Tariff Threats Offset Wall Street Gains; The State of China's AI Race
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Bloomberg Audio Studios. Podcasts, radio, news. Welcome to the Bloomberg Daybreak Asia podcast. I'm Doug Krisner.

So markets in Asia are looking to mimic Monday's performance in the U.S., where the bulls drove equities to all-time highs. Also today, the question of whether fierce competition in China's AI industry is muddying the long-term outlook for the sector. In a moment or two, we'll be joined by Bloomberg Opinion columnist Catherine Thorbeck.

But we begin this morning with markets. As I mentioned, equities in the states at all-time highs on the final day of the second quarter. So now the S&P 500 is up roughly 25% from its April lows, its best quarter since December 2023. Today, we broke above 6,200 for the first time, tech shares leading the charge today.

And for a closer look at the price action, I'm joined now by Burns McKinney. He is managing director, also senior portfolio manager at NFJ Investment Group. Burns, thank you so much for making time to chat with me. What's your view on the rally that we saw in Q2?

It's just amazing how, you know, if an investor went to sleep at the end of the first quarter and then woke up at the end of the second quarter, they'd think, hey, this has been a pretty quiet quarter. Not a lot has happened, but, you know, we've been on a pretty wild round trip. And, you know,

Really, it's at least pretty simple to explain. I mean, the markets really got pummeled after the April 2nd announcement of the tariffs, the liberation day or obliteration day, if you will. And as the markets have kind of gained more and more confidence that, okay, you know what? The president really does care what the markets think. And a lot of these tariffs won't be as bad as feared. They rebounded really just back where they were. That's

That said, the risk-reward may be a little bit worse than it was at the beginning of the period, simply because despite the fact that the tariffs may not be as bad as once feared, you're still looking at levels that will probably be three to four times anything that we've seen in our lifetime. Last Friday, strategists over at Bank of America were warning that there is an increasing risk of a speculative bubble in equities. Is that something you share?

Yeah, bubble is a word that I think it gets clicks. It gets people excited. You know, it's hard to say there's a bubble. But that said, you know, equity markets do look a bit richly valued. You're looking at, you know, the U.S. markets trading at about 23 times earnings. That's about a third above their long term average valuation. And it's really only been

more expensive than this about 20% of the time over the last 25 years. And so, stocks are rich. Looking forward, it's hard to see multiple expansion from here for an investor in the broader market. So, you're just going to have to rely on good old-fashioned earnings growth. And even that's at risk, given the fact that

tariffs could squeeze margins. Looking backward, the last couple of years, I say, last year was like throwing the football down the field, 40-yard bomb. Year before that, 40-yard Hail Mary. Going forward, investors probably looking at the good old-fashioned three yards in a cloud of dust. But there are opportunities to be had beneath the surface. You mentioned margins. Are margins really the biggest test in the upcoming earnings season?

It's definitely what investors are going to be keeping an eye on, and that's what they're going to be listening for in all the earnings calls. In general, in a capitalistic society, margins are one of the most mean reverting stats out there. Even prior to the current policy environment, corporate profit margins were really near

all-time highs. And now when you factor in the fact that we've seen tariffs start to go into place, we haven't necessarily seen a lot of those increases in costs be passed on to consumers. And so there's really nowhere for that to go but basically squeeze profit margins a little bit on the

corporate environment. And that's certainly what investors are going to be focused on. Maybe we can talk a little bit about the dollar. For the month of June, I think the Bloomberg Dollar Spot Index was down about 2%. And I think right now we're at about the lowest level since March 2022. I'm wondering whether you think this is an illustration of diminished appeal of U.S. assets globally. And if that's the case, why is that? There's definitely been more and more discussion about an

sort of an end to the period of U.S. or American exceptionalism. We've been in an environment whereby U.S. stocks have outperformed global markets outside the United States over the last decade by 100 percentage points.

a lot of that's had to do with innovation and environment, embracing innovation in the United States. But as investors have seen certain threats to that, again, trade wars, we say trade wars are easy to win. There really aren't

There might be relative winners in a trade war, but basically on an absolute basis, everyone loses. And so between that, between geopolitical risk and whether it's just smaller risks like threats to Fed independence, investors are starting to look elsewhere. And you've seen lower valuations overseas for a long time, but you haven't necessarily had the

catalyst to get investors to jump into those valuations. It definitely makes a case for maybe investors diversifying their portfolios. Maybe, again, not necessarily selling the U.S., but maybe diversifying away from your winners and maybe adding to some of your losers. The equity market seems to be telling us, "We will avoid a recession here in the U.S." The bond market seems to be suggesting that inflation is not an issue right now. Does the bond market have it right?

Well, first, I hate to admit this as an equity investor, but the bond market usually gets a little bit more correct than equity managers such as ourselves. But inflation, you really have seen. I think that the Fed

was fairly successful in threading that needle and navigating, cutting job openings without cutting jobs and taming inflation. The most important thing they had to do was keep investor expectations of inflation down, because that's the type of thinking that can just spiral out of

control. And we're in a world now where the Fed's preferred measure, the core PCE for inflation, is now running roughly 2.5%. And in fact, if you look at the last three months and annualize those, it's really right at the Fed's 2% target. And so, inflation has been coming down. One of the big fears has been that tariffs might cause resurgence in inflation. We haven't seen that yet. And so, it does seem that

You know, price increases are probably a bit behind us, notwithstanding whether we have a geopolitical shock that might actually drive up energy prices in the near term. So I think we can agree that a lot of the gains that we have seen in stocks have been built on hope that the Fed is going to resume rate cuts at some point. Do you have a sense of when that may happen? Is it September? Perhaps a little sooner, maybe July?

Yeah, I think what the markets are pricing in is something along the lines of September or October. The great thing about this, and this is the reason the markets have rallied, is that there's two reasons the Fed would cut rates. One is in case of emergency. You see something has been broken. You're heading towards a recession. And the other reason is simply

when they determined that the Fed rate adjusted for inflation has just gotten restricted because of the fact that they've been winning that war with inflation. So if you see a continuation of that Fed cutting cycle, this is actually for the good reason, the good news reason for the latter. As far as

when they cut them, whether it's July, September, October, really what investors should focus on is not necessarily what the Fed does next, but what they do last insofar as where they ultimately settle. And this is probably, if you're looking for a contrarian view, it would be that

given the fact, you know, inflation's coming down, but just due to deglobalization, it might not go back to the, you know, entirely to the levels that it's been over the last 10, 15 years. And as such, you know, when, you know, the Fed resumes cutting, they might not be able to get rates down to that near zero level that we've been at, which, you know, if rates are just a little bit higher for longer, that really makes a case for investors. Well, how do I

respond to this, it means go short duration. Within equities, go for value stocks, and specifically companies that are paying and raising dividends. Are those the key tenets of your strategy at this point?

You know, we're looking for relative valuation regardless of markets. We don't like to try to time markets. We like to stay fully invested at all times within the framework of diversification. But, you know, we've always made the case that some of the best strategies through time have been those that have focused on companies that are returning capital to shareholders, that are shareholder friendly. And that means companies that are either buying back shares or paying dividends.

What about opportunities offshore? Given everything that you're describing, I'm wondering whether you find the same thing to be true, let's say, in Asia or in Europe.

Absolutely. I think at this point in time, I noted a bit ago that whereas the S&P 500 is trading at 23 times earnings, stocks in Europe are trading at 14 times earnings. That valuation gap is as wide as it's been in the last 10 or 15 years. Again, investors have been looking for a catalyst. That catalyst may be the fact that you have overseas in places like Europe, a delayed

response to interest rate cuts there. They have, because inflation has really pulled back there, and they have been able to resume cutting interest rates. You have that. But the policy environment's also looking a little bit more favorable on the fiscal side. You're starting to see signs of life there, whereas places like Germany have basically been removing some of their debt caps and starting to focus on infrastructure and defense spending. The same goes for France and other countries. And so

that could be maybe that catalyst to kickstart a reversion of the mean in places like Europe. And one other place for investors to look, or at least for diversification purposes, is the fact that you noted a few minutes ago the weakening of the dollar. Historically speaking, when the dollar weakens, that bodes well for emerging markets equities. So it makes a great case for getting a little bit of

exposure there too. Burns, we'll leave it there. Thank you so very much. Burns McKinney is Managing Director, also Senior Portfolio Manager at NFJ Investment Group. Joining us here on the Daybreak Asia podcast.

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Welcome back to the Daybreak Asia podcast. I'm Doug Krisner. China's crowded AI landscape is not only fueling rapid innovation, but fierce competition as well. And it's that competition that seems to be dragging down profits. Let's check in with Bloomberg Opinion columnist Catherine Thorbeck. She covers all things tech in Asia, and she joins us from our bureau here.

in Tokyo. Catherine, thank you for making time to chat with me about this. Give me a sense of perspective on this. How recent has this kind of tension between innovation and competition been developing in AI in China?

This is really a story we've seen play out many times in the history of China's tech sector. You know, competition is notoriously fierce in the world's second largest economy. So whenever a new craze emerges, there's always just so many rivals that sort of come out of the woodwork ready to pounce. And, for example, we saw this in the food delivery market. There's some food delivery wars that were going on, and it really became a race to the bottom when it comes to pricing. You know, we saw bubble tea being sold for less than 25 cents last month.

And we also saw it in the electric vehicle market, which has sort of left behind a trail of zombie cars.

And now these sort of same forces are really in full swing in the booming artificial intelligence industry. And these AI firms have really been focused on this sort of classic playbook, which is scaling up their user bases and racing for market share. And the result has sort of been this rat race. You know, they're at each other's throats when it comes to pricing, and it's really become a race to the bottom. But I think a key difference here is that nobody has actually figured out, has really cracked the key to getting consumers to pay for these services.

So it makes the issue of monetization or a path to profitability seem a really long way off. And this is really unique to China's tech sector. You know, in in the States, there's in Silicon Valley, there's sort of a smaller number of large players that really dominate the market and they really have control over pricing. Whereas in China, you know, there's just so many smaller players and as well as the big tech companies.

So, competition has been really, really fierce, and I'm just not sure how sustainable it is. I'm just wondering, when you talk about big tech companies, I think of Alibaba, and you would expect maybe that company or companies like Alibaba to have some sort of advantage.

That's right. So Alibaba and ByteDance and Tencent, these sort of big tech players, I think they really can play the long game and they can sort of weather the storm a little bit better than these so-called little dragons, which are these sort of startups that are really driving innovation in China's tech ecosystem. And so I think the big tech players are definitely in a better position. But I also think that's a little bit unfortunate because we really see sort of the biggest breakthroughs in AI come from these smaller startups, which I think are at higher risk here.

Does the government have a view on what's happening, do you think? So I think post-DeepSeek, there's just been a lot of exuberance. There's been a lot of top-down support for the AI sector. And so it's sort of driving this. And in some ways, it's a double-edged sword, you know, because there's so much excitement for AI and so much top-down support. It has really been driving widespread adoption of AI services and AI tools throughout China, which...

The government wants, but I think it definitely puts these companies in a crunch when it comes to sort of figuring out how to make money. So when you talk about adoption, is it primarily on the part of consumers using more AI-related devices or is it in industry as well? That's right. So I think consumers definitely demand for AI services and tools is red hot. You know, we see so many chatbots, so many people using DeepSeek.

across local governments and across even hospitals. So I think the adoption has been widespread. And the way I kind of look at it when we talk about the sort of top-down support was

You know, I'm not going to remember which U.S. president it was, but there was a president that put electricity in the White House to sort of signal that, you know, this technology is safe and we can rapidly adopt it. And I think there have been a lot of top down signals coming from Beijing and coming from Xi Jinping about how AI is, you know, the future and we shouldn't be afraid of it. And I think we've really seen that play out when it comes to consumers really sort of embracing this technology and not being afraid of it and sort of rushing to adopt it.

One of the big questions in the States as it relates to the investments being made in artificial intelligence is the ROI, the return on those investments. Do we have any visibility into whether or not this is having kind of a similar conundrum in China right now?

Right. So I really think that's sort of the biggest existential threat hanging over sort of the entire AI ecosystem in China is that there really is not a clear path to profitability and there's not even a clear path to sort of monetization and making money off of consumers. You know, so many of these chatbots are being manipulated.

offered for free. And because, you know, competitors are offering them for free, it basically peer pressures all of the companies to do the same. And I think there's one statistic that our Bloomberg intelligence colleagues wrote, which was that I think all of the top 10 AI chatbots in China generated just $1 million in revenue from Apple's iOS app store in 12 months.

And during that same time period, OpenAI's chat GPT garnered $669 million in iOS revenue. So that's quite a big difference. And that's just one chatbot compared to 10 of China's. So what do we know about the rate of failure here? I mean, do we have enough data to begin to kind of quantify that?

So I think it's too soon to tell. Like I said, there's, you know, this top down support and there's just this insatiable hype, especially in the wake of deep seek. And I think for now, that's been a really strong propellant of the sector. You know, a former government official in China last week said that the nation is on the cusp of generating more than 100 deep seek like breakthroughs.

But I think, you know, if you look at more than 100 deepseeks, you know, what does that actually mean? That means such fierce competition. And so I think in the long run, we may see at least 100, you know, zombie AI tools or zombie AI agents. But I think, you know, that's still a long way off. And for now, you know, this hype is really driving a lot of exuberance.

But we'll have to see how it plays out. And I'm wondering about the workers that are involved in these companies, the programmers, the software engineers. I would imagine that it's a very good sign for them. The question is whether it continues.

Yes, we will definitely have to see. You know, I think the the exuberance has just been especially after deep seek has just been absolute pandemonium in China. And so we'll have to see how it eventually plays out. But yes, a lot of excitement. What is the next thing that you're going to be watching for in trying to understand this story more deeply?

So I think eventually it's inevitable that there's going to be some kind of cooling down, whether that's sort of a consolidation on the horizon. But like I said, I don't think that's coming anytime soon because, you know, because of all this excitement, because of all this top down support, I think that this frenzy still has a little bit of room to run. But I think

the big question is really how can any of these companies find a way to monetize if nobody's actually willing to pay for these services? You know, Chinese consumers historically have just not liked paying for software services. They're sort of intangible. And they've also refused subscription models, which are sort of the two sort of revenue streams that have taken hold in the U.S.,

So without those, we'll have to see how any of them, whether they could come up with a killer app that people are willing to pay for or whether enterprises decide it's worth shelling out for AI services. But for now, the market is pretty much dominated by free-to-use services. So I question how sustainable that is. We know the tension that exists, particularly in the realm of technology between the U.S. and China.

and the limitations that are inherently a part of that story. But I'm wondering about the adoption of AI-related products created by China, maybe being employed by or in other jurisdictions across parts of Asia.

Right. So I think that there was hope that, you know, if Chinese consumers aren't willing to pay and if the market at home is so hyper competitive, maybe these firms can start looking abroad for growth. But I think that's really an uphill battle. You know, we've already seen jurisdictions around the world, whether that's Italy, Taiwan, start to crack down on deep seek and restrict use just because of all those sort of geopolitical tensions. So I think going abroad would definitely be a

There's definitely hope that that's like a market. Overseas markets are where some of the growth is. But I think it's going to be very, very difficult for these Chinese AI firms to sort of distance themselves from Beijing. We'll leave it there, Catherine. Always a pleasure. Thank you so very much. Bloomberg Opinion columnist Catherine Thorbeck. She covers all things Asia tech from our bureau in Tokyo. Talking here on the Daybreak Asia podcast.

Thanks for listening to today's episode of the Bloomberg Daybreak Asia Edition podcast. Each weekday, we look at the stories shaping markets, finance, and geopolitics in the Asia Pacific. You can find us on Apple, Spotify, the Bloomberg Podcast YouTube channel, or anywhere else you listen. Join us again tomorrow for insight on the market moves from Hong Kong to Singapore and Australia. I'm Doug Krisner, and this is Bloomberg.

Thrivent can help you plan your finances for the people, causes, and community you love. What makes Thrivent different? Financial services and generosity programs are combined to help you build a financial roadmap for the future while also creating opportunities to give back along the way. Visit Thrivent.com to learn more. Thrivent, where money means more.

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