Once again I am fighting the desperate urge to sell everything and throw all my money into long-term inflation-protected bonds, known as TIPS.
My latest excuse is neither my inveterate pessimism about the human race, the latest, obvious signs of insanity on the stock market, the “Caligula’s horse” aspects of our looming presidential election, or the distinct possibility of a debt ceiling iceberg straight ahead.
It’s artificial intelligence.
The latest buzzwords to sweep Wall Street are already creating something of a mania. Computer chip maker Nvidia
NVDA,
is among the stocks thought to be among the likeliest winners from AI. Its stock price has tripled since last fall, and now trades at 30 times last year’s revenues and 180 times last year’s earnings.
For context, after the dot-com bubble of 1999-2000 burst, Sun Microsystems CEO Scott McNeely famously mocked investors who had bought his company’s stock at peak levels of just 10 times revenues.
“What were you thinking?” he asked.
And few, if any, investors could be found to explain rationally why they had bought internet equipment maker Cisco Systems
CSCO,
at 150 times earnings.
There will be plenty of money to be made in an AI bubble: Late fund manager Dan Bunting used to say, “Never let a bubble go to waste—you make the most money from the worst stocks.”
There will, naturally, also be plenty of money to be lost.
But if AI follows the path of most technological innovations in the past, some of its biggest consequences will be job losses, falling wages, and falling prices. In other words, deflation.
And the biggest beneficiaries of deflation are those who own bonds, especially long-term bonds. That’s because bonds lock in an interest rate until they mature. So if you buy a 30-year bond with a 4% interest rate, and we end up back in an era of deflation and 0% interest rates, you’re sitting pretty.
Bonds work like a seesaw: The price rises when the interest rate, or yield, falls. A bond with a 4% yield becomes very valuable in a world of 3% rates, or 2%, or even lower.
Before the Covid crisis, in 2019, 30 year U.S. Treasury
TMUBMUSD30Y,
bonds had yields of around 2.4%. During the depths of the Covid panic the next year that hit a record low of 1.2%.
The Pimco 25+ Year Zero Coupon U.S. Treasury Index ETF
ZROZ,
which is the most exposed ETF bet you can make on long-term rates, has halved in price over the past 3 years as inflation, and interest rates, have surged. If AI helps take us back to the pre-Covid world of disinflation, or outright deflation, it might reasonably double.
But I much prefer long-term TIPS, not long-term regular bonds. That’s because TIPS win if we get deflation or inflation. TIPS maturing 25 years from now, in 2048, are currently paying more than 1.7% a year above the rate of inflation—whatever it works out to be. The ETF for long TIPS is the Pimco 15+ Year U.S. TIPS Index ETF.
LTPZ,
The situation already seems more cheerful on inflation than it was last year. Key elements of producer prices, a major leading indicator, are on their way down.
The markets are predicting the Fed will cut interest rates by 0.5 percentage points by Christmas.
But why will artificial intelligence lead to deflation?
Technological innovations typically lower costs by raising productivity—output per worker. They also often increase competition, by allowing new companies to break into cozy old industries. Google’s AI chatbot Bard tells me, “AI-powered self-checkout machines are leading to lower prices in the retail sector. AI-powered ride-sharing services are leading to lower prices in the transportation sector. AI-powered medical diagnostics are leading to lower prices in the healthcare sector.”
And I believe him/her/it—because if you can’t trust an AI chatbot, who can you trust?
A few years ago Michael Webb at Stanford University, looked at all the patents filed for AI tech, and compared them to job descriptions. The main takeaway: Lots of white collar jobs are destined for the ax, especially if they don’t involve things, like interpersonal interactions, that AI can’t replace:
“I find that high-skill occupations are most exposed to AI,” Webb wrote. “While individuals with low levels of education
are somewhat exposed to AI, it is those with college degrees, including Master’s degrees, who are most exposed. Moreover, as might be expected from the fact that AI-exposed jobs are predominantly those involving high levels of education and accumulated experience, it is older workers who are most exposed to AI, with younger workers much less so.” Those most exposed including people like paralegals, medical technicians, chemical engineers and power plant operators, he said.
No word on reporters—but I am not hopeful. Another reason why I might want to think about owning more bonds.
