Earnings Outlook: AI Bounds Ahead as Broader Market Stays on Hold
- By John Tierney
- 4 min read
Summary
- Last week was supposed to be about the debt ceiling drama, but Nvidia (NVDA) stole the stage with its earnings and aggressive demand outlook.
- Investors are clearly looking for excitement in an otherwise lacklustre market, and that may power artificial intelligence (AI)-related companies for now.
- But AI prospects and valuations are overhyped. Investors entering this sector must pick their spots very carefully.
- A big test for the AI boom could be Broadcom’s (AVGO) earnings report on Wednesday, which could either confirm the NVDA rally or prick the bubble.
- Several major retailers report this week, including Dollar General, Victoria’s Secret and Macy’s (M).
Market Implications
- Attention returns to the debt ceiling this week as Congress considers the Biden/McCarthy proposal. A deal will be made – the only question is how bumpy is the road to that end?
- The VIX index of equity volatility trades near 18-month lows – given potential volatility, we like VIX futures.
What We Learned Last Week
Early last week, the big question was how the debt ceiling negotiations would go. Then Nvidia (NVDA) stole the show with a blowout forecast for demand and revenue.
NVDA soared 24.6% on the week. The Philly Semiconductor index (SOX) jumped 10.9%.
For better or worse, the broader market held back – the S&P 500 (SPX) gained a scant 0.3%; the Russell 2000 (RTY) was little changed. The regional bank ETF KRE gained 2.8%, but that was coming off the low point of the post-Silicon Valley Bank collapse.
We missed the boat. Then again, so did tech investor maestro Cathy Wood of ARK ETF fame, who sold her stake last November because its valuation was too extreme even for her tastes. So did a friend who has proven knowledgeable about meme stocks. The day before earnings were released, he said he was itching to short NVDA – but then he decided not, or so he said.
Given the Fed has little leeway to cut rates and the economy is at risk of downshifting to slower growth, we think most equities are essentially becalmed (stranded through lack of wind, to use a sailing expression). So, when AI suddenly bloomed into high growth mode, investors were ready to grab on.
Sour Grapes or Healthy Scepticism?
We hate to offer up sour grapes, but as Bloomberg columnist John Authers pointed out last week, the AI boom is not exactly new. It has quietly gathered steam for the past decade. That period has seen over 175,000 AI-related patents filed across 193 countries and at least 24,300 AI-related deals across 92 countries.
Anyone using Google Search encounters AI – for example, those useful summary answers that negate searching through links for the factoid you need. What about auto-correct software that (mostly) manages to anticipate what you were in the middle of typing (although the malapropisms that manage to get through can be hugely embarrassing).
As early as 1966 the computer program Eliza could conduct plausible conversations with people, and convinced some that it was a living therapist. And remember that IBM’s Watson won the TV gameshow Jeopardy in February 2011.
ChatGPT sparked the sudden AI frenzy. But amid all the wonder and fear it has inspired, what gets lost is how incredibly bad it is. In recent days, a lawyer got caught using ChatGPT to cite cases in support of a client – but they turned out to be fiction.
Try asking ChatGPT a few interrelated questions – the answers may be correct and even useful, but each one is answered as if the preceding questions had not been already asked and answered. Most people probably lack the patience to wade through more than a few paragraphs of the endless repetition.
Or ask ChatGPT to write on a topic that you have expertise. One might call it amateurish if they know it was computer-generated, but their view will likely be less kind if they think it came from a human.
AI Is Mostly Boring Stuff
Most AI today is seriously mundane stuff. It is a product of people inputting trillions of tiny factoids into databases on which machines are trained. For example, when a machine reads and interprets an X-ray or CT scan, it is because people analysed thousands of images and identified what every tiny blip means.
It is awesome that a machine can be ‘trained’ to read the images, but there is nothing ‘intelligent’ about this. Most processing does not need the high-powered graphical CPUs that are powering NVDA to the $1 trillion market cap club – which leads one to question how realistic NVDA’s demand forecast is.
And maybe that is because most AI research and development of the past decade has gone unnoticed until ChatGPT. Maybe AI experts know that AI is not ready for prime time – and it certainly does not belong on the pedestal that the public has placed it. It may be good at imitating humans, but it is nothing like humans – at least not yet.
We do not have a view on how sustainable last weeks’ AI frenzy will be. Certainly, the easy money has been made. We also caution that the extreme growth being priced into the sector is almost surely a mirage, and that valuations will come back to earth at some point. We suggest people who want to climb aboard seriously research the sector to identify companies that can profit from AI.
The Week Ahead: Congress Tackles the Debt Ceiling
For investors more focused on the macro environment, last week was a holding pattern. In coming days, the action will mostly return to the debt ceiling. President Biden and House Speaker Kevin McCarthy are trying to convince their unruly colleagues in Congress to get behind their compromise debt ceiling plan before the 5 June deadline.
A deal will be made. The only question is what happens before it does. We can imagine all sorts of scenarios. One that is surely not on the cards is that the Biden/McCarthy plan sails through Congress.
We appreciate that markets are brimming with confidence that a deal gets done without self-destructive drama. That largely explains why the VIX index of equity volatility is trading near 17.5% – near the low of the past 18 months. As a hedge against market volatility, we like VIX futures.
Only about 30 companies report next week, with several significant retailers and technology companies in the mix.
Tuesday
- Hewlett Packard Enterprises (HPE) and Hewlett Packard Inc (HPQ) cast light on more mundane corners of the technology sector – enterprise demand for IT equipment and consumer demand for laptops and printers, respectively.
Wednesday
- Nordstrom (JWN) and Victoria’s Secret (VSCO) report on upscale consumer demand.
- SalesForce (CRM) indicates whether companies are investing in client management systems and HR software.
Thursday
- Broadcom (AVGO) rode NVDA’s coattails last week, jumping 19%. Its results will be closely watched for signs that the AI boom is for real or not.
- Dell Technology (DELL) faces one simple question – when does it expect demand for consumer electronics to resume?
- On the retail front, Dollar General (DG), Macy’s (M), and Five Below (FIVE) report on what lower income and middle-class consumers are buying.
Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.
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