We heard from Google today on Q2. The capex boom continues, and the AI boom continues. 

Google spent $44.9 billion on data centers and chips in ninety days. That’s double a year ago. Full-year guidance was raised from $180-$190 billion to $195-$205 billion.

But the loads of quarterly free cash flow that Google has been funding its infrastructure investments with for the past three years, has gone negative.

Free cash flow is what’s left after a company pays its bills and builds its infrastructure. And Google has been one of the greatest free cash flow machine in the history of capitalism.

Over the past five years, Google has generated about $17 billion in FCF (on average) every quarter — until now. 

This quarter it burned $5.9 billion more than its operating cash flow.

And not only are they drawing down in excess of that monster, record $39.1 billion operating cash flow, they are borrowing money to fund the infrastructure spending — more than $50 billion in new debt since the beginning of the year.

Why do it?

Because the demand side is extraordinarily strong.

Cloud revenue grew 82%, to $24.8 billion, against Wall Street expectations of 64% growth. The backlog of signed, contracted future cloud business now stands at $514 billion. Those are contracts, not projections. Google’s models are processing 22 billion tokens a minute, up from 16 billion just one quarter ago.

With that demand, and that backlog, the faster they build, the more they monetize.

Over the past year, Google Cloud produced 54 cents of additional operating profit for every additional dollar of revenue. So, they borrow money at mid-single-digit rates, and turn that into datacenter revenue that generates better than 50% incremental operating margins.

Those are the economics behind the cash flow drawdown, and the borrowing. 

Remember, as we discussed last week, the AI inputs are scarce (advanced chips, memory, power, compute), margins are historic. Where AI output is abundant, competition hands the gains straight to the customer.

Google sits on both sides.

It ships ever-cheaper models on one side driving the abundance — and on the other side it’s now borrowing money to buy more of the scarce, high growth/high margin stuff.

The world’s biggest customer of the chokepoints (the compute) just told us the chokepoints are worth levering the balance sheet for.

The market ran ahead of big tech earnings today. The AI names ran, the Nasdaq closed up 1.3%, and the major indexes broke a three-day losing streak.

Meanwhile, the dollar, yields and commodities are all going higher.

The 10-year touched 4.64%, its highest since late May, and the long bond sits above 5%, near the top of its multi-year range. Italian yields at 4%. German yields above 3% (around 15-year highs). UK yields above 5%. 

Crude oil has now spiked 27% in 13 trading days on aggressive U.S. strikes on Iran. Higher energy prices are pushing yields higher. Higher yields are pushing the dollar higher. A stronger dollar has pushed dollar/yen past 163, its weakest since 1986.

Last month Japan’s finance minister and Bessent held a currency call and said they would take “bold steps” if needed. The officials drew a line. The market has walked straight through it.

Next, commodities. Silver jumped about 4% today. Gold is bouncing, after a six-month 30% correction — despite real yields climbing.

What does it all mean? It looks like markets pricing in risk of bigger, longer global energy supply disruption — more war. 

Halliburton’s chief executive said today that rebuilding reserves and supply runs “years, not quarters.”

Maybe the cleanest signal is in this chart …  

This (normalizing for unit of measure and exchange rate) reflects how much more Europeans are paying for energy (Dutch TTF Natural Gas) relative to Americans (Henry Hub Natural Gas).

It peaked a couple of weeks into the war.  Now, here we are more than 140 days in, and we have a new high (of 6.95x).  

Last Wednesday we made the case that AI’s gains accrue to users and builders, not to a permanent margin explosion for the companies using it.

We’ll learn more this week.

To this point, we’ve seen the clear gains continue to accrue to the primary AI chokepoint for world chip supply, Taiwan Semiconductor. 

Last week they reported record revenue and profit up 77%. 

Gross margin expanded to 67.7%.  Operating margin was up to 60.3%. Net profit margin was 55.6%.  The year prior, those margins were 58.6%, 49.6% and 42.7%, respectively. That’s a massive scale business doing 9 to 13 points of margin expansion in one year.

Now, let’s look downstream.

Netflix told shareholders it used generative AI in roughly 300 titles this year. Battle scenes, crowds, entire sequences. Its co-CEO said one documentary’s AI footage came “twice as fast and at half the cost,” and that without the tools, productions “would have left out those key shots.”

So AI is everywhere in the product. But revenue growth is decelerating, from 16% to 13% to 12% guided. The gains went to viewers, who get bigger shows, and to creators, who get bigger tools. They did not go to margins.

And IBM, you’ll remember, warned on its quarter because customers redirected software budgets to buy scarce servers and memory chips.

So, in companies producing inputs that are scarce (advanced chips, memory, power) the margins are historic. Where AI is abundant (content, enterprise software) competition hands the gains straight to the customer. Jamie Dimon said exactly this on his earnings call last week — the ultimate beneficiary is the customer.

The productivity benefits are arriving for users and end consumers of AI, though it’s not hitting the income statement (at least yet) for most companies.

That said, it’s early in Q2 earnings season. We’ll learn more this week.

Wednesday, we’ll hear from Google (Alphabet). This is the first big hyperscaler to report. And it’s all about the capex plan.  The Wall Street community continues (for yet another quarter) to speculate about a capex slow down.

The suppliers of the most advanced chips in the world say otherwise.  

The TSM report shows pedal-to-the-metal, and if we listen to Nvidia’s CFO two months ago, she told us “AI infrastructure spending is on track to reach $3 to $4 trillion annually by the end of this decade.” That’s per year! 

Google will be a big share of that $3-$4 trillion.

They’re already on the record to spend $180-$190 billion this year, with a “significant increase” signaled for 2027. The infrastructure investment is accelerating, not slowing.    

  

 

 

Take a look at this chart.

The orange bars are the price of European natural gas. The white bars are the yield on Italy’s 10-year government bond.

As you can see, the rise in European natural gas prices, due to the structural supply shock in the middle east, has resumed since the beginning of July. 

And because of what a sustained spike in energy prices does to the fiscal situation in the weaker spots in Europe, Italian 10 year yields are rising with it step for step.

That’s part of the doom loop formula for Europe, that we revisited yesterday.

Expensive energy drives European inflation. Inflation forces the ECB to hike. Hikes drive up the borrowing costs of Europe’s most indebted governments.

The gas price is a bond market problem. And the chart above tells the story.

Let’s talk about the boom loop.

The market has spent two days selling the AI trade. Chip stocks, memory makers, the whole supply chain. The second shakeout in six weeks.

But let’s look at what’s actually happening. 

ASML raised its full-year sales forecast — for the second time this year.

IBM told us its customers raided software budgets to buy servers and memory chips before prices rise again.

A Chinese lab just released the largest open-weight AI model ever built. How was it built/trained?  With a lot of computing power.

And on that note, we heard from Taiwan Semiconductor this morning. TSMC manufactures nearly every advanced AI chip on the planet. It sees every order book in the industry.

They reported record revenue (up 36%), record profit (up 77%). They raised full-year revenue growth forecast to more than 40%. They raised capital spending plan by $8 billion, to as much as $64 billion, and said the next three years will be “even more significantly higher.”

They continue to build more capacity to meet more demand. 

They committed another $100 billion to fabs in Arizona. And the Chairman said, “our conviction in the multi-year AI megatrend remains very high.”

The stock fell.

The one caution in the report was on consumer devices, where rising component costs are beginning to bite. It’s not a demand problem, it’s a bottleneck problem — another “scarcity” story. Every major tech player is aggressively over-ordering to secure scarce capacity.

So, the evidence this week went one way. The stock prices have gone the other.

But the underlying theme continues to strengthen. In a world racing toward abundance, you want to own the scarce things that abundance can’t exist without.

That’s what our two portfolios are built around. Our AI-Innovation Portfolio owns the scarce physical inputs the buildout cannot exist without. Our Billionaire’s Portfolio owns the still-undervalued producers of the hard assets that feed it.

Two portfolios driven by one thesis. If you’re not yet a member, it’s a good time to get positioned. Learn more here. 

 

Yesterday we looked at the war premium Europe is paying for energy.

This is the catalyst of the doom loop for Europe.

Energy dependence raises inflation. Inflation forces rate hikes. Higher rates raise sovereign funding costs. Funding costs raise political pressure on the European Central Bank to intervene (to push borrowing rates back down). But ECB intervention will be impotent, unless the Warsh-led Fed is there for support. 

And if we pay attention to the Fed leadership candidacy contest of the past year, and the geopolitical squeeze the Trump administration has put on Europe, that ECB support from the new Fed will come ONLY with political conditions — the same conditions European officials have been resisting.

So, that’s the doom loop we’ve been talking about for many months. It continues to progress. 

Let’s talk about the boom loop, in America, which also continues to progress.

We’re in the first week of a big earnings season. The banks have reported blowout numbers. Equity markets revenue, investment banking revenue (IPOs), AI capex financing — all booming. 

But at the same time, IBM pre-reported, and the stock had its worst day ever. Down 25%.

It wasn’t because demand is weak. It’s because demand for AI hardware is so strong that its customers raided their software budgets to buy servers and memory chips before prices rise again.

That’s a structural demand signal. The scarce core inputs to produce artificial intelligence are so valuable, companies are locking down supply years into the future.

With that, as we step through earnings season, the Wall Street focus continues to be on signs that AI is actually creating value for companies that are NOT selling access to the core AI infrastructure.

Is AI actually making the companies that are buying access to the core AI infrastructure more efficient, making companies more profitable (wider margins)?

Profit margins are indeed rising. S&P 500 net income margin is expected at 14.2%, almost 200 basis points over the five-year average (according to FactSet). But that’s pulled UP by the very healthy, and expanding margins in the tech sector.  Otherwise, there is a balanced mix of sectors with margins both expanding and contracting.

With that, let’s talk about a comment from Jamie Dimon on the JPM earnings call yesterday. 

When asked about the benefits of AI in the business, he said this: “you don’t uniquely benefit from AI. The ultimate beneficiary of AI will be our customers.”

He said they will use AI to do a better job for customers. It won’t accrue strictly to the benefit of JPM, via margins — “if that were true, our margins would be 80% today because of computerization of the last 20 years.”

With that in mind, there has been a widely accepted story about how AI plays out. The machines do the work. Margins explode for a handful of winners. The rest of us end up idle and poor.

History tells us a different story.

The gains from major technological innovations never stay locked up in corporate margins. Competition drives down costs, and pushes the most value to the users.

Think about electricity. It didn’t make the electric companies rich forever. It made everything else possible. The tractor didn’t end work. It moved work off the farm and into everything we built next.

The spreadsheet was supposed to end the accountant. Instead we got more accountants, more analysts, more finance than ever. When a tool makes the work cheaper, we don’t do less of the work. We do far more of it.  

That’s where AI accrues. Not in permanent margin explosion. It’s in new products. New categories. Cheaper goods and services.

Health care that watches over you between doctor visits. Software built for a single customer. Education tuned to one kid. Quality of life goes UP.

Intelligence is becoming cheap and abundant. And when something as powerful as intelligence becomes cheap, we consume much more of it (insatiable). That doesn’t make us idle. It makes us busier than we’ve ever been, doing things we couldn’t do before.

If we look back at the printing press. It enabled the broad distribution of ideas. We got the Enlightenment. And the Enlightenment turned into machines, and we got the Industrial Revolution. The age of building.

The internet was our printing press. It gave everyone access to everything known. That was the modern enlightenment. AI is what comes next. It turns all of that knowledge into the capacity to build.

We may be standing at the front of a new building age.  The American economy went through decades of over-consuming and under-making. The pendulum is about to swing.

P.S. Pro Perspectives is the daily note — the macro, policy and market structure work that ties everything together. To see how that work gets applied, we manage two model portfolios with documented, multi-year track records: Billionaire’s Portfolio and AI-Innovation Portfolio. Different strategies. Complementary research. Explore the platforms below… 

 

 

 

Tomorrow morning we get the June inflation report.

Expectations are for a decline for the month, mostly on the sharp reversal in gas prices. That would bring the year-over-year rate back down below 4%. 

Core inflation, which excludes food and energy, is expected to rise two-tenths, with the annual rate around 2.8%.

That said, the main event will come after the inflation report tomorrow morning, when the new Fed Chair delivers his first testimony to Congress.

Since Warsh chaired his first Fed meeting last month, the “Fed speak” has been notably quiet.

Under the old Fed, a policy meeting was followed by a parade of Fed governors and regional presidents, out in force, trying to steer the market to align with their view. 

This time, almost nothing.

The public appearances have been about bank regulation, AI, and ceremony. Not the path of policy. And, as we’ve discussed, that silence is consistent with what Warsh told us his Fed would be.

Less telegraphing. Less message management. More independent thinking. More dissent.

That brings us to Waller’s speech today. 

Remember, Chris Waller was a top candidate for Fed Chair. His speech today was titled “Monetary Policy at a Crossroads.”

He said tomorrow’s CPI report and Wednesday’s PPI report will help him determine the appropriate path for policy.

If core inflation cools, he wants to see “several months” of it before concluding the trend has changed. If it comes in hot, the Fed should consider tightening “in the near term.”

So, Waller gave the market a reaction function.

Cool number, keep holding. Hot number, think about hiking. Several good months, maybe the direction changes. This is akin to the Powell-led Fed telling us if the “labor market cracks” they’ll cut. 

That’s the old Fed.

It’s forward guidance involving the “conditions” for action.

Instead of telling us what the Fed will do, it tells us which outcomes will make the Fed do something. Either way, the market worries more about trading the Fed, and what they’ll do, rather than positioning for what the economy is doing. 

Now, remember what Warsh did at his first meeting. It tells us today’s Waller speech was just one vote, not the voice of the institution. 

Warsh let his colleagues submit their rate forecasts last month, the famous dots. He declined to submit one himself.  

He let them show their work, then pointed out they had done it in pencil, with big erasers (i.e. they don’t fully believe their own forecasts).

And in that first meeting (and post-meeting press conference) he then put the full machinery that produces those forecasts under formal review.

With that, last week, in advance of Warsh’s first Congressional testimony as Fed Chair (tomorrow and Wednesday), the Fed announced the leadership and objectives of the five task forces — and then released a 77-page semiannual report on the state of the economy, within which Warsh’s Fed criticized the timeliness of the data the Fed depends on.

Which brings us back to tomorrow’s number.

An inflation print driven by an oil shock is not the same as one driven by an explosion in money supply (the 2020-2021 analogue the media and some Fed members are anchoring to). 

The old Fed waits for the number. The Warsh-led Fed should ask what produced it.

 

 

Yesterday, we talked about the building burdens Europe is absorbing, to maintain access to safety (U.S. security guarantees), stability (the dollar and U.S. capital markets), and markets (the U.S. consumer).

This is the “political alignment” by consequence, we’ve talked about. 

Withdraw all the backstops. Let the bills come due (i.e. defense). Let the energy shock expose Europe’s energy dependence. Let the European financial system work through stress without the Fed’s dollar liquidity assistance. 

Let the political class face the consequences of the costs their voters are no longer willing to pay.

With that, let’s revisit an excerpt from my April 27 note …

With a liquidity crisis coming down the pike in Europe (accelerated by the energy shock), this time without the backstop of the world’s most powerful central bank (the Fed), the Brussels political class has only two paths.

Path 1) They can align with Washington, which would mean admitting that their policies — open borders, climate agenda, deindustrialization, energy dependence, dismantled defense capacity — destroyed Europe’s competitiveness.

If they do that, they relinquish their power grip, and likely end their political careers.

Path 2) They accept Chinese liquidity and solvency support in exchange for becoming the next debtor consumer market for Beijing.

Trump’s strategy has seemingly been to squeeze them economically and financially (by the vulnerabilities of their own design) until the costs of the current leadership become unbearable … and the people of Europe deliver their own change of leadership.

With that in mind, “change” seems to be underway. 

Britain’s Prime Minister resigned two weeks ago, with defense under-funding among the triggers.

Germany’s Chancellor just broke his own party’s decades-old balanced-budget religion to fund rearmament.

And now the second-largest economy in the euro area is headed toward a 2027 election with a nationalist (Marine Le Pen) potentially at the front of the field.

One by one, the personnel of the old regime are exiting or converting.

This morning’s Financial Times front page laid it out in one frame: the Le Pen ruling, NATO countries unveiling billions in defense deals “to mollify Trump” (their words), and a feature asking how Europe would fight without America.

Political regime change isn’t a risk to Europe’s realignment. It’s probably the only way alignment happens.

Meanwhile, we have more meetings in Europe on the agenda this week — to discuss how they will fund trillions of euros of defense, AI infrastructure and energy spending, without exposing solvency and liquidity vulnerabilities in the weaker constituent countries of the euro zone.

The market question is not whether Europe can discuss, plan and announce the spending, it’s whether they can fund it.

P.S. Pro Perspectives is the daily note — the macro, policy and market structure work that ties everything together. To see how that work gets applied, we manage two model portfolios with documented, multi-year track records: Billionaire’s Portfolio and AI-Innovation Portfolio. Different strategies. Complementary research. Explore the platforms below…

In my last note, we talked about Warsh’s debut on the international stage, at the ECB Forum in Portugal, and the placating tone from Europe’s central bankers. “My friend Kevin,” as Lagarde put it.

That was the public posture.

Today, the Wall Street Journal gave us the private one. The front page carried the rupture with America: European leaders, behind closed doors, venting about Trump, tariffs, Greenland and the breakdown of the old alliance.

Some in the room reportedly called it “therapy night.”

Now let’s look at the behavior.

Last week, Europe met Trump’s July 4 trade deadline three days early.

The Turnberry Agreement (the U.S./Europe tariff agreement from last year) finally entered into force July 1. The terms: Europe accepted the 15% U.S. tariff cap on most European goods, and cut tariffs on U.S. industrial goods to zero.

For context, that bill had been frozen for the better part of a year. Once Trump put it on the clock, with a July 4 deadline, surprisingly the European bureaucratic machine got it done.

But the day after Europe complied, Trump attached the next condition: a 100% tariff on any country imposing a digital services tax on American technology companies, superseding any trade deal “whether implemented, signed, or not.”

Remember what this is all about: tariffs are about restructuring global trade and realigning the world (away from China, back toward the U.S.).

Europe has been a hold out, if not moving in the opposite direction.

With that, Trump is forcing compliance by using the U.S. position of strength.

He used access to the U.S. consumer as leverage to get the trade deal done with Europe. 

And for decades, Europe’s security rested on the U.S. balance sheet. America provided the backstop, and under that umbrella Europe built the welfare state, the regulatory state, the green transition and the euro project.

Now Trump has made that umbrella conditional.

And when the security guarantee becomes conditional, the bill moves onto European government balance sheets.

That happened today.

The Financial Times reported that Germany plans to borrow more than 800 billion euros by 2030, mainly for defense. 

This is big. This is Germany breaking its fiscal religion, because it has to.  As Germany’s finance minister said: “We can’t defend ourselves against Putin with the Schwarze Null.”

The question isn’t whether Germany can finance rearmament. The question is what happens when the whole continent has to contribute to this new security regime. These countries enter this regime with high debt, low growth, and fragile politics.

Let’s talk about yesterday’s central bank event in Europe.

On Wednesday, Kevin Warsh made his first international appearance as Fed Chair, on a panel at the ECB Forum alongside the heads of the ECB, the Bank of England, and the Bank of Canada.

The placating from his counterparts was unmistakable.

Lagarde volunteered Warsh’s policy philosophy as her own (highly agreeable with “my friend Kevin”).

On forward guidance — the “policy tool” of telling the market what you want it to do, and then making policy decisions based on what the market is doing — they all followed Warsh’s lead. And under the Warsh-led Fed, it’s over (no more forward guidance).  

No push back from anyone on stage.

Why such warmth and verbal alignment?

Remember, every one of Warsh’s counterparts on that stage runs a system that, in a crisis, needs access to dollars. Warsh holds the keys.

And no one needs those keys more than Europe.

Also remember, at this same forum a year ago, the conversation turned into a public airing of Europe’s core problem: it cannot fund its own fiscal ambitions. The sovereign debt and banking flaws exposed in the global financial crisis were never fixed, only papered over by the ECB. And the ECB could “paper over”/backstop the wobbling sovereign debt in the weak spots of Europe only to the extent that the Fed stood behind it, in coordination, with unlimited dollars accessible.

That coordination is what’s now in question.

Warsh has the Fed’s entire framework under review. He told the audience at this ECB forum that the Fed’s balance sheet “borders on fiscal policy” and needs to come “down to size.” A Fed stepping back from financing government debt is a Fed rethinking the whole backstop business.

So, for the central bankers of Europe, Britain, and Canada, when your ability to weather a storm depends on the world’s most powerful central bank, you tend to ingratiate yourself to the man that runs it.