Earnings May Have Delayed Late-February Weakness
The S&P 500 climbed a solid 1.7% during the holiday-shortened week, with the lift coming almost entirely from Thursday’s strong gains following NVIDIA’s earnings release. Despite the S&P Technology Select Sector Index gaining more than 3% on Thursday, losses over the rest of the week had it lagging the S&P 500. The sector winners for the week were staples, materials, and industrials.
- Stocks climbed last week fueled by NVIDIA’s earnings reports on Wednesday evening.
- Late February into mid-March historically can be troublesome, increasing the likelihood of the stock market taking a break after its record run. NVIDIA’s earnings may have delayed but not alleviated the coming decline.
- Overall, the bull market is alive and well and we continue to expect further gains for the S&P 500 in 2024.
- NVIDIA’s earnings report was another blockbuster and reinforces the rapidly rising demand for AI-associated chips and hardware.
- AI is not only a NVIDIA story. Use cases are expanding across industries, reflecting an overall focus on increasing productivity that may have long-lasting effects, a theme we discussed in our 2024 Outlook Seeing Eye to Eye.
We cautioned last week that the stock market is typically weak during the second half of February and into early March. Historically, earnings season winds down at this point. But with NVIDIA garnering heavy market attention, the calendar may be shifting a little. With strong gains over the first three weeks of February, we maintain a note of caution over the coming weeks but still expect a strong environment for equities overall. NVIDIA’s strong earnings (more on that below) only added to the positive expectations.
We Aren’t Alone Anymore
A year ago, we told anyone who would listen that the economy would likely avoid a recession and stocks were going to have a great year. Few agreed (it felt like no one agreed, to be honest), but fortunately conditions played out as we expected. Many others are coming around to our optimistic views, which is why we titled our 2024 Outlook Seeing Eye to Eye.
In the near term, however, seeing bullish investors coming into the fold is a potential concern. Some of the more vocal perma-bears from last year are now claiming they are bullish. Of course, they attribute the rally to the Federal Reserve or U.S. Treasury Secretary Janet Yellen, as if they have a magic button that creates a bull market or grows productivity at a 3.9% annualized rate. The stock market is strong because corporate profits are improving, the consumer is healthy, inflation is trending lower, and the Fed will likely start cutting rates over the coming months.
Multiple sentiment polls are indeed showing big jumps in optimism, which has our contrarian bell dinging. The Bank of America Global Fund Manager Survey (GFS) recently showed overall sentiment at the highest level in two years. This is nowhere near previous peaks, which indicates there is a ways to go before the ultimate peak, but this jump in optimism should be noted.
Another data point from the recent GFS caught our attention: The number of managers looking for ‘no landing’ is rising. All of last year, Sonu Varghese, Global Macro Strategist at Carson, was saying the plane had plenty of fuel and never needed to land, and it appears others are finally catching on. From a contrarian point of view, this is worth noting. Since avoiding a recession is normal, falling concern about the economy isn’t contrarian in itself, but we do lose some extra fuel from bearish views unwinding.
NVIDIA Earnings Show AI Demand Ramping Up Faster than Supply
The economic story behind NVIDIA’s blockbuster earnings is very simple in some ways and goes back to Econ 101. It highlights a large, but still early, shift in demand for AI chips and hardware that simply can’t be met by current supply. From a microeconomic perspective that means strong profits from current suppliers, of which NVIDIA is currently the most important. We see that all over NVIDIA’s earnings numbers. Other players will surely be drawn by those profits (it’s already happening) and over time NVIDIA’s advantage will erode, but the company has a nice lead that will persist for some time.
IBM, a still-formidable company but not included among the so-called Magnificent Seven of tech-oriented giants, manufactured 70% of the world’s computers in the 1960s and became the largest company by market cap by 1966, holding onto the position until the late 1970s. While “Big Blue” may not be a dominant player in hardware anymore, it helped lay the foundation for the continued leaps in computing today. And it’s more-than-a-decade reign as the world’s largest tech company is impressive. Similarly, while today’s story is NVIDIA, the enduring story is AI. It’s hard to gauge whether to measure NVIDIA’s lead in years (as seems to be the emerging case with Tesla’s lead in electric cars) or the more than a decade that IBM had. But whatever the lead, any ground made up on NVIDIA will likely be accompanied by a rising tide that lifts all ships as the AI space continues to expand.
NVIDIA’s Growth Story Jumps Out from the Numbers
NVIDIA’s fourth quarter earnings report was impressive across the board. Sales more than tripled compared to one year ago, clocking in at $22.1 billion versus $6.2 billion in the fourth quarter of 2022. That’s more than an 8% beat versus the consensus expectation of $20.41 billion.
Every segment reported higher than expected sales. Demand for NVIDIA’s graphic processing units (GPUs), which are used in training AI, remains very robust. Data center revenue (the huge server farms that provide the AI computing environment) beat expectations by 7%. Even with the strong wins, revenue guidance topped expectations. And all this took place despite falling revenue from China because of U.S. sanctions, which makes demand look even stronger.
NVIDIA’s net profit was $12.29 billion. One year ago, its net profit was $1.41 billion, so that’s an 872% improvement. Gross margins surged to 76%, an extraordinary number for a hardware company.
Earnings, Not Rising Valuations, Driving Magnificent Seven Stock Gains
Of course, NVIDIA’s stock movement has been strong. It gained more than 16% on Thursday, the day after the company reported earnings and is up almost 60% year to date after a spectacular 2023 (following a very weak 2022, like many tech companies). While not reviewing NVIDIA in particular, we do wonder whether price appreciation for Magnificent Seven stocks simply reflects unreasonable valuations based on untethered investor enthusiasm. NVIDIA’s traditional valuation metrics are lofty, but since the start of 2022 valuation changes have been a drag on prices and have gradually become less extreme. While strong future profit growth is still needed to justify valuations, NVIDIA has more than grown into its valuations over the last two years, which is true of the Magnificent Seven in general.
Our Global Macro Strategist Sonu Varghese has provided some telling insight. In the chart below, he divided the total return since the start of 2022 for the Magnificent Seven stocks into three main components: earnings growth, valuation changes (“multiple growth”), and dividends. It’s noteworthy that since the start of 2022 all seven companies experienced multiples compression, which means any gains were driven largely by profit growth. This is quite different from the tech bubble, where multiples expansion drove returns, requiring a multiyear reset that was painful for markets. In a sense, investor enthusiasm during the tech bubble was correct. The lofty expectations of the global impact from the widespread adoption of the internet and associated technologies have more than been fulfilled. The bubble was about mispricing the business case — an important lesson but not what we think we have here.
The Next Wave of AI Still in Its Early Stages
AI is in a different place than the tech bubble was. Expectations are high, but leadership is coming from seasoned companies meeting investor demand by running lean while still investing in the future. This is also positive for the overall economy as it can boost productivity, which was a forward-looking theme in our 2024 Outlook. Perhaps Meta has been the poster child for this concept. Meta’s entire brand had shifted to the speculative potential of the “metaverse,” which required both creating an entirely new technological ecosystem and the demand for that ecosystem. Meta has since changed course, focusing more on learner investing in areas in which it is an AI leader. It’s a surprising mistake from Meta founder Mark Zuckerberg. After all, he started Facebook in his dorm room in the immediate wake of the tech bubble excesses. Talk about a lean beginning. We take a look at Meta in today’s blog as we continue to review earnings season.
It’s becoming increasingly clear that AI will become ubiquitous and is already being adopted at an aggressive rate. NVIDIA’s report reassured investors that AI’s prolific spread isn’t slowing down, but we’re hearing that from many other companies as well. UnitedHealth Group noted how it uses AI to improve customer service and employee productivity. Bank of New York Mellon is using it to do mundane or repetitive tasks. Nvidia noted that nearly every automotive company in the world is using AI for design and efficiency, although many are also developing autonomous driving capabilities. Quest Diagnostics is using AI to improve quality, and JPMorgan is employing it to improve fraud detection. AI is not just about NVIDIA or the Magnificent Seven; it is already impacting companies across the world. As NVIDIA’s earnings confirm, investment in AI isn’t slowing down for the foreseeable future, which is good news for the company’s stock and the stock market.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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