🎙️ Unseating China

One common fear in markets: The U.S. is too reliant on China. Its government and investors own hundreds of billions of dollars worth of U.S. debt, while much of America’s (and the world’s) supply chains run through China 🤔

On that second point, things are fast changing. The U.S. has a low-cost, blossoming manufacturing hub much closer to home: Mexico.

💭 For the first time in years, Mexico is once again America’s largest source of imports, eclipsing China (see our Chart of the Day.)

— Matthew, Shawn, and Weronika

Here’s today’s rundown:

Today, we'll discuss the three biggest stories in markets:

• Energy companies driving stock indexes higher

• Meta develops new, powerful AI system

• Google’s ties with Apple under the spotlight

All this, and more, in just 5 minutes to read.

CHART OF THE DAY

IN THE NEWS

🛢️ Energy Stocks Are Driving the Stock Market — Again (WSJ)

Last year, while just about every other sector sold off, energy companies were the market’s best performers. In fact, it was the only S&P 500 sector to close 2022 with gains. This year, oil-and-gas companies are hot again after a quick breather.

(Fossil) Fueling the way: The energy sector is the best performer this quarter among the S&P 500’s 11 segments — stocks like Halliburton, Marathon Petroleum, and ConocoPhillips have advanced 25%, 33%, and 18%.

• Worries about a global economic slowdown weighed on oil prices and, therefore, oil & gas stocks earlier this year.
  

• But production cuts by the world’s largest crude exporters, alongside rising optimism that the U.S. may dodge a recession this year, have pushed oil prices to their highest level of the year.

For investors in oil companies, that’s great news. For everyone else, the result is higher gas prices at the pump and higher prices for other products where oil is a direct or indirect input, like toys, clothing, and even food.

• Higher energy prices make further progress more difficult for the Federal Reserve, which is clinging to positive momentum in taming inflation.

Even though energy prices also surged last year (following Russia’s initial invasion of Ukraine), the worst economic consequences were largely nerfed, thanks partly to unprecedented releases from America’s Strategic Petroleum Reserve to boost oil supplies globally.

• Due to draining those inventories this time, it’s unclear whether reserves can have the same stabilizing effect.

Why it matters:

Another appeal? Energy stocks look historically cheap. Companies in the S&P 500 energy sector trade at an average price of 12x their expected earnings per share over the next year — well below the 10-year average of 19x.

• But energy stocks are largely exposed to the boom-and-bust cycles in commodity markets, where cheap price-to-earnings ratios can be misleading.

• In other words, oil & gas companies earn their highest profits at the peak in crude oil’s price cycle, making them look “cheap” based on financial ratios at arguably the worst time to actually buy in.

Whether because the companies appear cheap or because they expect oil prices to push even higher, investors are still piling in.

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🦾 Meta Is Developing a New, More Powerful AI System (WSJ)

Tired of hearing about AI? Buckle up, the industry is just getting started.

As AI models and tech giants strive to stay competitive, the corporation that owns Facebook and Instagram — Meta — is creating an AI system that can match the capabilities of OpenAI's flagship model, ChatGPT-4.

Thriving perfection: Meta is targeting the launch of a next-generation AI model next year, aiming to be substantially more advanced than its Llama 2 model released just two months ago.

The envisioned system aims to assist businesses in crafting services that generate sophisticated text, analyses, and other output types.

• Spearheaded by a team established earlier this year under the direction of Meta's CEO, Mark Zuckerberg, the project hopes to fast-track the development of generative AI technologies capable of mimicking human-like expressions.
  

• Meta plans to train this new large language model by the beginning of 2024, launching it after Google's advanced language model, Gemini.

The new model's development plans align with Zuckerberg's goal to make Meta a key player in the AI field. Zuckerberg wants the new model to follow Meta's previous AI initiatives in being open-sourced, allowing companies to freely access it for building AI-driven solutions.

• However, critics worry Meta's open-source AI strategy, focusing on cost-efficiency and flexibility, also poses risks like potential copyright abuse and spreading disinformation.

Why it matters:

Staying relevant: In the ever-changing AI industry, it’s not enough to be merely average. It’s a winner-take-all competitive arena, so Meta wants its upcoming model to be at least as good as GPT-4.

• But ChatGPT-4, released in March, is no easy competitor — it has substantially outpaced its previous model that first wowed the world.

A tough nut to crack: ChatGPT’s headstart is a big advantage. Typically, large language models become stronger when trained with more data.

• The most powerful Llama 2 model from Meta was trained on 70 billion parameters, while OpenAI's GPT-4 is estimated to be about 20 times larger, with 1.5 trillion parameters.

MORE HEADLINES

🛒 Instacart in freefall as valuation plunges

💰 Smucker to buy Twinkie maker Hostess for $5.6 billion

🤖 IRS will use AI to crack down on potential tax violations

🧠 Morgan Stanley analysts think Tesla’s supercomputer could drive $600 billion worth of market value

🤝 Disney & Charter ink deal to end cable blackout

🔦 Google’s Ties with Apple Under the Spotlight (Bloomberg)

When you think of big tech, what comes to mind? The big names, yes, but also fierce competition and fast growth. Apple. Alphabet (Google). Meta (Facebook). Microsoft. Usually, they’re competing intensely, as we discussed in AI above.

But Apple and Google also collaborate: Since 2005, Google has paid Apple billions to be the default search engine on the Safari web browser. One senior Apple employee wrote a Google peer in 2018: “Our vision is that we work as if we are one company.”

• That’s among the messages under the spotlight amid the U.S. Department of Justice’s (DOJ) antitrust case against Alphabet’s Google. The government accuses the search giant of restricting competition through deals like its agreement with Apple.
  

• The case is hailed as the biggest test of Silicon Valley’s dominance since a landmark decision against Microsoft over 20 years ago.

The DOJ has already filed another antitrust case against Google for dominating the advertising space, and the Federal Trade Commission (FTC) is trying to break up Facebook parent Meta, sue Amazon for antitrust violations, and look into similar issues related to Apple.

In other words, all of Big Tech is under the federal government’s watchful eye.

So what? The Justice Department may try to separate Alphabet's search business from Android and Google Maps if it wins the first trial, expected to last 10 weeks.

• The largest forced separation of a U.S. business since AT&T's dissolution in 1984 could result.
  

• Regardless of the outcome, the trial could harm Google and its partners, including Apple, whose executives must testify. Emails will be examined in public, too.

Why it matters:

The DOJ will come out swinging for the fences: The DOJ and 52 attorneys representing U.S. states accuse Google of paying billions to maintain its monopoly over the lucrative search market, mostly through agreements with Apple and wireless providers.

The Apple deal was inked 18 years ago, making Google Apple’s default search engine and giving Apple up to a 50% share of the ad revenue Google made from searchers by Apple users on Safari. Since then, both companies have grown into cash-generating behemoths.

• Now, Google has a roughly 90% share of the overall search market, while Apple reportedly made about $18 billion from the agreement in 2022 alone.
  

• The case brings back memories of the Microsoft trial in the late 1990s. Microsoft had pre-installed its Internet Explorer browser on computers with the Windows operating system, preventing other manufacturers from installing competing web browsers.

But Google says its agreements don’t include technical restrictions; users can opt for other search engines if they please, comparing its agreements to the ones grocery retailers have with cereal manufacturers for prominent shelf positions.

See you next time!

That's it for today on We Study Markets!

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