— Haris Pašović
“There is no real theatre without taking risks.”
February was essentially a market play in three acts. The first was still rather macro driven but saw a modest march higher for stocks. In the second, markets leapt up amidst renewed AI ebullience. Since then, the third act has been almost eerily quiet, as markets digested their gains and waited for the next impulse.
The curtain rose on the month just as the Fed left the stage. The US central bank’s FOMC met on the very last day of January and, as expected, opted to make no change to interest rates, tweaking only their forward-looking language. The rate-setters removed the threat of further rate hikes, instead paving the way for easing in 2024 – but Chair Powell pushed back firmly on expectations (expressed in futures prices) of cuts as soon as March. Striking macro data prints then kept the focus on the macroeconomic context – and downward pressure on stocks and bonds. January jobs and inflation numbers surprised firmly to the upside. Headline payrolls rose a whopping +353k, versus +185k expected, confirming the US jobs market (and economy) is still humming. January Consumer Price Index (CPI) figures then dealt a blow to the disinflation narrative. Both headline and core CPI exceeded forecasts. Perhaps most important, though, was the ‘supercore’ number (covering core services ex-housing and thus a good measure of wage-driven, domestic price pressures), which was well up at +4.3% YoY.
This trio of macro inputs forced markets to reassess the view that inflation was coming into land and rate cuts were round the corner. Bonds sold off, sending yields up, and equities registered some of their heaviest daily retreats in months. Futures markets rapidly unwound expectations for March rate cuts. This was precisely the kind of danger we flagged in our last update: with the soft-landing narrative heavily priced in, markets are primed to correct sharply to data contradicting that model.
But the month’s real drama came from earnings season – and from one earnings report in particular: AI semiconductor chip leader NVIDIA.
NVIDIA did not report until late in the month, though, and a foretaste came from Meta. The Facebook parent registered strong revenue growth and surprised with its first ever quarterly dividend. The market response was remarkable: the stock rocketed +20.3% in a day, adding +$197bn to its market cap to set a new all-time record for a stock’s daily value gain. This, and other Big Tech results, was enough to keep the S&P 500 positive across February’s first act, despite those downward macro pressures; the index dialled up +2.8% in the first three weeks, though on a tapering trend.
Then came NVIDIA’s results. CEO Jensen Huang sweepingly declared that demand for the firm’s AI-enabling chips was ‘surging worldwide across companies, industries and nations’ and the evolution of generative AI was at a ‘tipping point’. The numbers behind these claims were stunning. Quarterly revenue was up +265% YoY, as the company raked in $22.1bn in Q4 to smash Wall Street forecasts of $20.4bn. The company expects $24bn of revenues this quarter. And the market numbers that followed were similarly stunning. The stock rose +16.4% on the day; in market value terms this was a gigantic +$276.7bn increment, sweeping away that Meta record so newly minted. NVIDIA leapt over Amazon and Alphabet to become the third most valuable US listed company (behind Microsoft and Apple) and it is now up +60% YTD.
Some of the market glow around AI had seemed to dim in the last months. NVIDIA’s results confirmed it was back to full power.
Some of the market glow around AI had seemed to dim in the last months. NVIDIA’s results confirmed it was back to full power.
Crucially, it radiated onto other stocks and markets. February saw multiple major equity indices reach new heights. Certainly, not all of this came from NVIDIA and the promise of an AI revolution, but February’s risk-on second act pushed global stocks firmly into the green for the month, whereas many had hitherto been rather muted.
Earlier in February, the S&P 500 crossed the 5000 point line for the first time ever and continued on to successive all-time-highs. The post-NVIDIA surge took France’s CAC and Germany’s DAX to new all-time-highs and the Euro Stoxx 50 reached a 23-year record.
But the record with the greatest weight of history behind it came in Japan. As we anticipated in our last note, after 34 long years, Japan’s Nikkei 225 finally surpassed its December 1989 all-time-high.
So what was the net result of all that – and where does it leave us looking ahead? Well, in truth, not all that different from our last note a month ago. Many of the same themes, concerns and questions hang over markets, having merely been underscored by February’s developments.
We still like the AI theme. This is a long-term conviction of ours, to which we have had exposure long predating the buzz that began last year. We therefore naturally welcome the latest indication that this market and economic development is not going away – and the positive impact it has had on portfolios.
But evidently, nobody knows what the true social, economic and financial impact of generative AI will be – nor who the true market winners will be. It is clear from history that even if a new technology proves genuinely revolutionary and has irreversible, real-economy impacts, that does not mean it cannot cause a painful stock market bubble on the way. We still use railways and the internet but it was certainly possible to lose money betting too big or unwisely on them in the stock-market bubbles they caused in their initial euphoria. For now, though, we are reassured by the fact that both the numerator and denominator of NVIDIA’s price-to-earnings ratio have grown so rapidly that the valuation multiple is not yet completely out of whack, even if that rate of growth feels dizzying.
It is clear from history that even if a new technology proves genuinely revolutionary… that does not mean it cannot cause a painful stock market bubble on the way.
Related to this uncertainty, we reiterate our previous point about market narrowness. Even though last week’s rally saw some broadening, all-in-all February simply continued the trend towards concentrated market leadership. NVIDIA alone is responsible for a quarter of the S&P 500’s YTD gains. The preponderant weight of the Magnificent Seven is inherently a risk to the stability of index-level measures, especially at their rich valuations. The atmosphere around NVIDIA’s earnings call underlined this, with market participants approaching it as a market-wide risk event akin to a US CPI print.
We therefore continue to look for other sources of opportunity in the equity space, including with positioning away from more stretched valuations. Japan remains one area where we see further opportunity for gains, even as its outperformance has continued. The country’s victory over deflation is not yet assured and its demographic challenges are well known but equity valuations have plenty of room for appreciation and the catalysts we set out in our last note remain fresh. European financials remain a further area we favour; we prefer their credits but European banks have set out plans to return over €120bn to shareholders on the back of strong 2023 profits, underscoring the health of the space.
Japan remains one area where we see further opportunity for gains, even as its outperformance has continued.
On the macroeconomic outlook, our views also remain little changed since our last note. Today’s Personal Consumption Expenditure (PCE) inflation data print will certainly be important (it’s the one the Fed watches), especially if it confirms the upward price push in January we saw earlier with the CPI numbers. This will reiterate the danger of stubborn inflation. Nonetheless, this is just one month’s data and January inflation numbers have historically been volatile. We still see inflation in the US (and other developed markets) on a downward trend. Our base case remains for US economic softening later in the year but most data still emphasises resilience – and current momentum should carry the economy someway further. This leaves our expectation for Fed cuts not to come until the second half unmoved – barring surprise developments.
For now, markets have settled into a very quiet third and final February act, with the S&P 500 chart describing an impressively flat plateau since the NVIDIA surge last week, as they await a new steer. These will not be wanting in the next week or so, with potential market events coming thick and fast, starting with today’s PCE number, then onto another US jobs report, Powell’s congressional testimonies, US primary elections, the ECB policy decision and the UK budget. We are confident we will have plenty to discuss in our next update.
If you have any questions about the themes discussed in this article, please do not hesitate to get in contact with us: info@bedrockgroup.ch
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