Balancing High-Conviction AI With High-Dividend Diversification

0:00to discuss investment strategy for this fall and into year end. Let's welcome in our next guest, Kristi Akulean, head of iShare's Investment Strategy for the Americas at BlackRock. Kristi, great to talk to you. Now, I read through your paper, my take on the central message is that the economy is healthier than investors may be appreciating right now. So how are you looking at the underlying economy? Yeah, absolutely. And thanks for having me. It's great to be back. Yeah, I think that that's a good read. If I could sum up our overall investment directions paper, which we just published, I would call it constructive, but not calm, necessarily. So yeah, in terms of growth, we see that as being a bit stronger than was expected earlier this year. We do have a view that inflation is on a relatively more benign path, maybe relative to market consensus. And even though we think that rates are going to stay higher, we don't actually think that the Fed is going to move into an aggressive hiking campaign into the end of the year. So put all of that together and we think that it makes for a fairly constructive,

1:03again, outlook in terms of risk assets. And we're leaning into some of the highest, you know, highest revenue, highest earners, which are, of course, in the AI trade as well. So let's talk about the AI trade. I mean, we've had an enormous run in AI-related stocks. So what is giving you the confidence that we are still in the early stages here of opportunity, rather than getting closer to an earnings or evaluation peak? Yeah, absolutely. I think this is one of the most important questions for markets right now. We took a lot of confidence from Q2 earnings. And specifically, you know, I think that we saw a much more direct linkage between CapEx spend and profits. And so if you think about the money that, especially the hyperscalers put into the AI build out over the course of 2023 and 24 and 25, we're really seeing that come to fruition in terms of the incredible earnings growth. And I do think that Q2 earnings was, you know, nothing short of incredible. We saw about 31 percent

2:03on the S&P 500 year over year. That's one of the highest levels ever outside of a recession, right? So keeping in mind that last year wasn't too shabby either. That year over year earnings growth was really strong. We saw that broaden out to about nine out of the 11 sectors grew earnings by double digits. And really, we are continuing to see the demand for compute outstrips supply. So there's lots of metrics that we're watching there. One quick example I'll give. There's about 66 gigawatts of compute capacity that is in development right now in the US of that, which has not yet come online. 95 percent of it has already been contracted. So again, just one of the many metrics we see where we're just again continuing to see that demand for compute really, really move ahead of supply. So it's benefiting kind of the whole AI supply chain, something like BAAI, our block rock AI ETF. It really is making some of those activites across the supply chain and seeing some of those really strong results from Q2 as well.

3:06And you said you don't expect the Fed to move into any sort of aggressive hiking cycle here. But we are likely going to be in a higher rates for longer scenario. You said you expect them to remain higher for longer. At the same time in the note, you warned that AI CapEx, the heavy treasury issuance and competition for capital could have contributed to keeping our yields higher for longer. How long can long term yields go and how high can they get before they start to in some way materially affect the equity markets outlook? Yeah, absolutely. And in terms of the Fed, certainly CPI data that we're going to get tomorrow is going to be hugely influential in that. I will say we're a bit out of consensus and that we still think that there's a case to be made here for the Fed to be on hold next week as opposed to necessarily needing to hike. But as exactly as you kind of framed it, we think the more germane piece of information to the market is this higher reset and longer term yields that we're seeing globally. I think there's kind of two

4:07ways for this to play out to answer your question. One is that I think the yields can be moving higher for good reasons. And that's typically the way we're leaning into this as well. Stronger nominal growth should result in higher yields. And as you pointed out, there's just more demand for capital as this AI build out requires so much capital to be to be to be hit sourced. So we're just seeing competition in the private sector and the public sector. It just means that yields are moving higher globally. What we would be concerned about in terms of the equity market and where those higher yields really start to bite is if they're moving up for the wrong reasons. So if we start to see inflation expectations become stickier, if we start to see more concern around debt and deficits, and that's really in the driver's seat for those longer term yields, then I think it could be more of a concern. But really more broadly, I think to translate that kind of macro outlook to your portfolio, I think higher yields make us lean into higher quality a little bit more. So something like QUAL is our quality factor ETF. I think that that screens

5:12for socks across different sectors that have consistent earnings growth, strong balance sheets. And those are going to be the companies that are going to do well and do better if rates remain elevated as opposed to something like small caps, which we think can suffer even more. And so you like quality companies, but if we're in this area of potentially higher yield, we're in a time that historically has higher volatility, September volatility here, what characteristics are you looking for beyond quality companies that can provide some balance here to offset just how big the AI trade has become? Yeah, absolutely. So as we started and as every conversation about markets these days starts, we do have a high degree of conviction in AI. That is our corthesis, right? Is that we do think that they're continuing to grow earnings. We expect them to do so. But that said, I think there is still a lot of investor demand that we hear and we've been really deliberate about where you can get diversification even within your equity sleeve. So for that, we're actually leaning into

6:14dividends. So something like HDV is our high dividend fund, where we actually think that prioritizing some near-term cash flows can be a really helpful counterbalance in a portfolio against some of those longer-term AI expectations. So we've seen HDV be really negatively correlated to semi-conductors this year, again, just presenting some of that ballast against the AI trade. And I think almost definitionally, if you think about companies that are returning cash to shareholders, they're probably not getting over their skis in terms of cap expense, which is typically where we start to see the market get concerned when we do see some of those AI pullbacks. Christie, always great to have you on. Sadly, we've run out of time, but really appreciate you joining us to take a look at how you're approaching the fall and through the year end in terms of your strategy there. Christie, Aquilean, the head of I Share's Investment Strategy for the Americas at BlackRock.