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Summary
- The boardroom drama at OpenAI managed to upstage Nvidia’s impressive earnings beat and spark new debate about the risks of headlong AI development.
- NVDA sold off on the week, dropping about 3%, ostensibly on valuations concerns.
- But make no mistake, NVDA is fairly valued based on projected earnings – and outright cheap if analysts’ recent (and massive) earnings projection misses are any indication.
- In equities more broadly, economists may be expecting the US economy to slow next year, but S&P 500 and NASDAQ 100 earnings are expected to rise 12% and 18% in 2024. We see that supporting a modest equity rally into yearend.
- Only 27 companies are slated to report this week, including discount retailer Dollar Tree and Salesforce and Snowflake in the tech sector.
Market Implications
- For investors who can live with some volatility, we would go long NVDA.
- We continue to like overweighting the Russell 2000 via the ETF IWM, and interest-sensitive ETFs, including homebuilders (XHB), regional banks (KRE), REITs (XLRE), and residential mortgages (MBB) on expectations that longer-term rates have peaked.
What We Learned Last Week
10 days ago, no one was expecting anything to overshadow Nvidia’s (NVDA) coming earnings report – which was another blowout. Revenue beat by 12%; earnings beat by 19%. NVDA further forecast Q4 revenue of $20bn, 22% above consensus forecasts.
A rational person would have been looking for a geopolitical shock. But the nature of shocks is that, well, they are shocking. And so it was. Far from geopolitical, the shock came from within the AI space, with the boardroom drama at OpenAI and Microsoft swooping in to solidify its leadership position in AI.
With the dust still settling, NVDA ended the week down 3.1%, while MSFT was up 2%. The NASDAQ 100 was up 0.9%.
The quick and easy answer for NVDA selling off was an excessively high valuation, plus a sudden rethink about whether society should put the brakes on AI development until we can ensure it does not somehow go rogue and wreck humanity. Any such move would certainly dent NVDA’s projected growth trajectory.
In reality, that debate will not happen until the rogue event actually happens. Until then, it appears MSFT and others (included the reconstituted OpenAI board and company) are driving (or should we say riding?) the AI express train.
About that valuation…NVDA trades at an absurd P/E of 65 relative to trailing earnings and over 39 based on projected current fiscal year earnings (Table 1).
But looking ahead over the following two years, projected earnings and P/E ratios are less than Apple (APPL) and Microsoft (MSFT).
Analysts probably have a pretty good handle on APPL and MSFT prospects assuming the economy avoids recession. But if they are missing on NVDA revenue estimates by more than a fifth one quarter out, we can all but assume that they are still far behind the curve on NVDA’s prospects in coming years.
Granted, the semiconductor industry is notoriously susceptible to boom-bust cycles, so a healthy risk premium is warranted. And keep in mind that AI technology will face many hurdles once the easy-win stage passes. For example, will AI developers be able to use copyrighted information and data to train AI systems for free? Or will they face restrictions or costs that render the technology uneconomic?
Still, we currently see NVDA as a buy-and-hold investment.
Rally into Yearend?
We recognize analysts and pundits are pencilling in slowing growth for the US in 2024, which should weigh on corporate earnings. But ever-optimistic equity analysts are also calling for S&P 500 (SPX) and NASDAQ 100 (NDX) earnings to be up 12% and 19% in 2024. We expect investors will focus more on the latter into yearend. We look for equities to continue rallying modestly in coming weeks (Chart 1).
We reiterate our call for the Russell 2000 (RTY) to outperform SPX in coming months. We also like holding interest-sensitive ETFs, including homebuilders (XHB), regional banks (KRE), REITs (XLRE), and residential mortgages (MBB) on expectations that longer-term rates have peaked.
The Week Ahead
It will be another quiet week on the earnings front, with about 27 companies reporting, with the bulk of them coming on Wednesday. It includes a good mix of retailers and technology companies.
Tuesday
- Hewlett Packard (HPE)
- Intuit (INTU)
Wednesday
- Dollar Tree (DLTR)
- Hormel Foods Co (HRL)
- Salesforce Inc (CRM)
- Snowflake Inc (SNOW)
- Victoria’s Secret (VSCO)
Thursday
- Kroger (KR)
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.