused HY funds. As resilient as high-yield performance may appear, dispersion is elevated. Investors aren't treating junk bonds as one uniform basket, and picking winners and losers matters more than ever. The lower the credit rating, the more performance will vary. Barclays' Corry Short notes that the overall index tightness distorts this reality: At the ratings level, CCC dispersion is its highest ever. The standard deviation of CCC spreads is near its 80th percentile since 2000, and CCC spreads still appear quite wide versus the rest of the index on both a long-term and a year-to-date basis. That said, the year-to-date return distribution of CCCs is remarkably normally distributed. These Barclays charts illustrate the low volatility, and the rising dispersion: Regardless, the recent tightening of US spreads cannot be ignored. Longview Economics' Harry Colvin points out that margins are rising while indebtedness is relatively low, and companies' cash-flow position has returned to surplus. This is all good. Still, there are underlying risks: With a worsening US cyclical outlook, the corporate sector's health is deteriorating at the margin. The risk to consensus earnings expectations, which are particularly strong for coming quarters, is therefore skewed to the downside.  The Fed's lack of response as growth projections cool adds more concern — and not just in the White House. Tight money is typically linked with wider spreads and higher risk premiums. The next development in that drama will come at the annual Jackson Hole symposium later this week. For now, UBS's Leslie Falconio suggests that when easing comes — and almost all still expect it this year — investment-grade credit and agency mortgage-backed securities will look attractive. And if an economic downturn were to show up first, that would be a problem. —Richard Abbey

Survival Tips

Antonio Salieri around 1800. Source: Imagno/Getty A happy 275th birthday to Antonio Salieri! The luckless Italian classical composer has gone down in history for his (alleged) role in driving Mozart to an early death. That was the subject of a Pushkin play in the 19th century, and of a truly great play by Peter Shaffer, later converted into an equally great movie, with a surprisingly different ending. The tale of the genius touched by God brought down by a bitter mediocrity tortured by his ability to perceive what nobody else can surely appeals to us all. It's almost certainly not true. Alex Ross set out the case for Salieri's defense in the New Yorker, and it's a fascinating read. The Italian co-wrote a few pieces with Mozart, probably conducted the premieres of his 40th symphony and his Requiem, and went on to teach Schubert and Beethoven. As for the quality of his work, I've linked a few pieces, and they're not as good as Mozart. They're not terrible, either. As for Amadeus; it isn't historically accurate, but neither is Shakespeare. Richard III and Henry V are still great plays. The same is true of Amadeus. It's a glorious work of art, built  around Mozart's music. As for Salieri, let's wish him a happy birthday and try to set the record straight. More From Bloomberg Opinion Allison Schrager: Sorry, New York. The Era of the Big City May Be Over. Dave Lee: Is the AI Winter Finally Upon Us? Javier Blas: Saudi Aramco Gets Wall Street's Thumbs Down — Again

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