Capital markets perspective: Pencils down

Capital markets perspective: Pencils down 


Talk about acing the test: Chipmaker Nvidia blew the doors off its fiscal fourth quarter earnings, with revenues, profit margins and earnings all better than expected. But the real story was the company’s outlook: Demand for Nvidia’s next-generation products “far exceeds supply,” and the generative artificial intelligence (AI) boom driving that demand “has hit a tipping point.”1

That loud and not-so-implicit endorsement of the AI-fueled rally that has helped U.S. stocks to new records so far this year was enough to send the S&P 500® Index to its first 2%-plus day of 2024 on Thursday, with Nvidia itself accounting for a sizable share of that move. But things could’ve turned out far differently: If profit margins were just a little leaner, or if management had injected even a hint of caution into its outlook, investors might have smelled fear and run away with their AI profits, taking all those index records with them in the process.

The fact that that didn’t happen reflects a very important reality: The AI boom is real, and it’s already here. Companies like Nvidia and many others could indeed see years of rising revenues and profits as a result. But as with any boom that promises to reshape society and reinvent the global economy, the AI revolution has created its own hype cycle. I suspect, for example, that a certain percentage of people who have piled into anything even tangentially related to AI this year haven’t spent much time even trying to understand the subtle difference between large-language models and generative AI, let alone attempted to do an inventory of who really stands to benefit.

These are the types of basic details that weren’t on Wednesday’s test but will become important to investors as AI evolves and begins to work its way even deeper into our everyday lives. For those of us who began our careers when most internet users were still using dial-up to access the web, that feels uncomfortably similar to another hype cycle that ended badly for so many sudden “experts” – many of whom passed the first few quizzes with flying colors but flunked the final.

I have a hard time seeing how markets won’t get ahead of themselves, even while AI is busy transforming how we work, drive, game, recreate and eat in very visible ways. That, after all, is exactly what happened during the most infamous hype-cycle that any of us, no matter how grizzled and cranky, are likely to remember: the dot-com boom. Despite all the optimistic analysis to the contrary, even those companies responsible for building the very backbone of the internet by selling servers, storage hardware and other tangible stuff were ultimately shown to be almost as exposed to the ups-and-downs of the business cycle as the less-sexy “old economy” firms and the ephemeral “dot-nothings” were, even as they busily transformed the world by bringing us all online. At the risk of mixing metaphors, the problem with rising tides, floods and tsunamis is that no matter how powerful they are, the water eventually and inevitably recedes, leaving some unfortunate souls high and dry (and a whole lot of others in mud).

Next up in this week’s Perspective is what you may title “recession watch.” Last week’s economic calendar was pretty light, leaving Nvidia’s earnings to capture almost all the attention. Two other macro-relevant earnings releases – Walmart and Berkshire Hathaway – saw both companies easily beating expectations. But two small anecdotes inside the results got lost in the coverage of Nvidia’s blow-out: Walmart executives mentioned that market share gains among households earning more than $100,000 per year was a particular bright spot, repeating a phrase they had used (but with more cautionary overtones about consumer behavior) in earlier quarters.2 Meanwhile, Warren Buffet lamented that Berkshire Hathaway wasn’t finding many compelling investment opportunities; Berkshire is now sitting on a record $167 billion, the kind of cash cache that raises eyebrows in less frothy times.

Neither of those two anecdotes are exactly reassuring if soft landing is your default view, but they were admittedly small potatoes compared to evidence on the other side of the debate. For example, last week’s Index of Leading Economic Indicators (LEI)3 and the Chicago Fed’s National Activity Index (CFNAI) both joined the growing group of economists and economic indicators walking away from predictions of near-term recession. While there are reasons to believe that both indices might soon turn lower again, for now those who still fret about recession have lost two important allies in the fight. (And for what it’s worth, last week’s flash Purchasing Managers Index (PMI) report, which showed the manufacturing and service-producing sectors expanding simultaneously for the first time in months,4 was another turncoat in the recession debate.)

Finally, a quick note about Japan. The Nikkei 225 – Japan’s version of the Dow Jones Industrial Average – closed above 39,000 last week. Don’t get hung up on the number; like most equity indices, the figure itself is mostly meaningless. But when you consider that the last time the Nikkei traded above that level was 1989 and when you further consider that the Nikkei is outpacing even the AI-fueled Nasdaq Composite so far this year, it suddenly gains a little relevance. Add to that the idea that Japan’s long-moribund economy still looks that way when stacked up against the U.S., and it seems worth mentioning.

In fact, it’s almost as jarring as watching the AI hype-cycle as it tentatively retraces the steps of the dot-com era.

History, I guess, is just a long cycle after all.

What to watch this week

The economic calendar heats back up this week, just in time for the earnings calendar to slow down. This week’s highlights will revolve around the consumer, who might finally be showing signs of breaking under the stress of multiple headwinds (at least if January’s retail sales report from the Census Bureau two weeks ago is to be believed.5) Beyond a small collection of retail earnings (Lowe’s, Macy’s and Autozone are all expected to report Tuesday), this week’s most important cross-check of that conclusion will come on Thursday when the Bureau of Economic Analysis releases its estimate of personal income and spending. If those figures corroborate the slowdown in sales at the retail level, it will suddenly become a little easier to argue that economic growth is softening behind a consumer who is finally getting sleepy.  

Ditto for a pair of consumer surveys due this week, the Conference Board’s consumer confidence index on Tuesday and the University of Michigan’s consumer sentiment index on Friday. Both indices have been improving recently, but much of the progress depends on the view that inflation is dying away and interest rates will soon head lower. If consumers suspect that either of those factors has switched direction, it will very likely show up in the surveys. (Notably, Thursday’s income and outlays report discussed above also includes so-called Personal Consumption Expenditures or “PCE prices,” an alternate measure of inflation that the Federal Reserve follows closely.)

On the productive side of the economy, we’ll get durable goods orders on Tuesday, alongside regional manufacturing data from the Dallas, Richmond and Kansas City branches of the Federal Reserve scattered throughout the week. Similar reads from Empire State and the Philly Fed a few weeks ago were mixed: After massive declines in January, conditions stabilized somewhat in both regions in February – a fact that undoubtedly showed up in last week’s better-than-expected flash PMIs discussed above. This week we’ll have the opportunity see exactly how broad-based that stabilization for the factory sector was, as well as a more definitive read of the PMI data, when we get final manufacturing PMIs from both S&P Global and the Institute for Supply Management, both due Friday.

We’ll also have several reads into the state of the housing market, including two separate views into home prices on Tuesday and sales volumes for newly built homes (Monday) and pending resale transactions (Thursday). High mortgage rates and stubbornly high prices have kept buyers at bay for well over a year, placing a bright spotlight on anything that impacts affordability. While it’s hard to imagine much progress will suddenly arrive in this week’s data, a softening of prices would be a welcome change.

Finally, one “dark horse” candidate that could be worth more attention than usual is Friday’s advance retail and wholesale inventories data, which is released in conjunction with international trade data each month by the Census Bureau. Last week’s Fed minutes were mostly a non-event, but one line in the staff review of economic conditions stood out to me: When discussing last quarter’s faster-than-expected 3.3% growth in Gross Domestic Product (GDP), Fed economists pointed out that fourth-quarter growth was driven by a rise in exports and inventory investment, all of which are volatile “and may carry little signal for future growth.”6  If that’s the case, and if any of these items are weaker than first estimated, it would likely show up in Tuesday’s update of fourth quarter GDP. 

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1, company reports, and Bloomberg 






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Tom Nun, CFA


Tom Nun, CFA, Portfolio Strategist at Empower, works alongside teams overseeing portfolio construction, advice solutions, portfolio management, and investment products and consulting.

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