NVIDIA’s (NVDA) recent earnings report was one of the most important market events – not only because the chipmaker is the third most valuable company in the S&P 500 (SPX) – but because of its artificial intelligence (AI) market leadership. The company holds around 90% market share for AI chips, making it a chip-design monopolist, at least for now (and, probably, for several more years). This fact makes NVIDIA the bellwether not only for AI, but for the stock market as a whole.
The AI Era Is Now
Since the current stock-market rally has been centered around disruptive technology, of which NVIDIA is a symbol, it has been widely accepted that the broad market’s further trend hinges on the AI poster child’s direction. Now, NVIDIA has supplied more than sufficient evidence that the AI-propelled rally may continue its run. The AI darling has shown surging demand for its products – which is expected to continue outstripping supply well into the next year – and confirmed that spending on AI hardware is accelerating.
NVIDIA’s stock surged after posting extraordinary results and outlook, while the rest of the market tanked. The market was taken down by fears of continued sticky inflation, as investors fretted that it could lead the Fed to keep rates higher for longer or even raise them.
Of course, no single company news, however wonderful, can outweigh the economy and the central bank in terms of influence on general investor sentiment. However, NVIDIA’s results and outlook once again underscored the fact that we now live in the AI era, with long-term implications spanning the economies, the markets, and society as a whole.
Rates May Stay High, AI Doesn’t Mind
Notably, while hyperscalers such as Microsoft (MSFT), Alphabet (GOOGL), and Amazon (AMZN) are responsible for about half of the chipmaker’s total revenue, NVIDIA’s CEO Jensen Huang confirmed that AI is not an area reserved for large-cap cloud providers only. According to Huang, “Generative AI has expanded to consumer internet companies, and enterprise, sovereign AI, automotive and healthcare customers, creating multiple multibillion-dollar vertical markets.”
This means that the AI capital expenditure cycle is just starting, signifying “the beginning of a new industrial revolution,” as per Huang. The lingering concern that the tech rally has run too hot, and that hardware spending plans may underwhelm expectations, can now be put to rest. Sustained AI Capex momentum, reflected in NVIDIA’s surging data-center revenues, suggests that the revolutionary technology’s advancement can propel stocks further, regardless of whether the Federal Reserve’s interest rates are reduced or remain high.
That’s because the world is undergoing a technological revolution – which could be even more life-changing than the invention of the Internet. As such, it has already started to disrupt existing industries, while creating whole new ones. For example, NVIDIA said that it sees an enormous, potentially multibillion-dollar opportunity in sovereign AI – an area that hasn’t existed at all up until two years ago but is slated to grow quickly as countries invest in developing national AI capabilities.
According to Goldman Sachs research, AI hardware investment alone will be equivalent to 1% of the U.S. GDP this year and next, reaching 2-2.5% of GDP by 2032. This forecast, made just a month ago, may prove too conservative, judging by NVIDIA’s sales and orders data. Hardware (CPUs, servers, etc.) is crucial for the technology’s integration into business processes across the economy, starting with the hyperscalers and trickling down to all economic industries.
Signs Of Life Outside of the Big Five
NVIDIA’s report was “a grand finale” of the first-quarter earnings season, with stronger-than-anticipated earnings – and, more importantly, robust guidance upgrades – supporting the market amid decreased rate-cut expectations. Technology firms have beat the market – and analysts’ expectations – for yet another quarter, producing more positive guidance updates than any other sector.
Within the tech sphere, megacaps shone brighter than ever. Before NVIDIA’s results came in, five “Magnificent” stocks – NVIDIA, Alphabet, Amazon, Meta (META), and Microsoft – were estimated to post 64% EPS growth, with the number expected to be lifted now as NVDA beat all expectations. While earnings growth excluding the tech megacaps was still negative, the last three quarters showed a clear trend of improvement. Analysts now expect the “other 495” companies to start showing notable positive EPS growth starting from the next reporting season.
The broadening of the earnings growth can support continued rally expansion, which was already apparent this year as stocks from various sectors moved above their multi-month highs. As concerns about market concentration subside, investors are more likely to pour money into stocks outside the tech megacaps, feeding the positive cycle.
Stock Market Direction: Bears vs. Statistics
Amid the economy’s apparent resilience in the face of high interest rates, the near-perfect earnings season, and the stock market’s march higher under the AI banner, most of Wall Street’s bears have officially capitulated. The last shoe to drop was the significant price target upgrade by Morgan Stanley’s strategist Michael Wilson, who previously forecasted that the S&P 500 would tumble by 15% by year-end.
Now, the last bear standing is JPMorgan, whose strategists forecast a 20% tumble in the broad-market index by year-end. They say that the markets overestimate S&P 500 companies’ earnings growth in the second half of the year, as softening economic growth is expected to put a lid on revenue expansion. In addition, JPMorgan stated sticky inflation, “higher for longer” interest rates, and rich stock valuations among the reasons for its bearish outlook.
However, according to Wilson, elevated data volatility is expected to continue, making it harder for analysts to predict economic outcomes and thus muddying the stock-market outlook. With no clear indication at hand, many market participants are turning to historical data for clues.
Various statistics seem to support an optimistic outlook for the rest of the year. May 23rd marked the 100th trading day of 2024, and the S&P 500 was up by double digits. Historical data shows that when the index made 10%+ gains in this period, it ended the rest of the year higher on 85% of occasions. The 11% gain is also the best first 100-day result for a presidential election year since 1928.
Quality Will Be the Winner
However, all this AI optimism does not mean that the stock will continue going up in a straight line forever. We will most certainly see a bear market sometime in the future, as well as many corrections of different magnitudes. Downturns are a healthy part of the cycle, allowing for taking froth off the market and bringing stock prices down to reality.
However, as excellently stated put by futurologist Roy Amara, “We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.” It may be that outsized stock valuations represent this short-term overestimation of AI, but the fact that it will have a profound impact on the global economy – and the stock market – is not up for debate.
How exactly all this will transpire is still unclear: as with all disruptive, sweeping changes, there will be a fair amount of damage and failure, along with NVIDIA-style success stories. Whereas it’s hard to predict with any amount of certainty which stocks will rule the markets several years from now, it is logical to assume that fundamentally strong, well-managed companies with robust business models will do better in harnessing the revolutionary tech to their advantage than their weaker peers.
