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Software Can’t Eat Everything: The Shift From Digital Scale to Physical Growth
Markets are rotating as growth shifts from software to the physical economy. Capex, labor and infrastructure now drive returns, while AI exposes its dependence on energy and materials.
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Key Points
Markets are rotating as growth shifts from digital scale to the physical economy — from Wall Street narratives to Main Street activity.
AI is disinflationary, but capital‑ and resource‑intensive, pulling investment into energy, materials and infrastructure.
As software starts eating software, markets must reprice what it can’t eat: the physical skills, materials and infrastructure that make the digital possible.
The Weekender is my bi-weekly take on macro shifts and emerging themes. It’s not investment advice — or even our firm’s official view. I aim simply to inform, challenge, and maybe entertain. If you’d like this in your inbox every other Saturday morning via Northern Trust, subscribe to The Weekender.
Resource scarcity, nothing new
We wrote this some years ago; it’s worth repeating now:
“The race to secure critical materials for geo-strategic purposes is nothing new. During WWI, for example, the UK had to lobby the Swiss to persuade Germany, their enemy, to send them precision optics to ensure they had enough binoculars to assist with range finding, a prerequisite for military success. Thanks to previous industrial policy, Germany had cornered the precision glass market, scaling what was before then a niche industry via huge subsidies. Sound familiar? What’s fascinating about this story is how it ended. As Ed Conway writes in Material World, the Germans actually gave the Brits the binoculars! But only in return for something they were short of, but that the Brits had cornered: rubber!”
“So, where are the scarcities in this arms race? Where are the gaps? Well, as discussed, it may no longer be in the ephemeral. But it might be in the material world: in atoms not bytes, in things not ideas, in hands not heads, and in welders not coders. Software can’t eat that world, although it’s critically dependent on it. And this at a time software is now eating software. Yes, ‘AI will build AI,’ so says Jensen Huang. And he should know. He’s the CEO of Nvidia.”
Which brings us back to the present. If the last cycle was defined by digital scale and low marginal costs, the next may be shaped by capacity, constraints, and capital intensity. Not because innovation has slowed, quite the opposite, but because the build out has moved from the intangible to the tangible. From the ethereal to real world. From Wall Street, to Main Street.
Main street momentum
Whichever narrative tickles your fancy — a healthy rotation, large to small, real‑world revenge, intangible to tangible, ethereal to material, ideas to things, bytes to atoms, compute to commodities, or artificial intelligence (AI) builders to beneficiaries — the reality is the pivot to Main Street is gathering momentum, in both policy and price. As we’ve discussed, policy has increasingly turned toward the lower leg of the K‑shaped economy, with affordability now firmly in focus. The principal aims are squarely on rates, housing and student loans. The fact Wall Street often funds itself several hundred basis points cheaper than Main Street has become a notable point of tension. It is also something Treasury Secretary Scott Bessent, Vice Chair for Supervision Michelle Bowman, and the likely new Fed Chair, Kevin Warsh, appear determined to address.
“A significant disinflationary force…”
As noted in Beyond Consensus, Warsh shares the Bessent worldview that AI is a “significant disinflationary force.” This idea gained additional support this week as several AI applications emerged that dramatically shortened workflows and/or lowered costs. For example, Lemonade announced materially cheaper car insurance for AI‑driven vehicles. JPMorgan released Proxy IQ to reduce reliance on third‑party solutions. Anthropic’s Claude drew significant attention within the legal community, and Open Claw had a similar effect for those willing to adopt it. The point is that we may still be underestimating the (disinflationary) productivity gains from AI — and, by extension, the eventual destination for rates. At least that seems to be Kevin Warsh’s view.
Whether a smaller balance sheet forms part of that playbook remains to be seen. What a new Federal Reserve chair wants to do, and what he can do, are often very different. What does seem clearer is that moving from the balance sheet toward banking intermediaries as the principal channel for liquidity likely requires some measure of bank deregulation — think , global systemically important bank (G‑SIB) surcharge regulation and easing constraints on smaller banks. Could bank stocks hitting new highs be signaling this already? And if they are, is this a more important signal for the real economy than our current fixation on software stocks and tech sector ETFs?
Software eating software
What’s happened recently in the Software/Software as a Service (SaaS) sector is the continuation of the theme of software eating software. What’s eyebrow‑raising, perhaps, is not the disruption per se, but the speed of disruption — and the market’s reaction.
No doubt bears will call this the end of software, and one shouldn’t dismiss the threat. As with disinflation, we may be underestimating its impacts. Some SaaS productivity tools with appealing graphic user interfaces but marginal utility will face more pressure. So too might their owners (see listed private equity proxies, where software often represents a meaningful exposure).
But disruption is seldom zero‑sum. Software suites that are deeply embedded in a company’s workflows — and hold its data, context and security (especially for clients in regulated industries) — should fare differently. Over time, they are more likely to become corporates’ partner of choice for AI, where apps like Claude might even amplify interactions and engagement. But until markets are prepared to reward the transition, it’s “sell first, ask questions later.” A little like what we saw with a certain stock last year — one taken to the woodshed on concerns about reliance on Search, another area AI was expected to disrupt.
Now look at them… and what they are doing.
More signs of a “Capex Supercycle”
Alphabet’s capex numbers are staggering, roughly double what they spent last year to about $180 billion — a mind‑boggling figure that blew past expectations.
Supplementary leverage ratio is a measurement of a bank’s Tier 1 capital relative to its total leverage. US regulators set minimum required SLR ratios.
The “Magnificent Seven” companies are Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla, which drove the sharp rise in U.S. stocks in 2023.
These capex announcements, along with Microsoft and Meta’s, come with meaningful gross domestic product (GDP) multipliers. It’s not just chips, but construction, concrete, consultants, copper — and the ecosystem that supports large‑scale build‑outs.
While Wall Street debates magnitude and payback periods, Main Street may benefit from the momentum. A labour‑intensive activity (super)cycle is accelerating, buoyed by mega‑forces and powerful tax incentives. In evidence, we’ve seen durable goods orders improve and surveys of U.S. manufacturers show activity growing at the fastest pace since 2022. Commodity stocks are closing the gap between end‑market demand (structural) and stock‑market framing (cyclical).
Capex plays like Caterpillar (+20%), Fastenal (+20%), and Komatsu (+40%) are rallying. Industrial bellwethers like Parker Hannifin (engineering solutions) delivered organic growth of +6.5% and raised guidance. LyondellBasell (industrial plastics) is +30%, Dow (chemicals) +38%. And for those who watch it closely, the is breaking out to record highs, led by Old Dominion Freight, which moved sharply after suggesting the multi‑year freight downturn had ‘ended.’
The timing is telling.
Is oil the new copper?
With metals already discounting these dynamics to some degree, the real opportunity today may be in commodities that have yet to do so. “We may be living in a ‘just in case’ world but most traders still have a ‘just in time’ view on oil, and they seem to assume there is no trouble on the horizon,” writes Rana Foroohar in the Financial Times. Climate objections aside, she may have a point.
The has recently reversed its earlier view that global oil demand would peak before 2030. According to CNBC, the IEA’s latest World Energy Outlook includes a scenario in which oil demand continues rising through 2050, reaching 113 million barrels per day. This comes as power‑hungry data center investment now exceeds that of all oil and gas capex combined.
Silver Thursday
While on the topic of scarcity, consider that according to YouGov, nearly 40 percent of American adults didn’t read a single book last year. Another large share read only one to four. Just 19 percent of the population read ten or more books, and a tiny four percent accounted for nearly half of all the books read in the country. Reading, like so many other things, has become highly concentrated. The investment conclusion: diversify. Read more books — especially old books, because the future is often hiding in the past.
Speaking of which, I remember Panic, Prosperity and Progress by Tim Knight referring to an episode called Silver Thursday, which had uncanny echoes to last Friday. On March 27, 1980, the Hunt Brothers had cornered the silver market, fearful of inflation and a weak U.S. dollar. Their buying led to FOMO and a roughly 700% increase from $6 to $50. The regulator then lifted margin requirements, the Hunts received a large margin call, and they ended up converting equity into what was, at the time, one of the largest debts in the world.
Different this time? For silver bulls, let’s hope so — it took roughly 45 years for silver to surpass the Hunt Brothers’ 1980 peak. But there are reasons to believe this cycle may differ from past episodes. The correction may have washed out speculative excess rather than fundamentals. There is still a significant physical shortage, and new demand categories are growing.
With respect to gold, its tactically very overbought but it remains structurally under owned.
My biggest worry
My main concern with AI as it relates to markets isn’t whether it’s a bubble or a disruptor per se, but whether irrational fears about its use might curtail its development. One historic parallel could be nuclear energy. After WWII and through the 1960s, nuclear power began as a government‑led national priority and was seen as central to America’s technological future. It then slowed — in large part because of fear and regulation.
So when I read things like The Real AI Race | FSI (Stanford University) — which says that in China, about 83% of people view AI products and services as more beneficial than harmful, while in the U.S. the positive view is around 39% — I’m reminded that public sentiment can matter. While there is little to suggest momentum is slowing at the moment — if anything, the opposite — it’s still worth monitoring.
Range-bound markets
A recent topic of interest in client conversations is that mid‑term election years have historically been less favourable for equities, with average returns often subdued (and with stronger performance thereafter). With elevated valuations, some even fear of a range‑bound or sideways market where multiples compress, prices anchor to earnings, and indices oscillate before breaking higher — as seen in the post‑1929 period (24 years), the Nifty‑Fifty era (14 years), and the dot‑com aftermath (10 years).
For those of that persuasion, you might consider:
- Vitaliy Katsenelson’s Active Value Investing
- Robert Hagstrom’s Who’s afraid of a sideways market?
From Hagstrom: The Dow was 784 in October 1975 — and still 784 seven years later. Yet 40% of stocks doubled in that period. The key during these times is selectivity. While markets (beta) go nowhere, certain characteristics (factors) can do very well — notably Quality, Value and Dividends.
Things several of my colleagues know an awful lot about!
Have a great weekend.
Gary
The International Energy Agency, comprising 30 member countries, facilitates data and statistics collection, training, innovation and international cooperation to ensure secure, affordable and sustainable energy systems.
The index measures the performance of 20 US transportation stocks.
Main Point
Software Can’t Eat Everything: The Shift From Digital Scale to Physical Growth
Markets are shifting from digital scale to physical growth as capex, labor and infrastructure drive returns. AI may be disinflationary, but its heavy demand for energy and materials underscores a simple truth: software can’t eat everything.
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