Earnings Outlook: Will Nvidia Live Up to Its Hype?
- By John Tierney
- 4 min read
Summary
- With equities down 5% or more so far in August, the slow leak is clearly becoming a slide – and a broad-based one at that.
- The drivers seem to be rising rates and China jitters – and niggling concerns that the Federal Reserve (Fed)’s terminal rate could be nearer 6% than 5%.
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Even in that scenario, we think the Fed is still taking a dovish stance toward inflation.
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Summary
- With equities down 5% or more so far in August, the slow leak is clearly becoming a slide – and a broad-based one at that.
- The drivers seem to be rising rates and China jitters – and niggling concerns that the Federal Reserve (Fed)’s terminal rate could be nearer 6% than 5%.
- Even in that scenario, we think the Fed is still taking a dovish stance toward inflation.
- Only 35 companies report this week. The one to watch is Nvidia. Can it can live up to the extraordinary hype that followed its forecast of a 50% gain in sales quarter-over-quarter?
- Away from that, a bevy of retailers that cater to middle- and lower-income households will provide colour on consumer priorities.
Market Implications
- A sustained equities rally is unlikely for now, but we also see little risk of a significant selloff. Should it occur, it will likely be a buy-the-dip opportunity.
- We like a tactical underweight in the homebuilder ETF XHB.
What We Learned Last Week
The slow leak lower in equities is turning into a slide. The S&P 500 (SPX) dropped 2.1% last week; it is down 4.7% since hitting a recent high on 31 July. This has been largely attributed to weakness in the tech sector – the NASDAQ 100 (NDX) is down 6.7% in August. But the slide is broad-based – the equal-weighted S&P 500 (SPW) is down 5% this month.
The catalysts seem to be a combination of jitters over China’s growth and rising rates. The 10Y Treasury rose 10bp to 4.25%; the 2Y Treasury was up 6bp to 4.95%. Interest rate sensitive sectors were hit hard – the homebuilder ETF XHB was down 6.4% last week and 8.1% in August; the regional bank ETF KRE fell 4.4% last week and 5% so far in August.
It is August and many people are away. But concern is clearly rising that the Fed may keep rates higher for longer – and that higher could be nearer 6% than 5%.
Here is why.
Markets and the media have fixated on the decline in headline CPI to 3.2% while all but ignoring core CPI (CPI ex food and energy), which is still high at 4.7%. Historically, when CPI and core CPI have diverged, there has been a strong mean-reverting relationship, with headline CPI converging back to core CPI (Chart 1). If core CPI drops toward headline CPI, the Fed could well hold near 5%. Should headline CPI turn up toward core CPI, the 6% policy rate will be all but baked into the cake.
Little wonder interest rate sensitive sectors are nervous.
Tactical underweight homebuilders – Given the higher rate environment, we like a tactical underweight of homebuilders via the XHB ETF.
We stress this is a tactical rather than fundamental trade. We think underlying fundamentals for homebuilders remain good. There is a significant housing shortage in the US, so would-be homebuyers are turning to new construction. Further, homebuilders mostly build to order now; unlike previous cycles, they do not go for large speculative building programs. Short of a 2020-type economic collapse, homebuilders can continue to operate profitably.
But conventional wisdom is a powerful force, and we expect investors will continue to err on the side of assuming higher rates will crush homebuilders. More cautious investors may wait until Toll Brothers (TOL) reports earnings on Wednesday and see what its outlook is considering higher rates.
Fed is still dovish – Still, this is not all bad news for equities. We continue to think the Fed retains a dovish bias. While it could raise rates over 6%, that is still well short of the 7%+ level needed to curb inflation. And, if the economy shows signs of weakening significantly, we believe the Fed will err on the side of easing to maintain the recovery rather than pushing the economy into recession.
Downside risk is limited – Until the Fed shows that it is turning hawkish and prioritising inflation not the recovery, we expect equities to trade in a narrow range or leak lower. It is possible that some new development raises fears that the Fed will turn hawkish and set off a more substantial selloff. But this will likely be a buy-the-dip opportunity.
Trading-oriented investors may want to reduce exposure to equities on hopes that this scenario develops. For buy-and-hold investors, we like to hold for now.
Earnings are not the problem – On the earnings front, companies mostly continue to report solid beats – with 95% of 2Q earnings in, earnings are running ahead of consensus expectations by 7.6%. But outlooks have been decidedly mixed. Companies that offer disappointing outlooks have tended to sell off sharply even if they are more likely managing expectations lower. Those that are more optimistic have tended to rally – but clearly losers have had the upper hand.
The Week Ahead
About 35 companies in our Russell 1000 universe report this week. The biggie of the week will be Nvidia and whether it makes good on its forecast quarterly jump of 50% in sales. We will also hear from a variety of retailers serving the middle- and lower-income brackets.
Tuesday
- Lowe’s (LOW) will likely follow Home Depot with disappointing big-ticket sales.
- Zoom Video Communications (ZM) gives another read on how ‘back to the office’ is affecting ‘working from home’ demand for its services.
Wednesday
- Nvidia (NVDA) sports trailing and forward price-earnings (P/Es) at 210 and 53, respectively – Both are unsustainable. NVDA must live up to the hype and then some or suffer an epic selloff.
- A bevy of retailers who cater to middle- and upper-middle-class-income customers report, including Dick’s Sporting Goods (DKS), Kohls (KSS), Macy’s (M), and Nordstrom (JWN).
- It will be interesting to see if the recent jump in rates causes homebuilder Toll Brothers (TOL) to rein in its outlook.
Thursday
- Everyone will be watching how tech vendors Salesforce (CRM) and Snowflake Inc. (SNOW) plan to leverage AI in their offerings.
Friday
- Retailers, Dollar General (DG) and Dollar Tree (DLTR), who cater to low-income customers, should report rising demand from strapped consumers; will that translate into profits?
- Peloton (PTON) has largely dropped its reliance on hardware; its fortunes now depend on whether people are still subscribing to its immersive workout videos?