AI-Driven Growth Versus Deficits: Dual Forces Shaping Economic Outcomes

Key Quotes

"The core of our research was trying to develop data be data driven right not opinion and then look at where scientific discovery could lead to to technological change which ultimately drives markets earnings and growth and um and that led us down what we call the idea multiplier effectively it is looking at all the ideas that are being generated that can be written down patents new medicines articles by scholars and we were looking at is that accelerating and good ideas within those works."

Joe Davis explains that their research methodology shifted from relying on opinions to a data-driven approach. This involved analyzing scientific discoveries and technological changes by examining patents, medicines, and scholarly articles to gauge the acceleration of good ideas. This "idea multiplier" concept is central to their framework for understanding economic drivers.

"The most likely outcome is that what is a scenario that i call ai wins which means over the next five years we will have economic growth accelerate despite the aging of society and poor demographic profile in the united states so much so that growth could be above 3 closer to the level we had in the late 90s and i'm not just saying that because i'm optimistic on ai it's based upon what it will do to the workforce and it'll be disruptive it'll probably be the biggest change in around 600 out of the 800 occupations we've looked at it'll be the greatest change in how we spend our time in at least 40 years it's going to be a big change and it'll be disruptive and there will be some job loss."

Davis outlines the "AI wins" scenario, which he considers the most likely outcome. He projects that AI will drive economic growth above 3% over the next five years, even with demographic headwinds. Davis emphasizes that this growth will stem from AI's disruptive impact on the workforce, affecting a significant portion of occupations and fundamentally changing how people spend their time.

"The most compelling investment strategy in the investment cycle in that world now you have to give it five or seven years is actually the more bullish you are on ai the more you underweight technology in your equity portfolio oh that's a spicy take let's hear it and the reason i don't see this coming necessarily because it sounds like hey we're going to have a tech boom invest in the tech companies but i actually the more we did digging and we looked at like 150 years different technologies emerged electricity the automobile transistor computer internet but you know you know a thousand of these examples but you've got enough what becomes readily apparent although the timing always varies a little bit is that there's two phases to this technological transformation assuming we you know ai is the next general purpose technology which again i'm saying there's a 60 odds that's going to happen from what we know today the first phase is almost without exception is the production of that technology people are buying it businesses are unleashing it if it's the personal computer and the internet it's the late 90s it's you can think of the internet's companies it's the personal software and computers i talk about this all in the book and of course those stocks the tech i'll call it the tech sector but electricity utility companies were the tech sector in the 1910s yeah automobile manufacturers were the tech companies in some of the 20s and 30s but let's call it the tech sector they they drastically outperform in the first half and and there's no surprise perhaps that some technology stocks are outperforming today what i was surprised to find is that in the second half of the cycle the non tech companies outperform."

Davis presents a counterintuitive investment strategy: the more bullish one is on AI, the more they should underweight technology stocks in their equity portfolio. He bases this on historical analysis of technological transformations, noting that while tech stocks lead in the initial phase, non-tech companies tend to outperform in the second half of the cycle as the technology becomes more widespread and benefits other sectors.

"The fact that they're both going up is actually consistent at least with our projections that you have non consensus outcomes emerging both a pessimistic one which is a little bit closer to what the those that are buying gold it would be consistent with their thesis as well as the more optimistic one in terms of ai being potentially transformative right and the stock market is very excited about that so the prices today i i i'm asked a lot like how do you square that circle it's and and it's actually to the best of my knowledge our framework is the only framework that actually explains the rise of both because we are saying there is high ai though we are not getting consensus outcomes and it's going to push one way or the other and i wish i could just tell this audience it is only skewed one way or the other because it's a very easy narrative but it is it's too early in both ai's pace and the deficits would have to materially worsen and ai has to get materially better so everyone who's using chat gpt it better get way better than it is right now to get the lift we need to overcome some of the headwinds the world faces and our model and our projections are are simulating what those futures could be and that's where those probabilities are coming from."

Davis explains how the simultaneous rise of gold and the S&P 500, particularly tech stocks, aligns with his framework's prediction of non-consensus outcomes. He argues that this phenomenon is explained by his model, which accounts for both a pessimistic scenario (benefiting gold) and an optimistic AI-driven scenario (benefiting stocks), suggesting that markets are beginning to price in these divergent possibilities.

"The greatest diversification is actually in the fixed income side even though you do get more volatility in bonds and that's because of the downward draft in equities but you have the federal reserve that's that's keeping rates well above the rate of inflation in part they have to because deficits continue to rise and are showing some inflation there and that's what the gold camp misses the gold camp assumes that the federal reserve does nothing they receive from the battlefield we have high deficits keep going up we get a currency debasement and we get this inflation like the 70s that's possible we show about a 5 probability of that happening it has happened in the past in some countries my my point being is gold that's the achilles heel of the gold trade even if you're pessimistic on ai you're giving no role for the fed if you and most likely than not the fed is holding the line on some of this and you get that high income income carry of short and intermediate duration fixed income there's more volatility but the greatest volatility is in the equity market so that's the that's actually the strategy is your market if you have a world where fiscal pressures have manifested and we haven't had the ai boom you actually want to overweight fixed income."

Davis argues that in a scenario where fiscal pressures are high and AI has not delivered a boom, fixed income offers the greatest diversification, despite potential volatility. He criticizes the "gold camp" for assuming the Federal Reserve will be inactive, stating that the Fed will likely maintain