Why a Cooldown in Nvidia’s Party Could Be a Bad Thing for US Stocks

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If you’re wondering if the markets were still in their silly summer season, let me clear that up for you: they definitely are. August is traditionally a month where markets face off at night due to reduced trading desks in the Northern Hemisphere summer, and 2024 is a particularly good example.

Remember the yen trade? No, neither does anyone else, but just about three weeks ago it was one of several factors thrown into the mix to help make sense of the ugly and quickly reversed stock market selloff. Bond and currency markets continue to exaggerate the likely extent of the impending US economic slowdown.

But the real proof of the summertime flights of fancy comes from the extent of the focus this week on the earnings of one company, Nvidia.

Hype and general overexcitement are fairly standard fare in the markets, and Nvidia is, after all, one of the most valuable companies on the planet, but the breathless preliminary period leading up to this week’s results from the chipmaker in Silicon Valley was intense, even by those standards.

Several analysts compared the importance of the results to the strongest of all US economic data, such as inflation or non-farm payrolls – the only regular data reports for which fund managers will ever rearrange a lunch. Nvidia’s numbers are, as Deutsche Bank pointed out, “an important macro event in itself,” up there with those key inputs into US monetary policy.

That’s curious, but perfectly rational, given the huge role Nvidia plays in driving US and global stocks. But the real excess exposed by this “macro event” is the weight of investor expectations.

Nvidia managed to double its revenue in the three months to the end of July compared to the previous quarter, reaching $30 billion. The company said that in the third quarter, the amount is expected to stretch to $32.5 billion. That’s serious money.

And what did the stocks do? They fell in after-market trading, of course, by about 6 percent, largely because some investors had been looking for a slightly higher forecast for the third quarter. Analysts at UBS, among others, suggested it was nonsense. “This is it. . . missing the forest for the trees,” wrote Timothy Arcuri, an analyst at the bank, and reflected, he said, “somewhat frothy expectations.” He advised clients to buy the dip in the stock, which is still expected to rise 20 percent from here.

That’s something that’s always worth remembering about markets: they tell you very little about what’s happening today and a lot more about what investors think will happen tomorrow. In this case, these are high expectations indeed. The larger explosion in Nvidia shares — about 800 percent since the start of 2023 — is already a reflection of the largely unproven potential of artificial intelligence. The task now is for AI-related companies to prove they can live up to the hype. In this run-up phase, the markets will punish any small crack or wobble, even if only for a short time.

The reasons for emphasizing the positive fall in two areas. The first is that ultimately, barring some kind of inflationary disaster, interest rates are on the way down, as US Federal Reserve Chairman Jay Powell pointed out at the Jackson Hole Monetary Policy Symposium earlier this year. Monday.

Another thing is that, putting aside the market’s myopic obsession with Nvidia, the broader US stock market is in good shape. French bank Société Générale points out that 80 percent of US companies beat earnings per share expectations during the quarter and, most importantly, the proportion of companies delivering positive surprises is increasing.

The shedding of technology-focused Nasdaq 100 companies from the larger S&P 500 offers encouraging news, said analyst Manish Kabra of the bank. Profit growth for non-tech companies is outstripping the glitzy tech sector that’s been garnering so much attention lately. “The biggest theme we find is that of rotation — the rotation from narrow ‘bubble’ trading to broader ‘breadth’ trading should continue,” Kabra wrote.

Surprisingly, despite the significant hit to Nvidia shares this week, the S&P 500 continued to advance. Maybe from now on, the intense focus on this company will go away, just a little.

Charlotte Daughtrey, equity investment specialist at Federated Hermes, is among those who expect some of the profits extracted from mega-tech stocks this year to flow through to the rest of the market here. She notes that the gap in valuations between the tech giants and the rest of the market is abnormally wide at over 25%. Monster Tech shares could be “vulnerable” for the rest of this year, she said, while small- and mid-caps finally get their time to shine.

This healthy dynamic lacks the fireworks of the spectacular rally in AI-related stocks. Let’s be honest, it’s pretty boring. But broad-based market gains and a Federal Reserve poised to start cutting interest rates are unambiguously positive news for stock market investors. Ignore the short-term tech obsessives – they’re too tough a crowd.

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