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All eyes are on big tech earnings this week. Our next guest maybe we'll think that tech might be in between a rock and a hard place this season. He's going to break that down for us and exactly what he means in terms of how maybe you should take that and position your portfolio. We want to bring in Jake Manu Kian. He is JP Morgan's US head of investment strategy. Jake, so explain what I just read there. Between a rock and a hard place, how should investors be thinking about tech this earnings season?

Yeah, absolutely, and and thanks for having me this morning. I mean, the first thing I want to say is that we're believers in AI. We're we're believers in the trend. I was watching the show earlier this morning and the baseball game analogy always sticks out to me because in a lot of ways we're we're driving to the ballpark. I mean, we're warming up in the bullpen. Like this is this trend is going to take decades to play out fully, just like the internet, just like cloud computing. Um so, you know, thinking thinking through that in a in a kind of longer term sense, I think is important for investors. But in the short term, I think it's clear that markets are looking for reasons to kind of fade the trade. And what I mean by a rock and a hard place is that management teams are going to have to walk a very fine line between uh underscoring their enthusiasm for the AI build out, as well as making sure that their capital spending plans are rational and and uh and cheered by investors. So that's that that's that fine line that management teams are going to have to walk this earnings season.

I mean, it sounds like, you know, we might not even had the game started. It sounds like we might still be building out the ballpark here, where the winners are picks and shovels, as we've continued to hear from analysts who have covered these names and anyone who's strategizing around how to position their portfolios. So, how do we really get a sense of knowing when the game is fully underway, when generative AI should start to produce margins for these businesses?

Yeah, and I mean, I think you you look at the statistics from the census bureau, only 5% of businesses are actively using AI. Um so again, we're we're building out the infrastructure to do this. So you know, we at JP Morgan are lucky enough to have a management team that's are really, you know, true true believers in this trend um and have implemented the technology in our day-to-day lives, but that's not the common theme. Um I I think, you know, people are going to look for the early use cases and look for the clues. I think, you know, watching the Olympics, a lot of the advertisements around AI platforms, so I think it's it's fully, you know, starting to enter the the lexicon, but we have a we have a long way to go. The what what I will say, what gives us comfort as investors is these companies, these hyperscalers, are driving this investment through cash flow. Right? This is very different than the kind of internet boom in the 2000s when when companies had to take capital from investors, take capital from the bond market to build out the internet. Um AI CAPEX from the four hypers, four biggest hyperscalers, is going to be 200 billion this year. Last year they did 270 billion in free cash flow. So the the balance is there and gives companies a little bit of buffer and a little bit of wiggle room to actually build the ballpark.

Jake, what do you think about this rotation? When you take a step back outside of the mega seven, we've seen some excitement, some money pouring into those that haven't performed as well. When you take a look at even the remaining 493, or when you take a look at the Russell 2000, clearly has been attracting some investment opportunity there from investors. I guess, do you see that outperformance that we have seen in the Russell 2000? Is that a trade that you think is going to stick at least for the shorter term? Or how are you evaluating those opportunities with the expectation of a Fed cut?

Yeah, we've been we've been thinking that this equity market rally would broaden for a long time. You know, finally it's started, it started to. A big catalyst for that was the negative CPI print we got a few weeks ago. Um, you know, our chairman of marketing and investment strategy, Michael Sembilis, just wrote a a really interesting piece about small caps and just how cheap they had gotten. And what he pointed out is, you know, 40% plus of those companies don't make any money, and only 50% of their debt is fixed. So for the S&P 500, almost 90% of their debt is fixed. So they're really sensitive to lower interest rates because it's going to make them it's going to make it easier for them to finance their operations and alleviate the biggest risk case. Um so that's been the the spark and the catalyst. But to us the most important thing is even when you adjust for quality, so when you look at the top quality free cash flow margin, small cap companies, they're trading at a record discount to top quintile free cash flow margin large cap companies. And that's the valuation gap that we want to exploit with our clients.

When you think about the back half of this year, I mean, we're just in the early phases of it. What is the the biggest headwind risk to the market? Is it is it the Fed? Is it election? Is it Japan selling down some of its treasuries? Where are you kind of identifying some of those risks and trying to mitigate them?

Yeah. Well, most investors I talk to think it's the election. So I don't know what what it's going to be, but most investors I think are focused on the election here. Um when we talk about the election, we want to focus on what's going to be the same, no matter how the the outcome goes, just because we don't feel like we have an edge in in forecasting election outcomes. And it does feel like um the fiscal backdrop isn't going to improve either way. So I think most people point to kind of risks in the in the bond market based on um 2025, which is, no matter what, going to be the year of tax legislation, just because the tax cuts and jobs act is set to expire at the end of the year. Um we're obviously going to have to see how Congress uh shake shakes out to have a base case around that. Um but it might be one of the reasons why you've seen some of this yield curve steepening, in addition to the fact that we're 50 days away from what is likely to be the first Fed cut of this cycle.

Jake Manu Kian, who is the JP Morgan US head of investment strategy. Great to have you here with us in studio.

Thanks for having me. It's been a blast.