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US MARKETS CALL: Below The Calm Deep Blue Sea
The major stock market indexes have gone nowhere since early August. On the surface, the seas have been calm. Underneath, plenty of turbulence has been occurring. Most of the volatility has been within sectors. In mid-September, we warned our readers to proceed with caution through the midterm elections. We expected and are now seeing buying opportunities. The S&P 500 closed at 7,561.67 on Friday. It has been fluctuating around 7,600 since August 3. We think it is set for another rally that should take it up to 7,900 by the end of this year. I. Stock Market Performance The S&P 500 is down just 0.5% since August 3, while the equal-weight version of the index is up 1.8% (chart). The MAGS ETF is up 0.4%, while the XMAGS ETF is up 1.2%. The Nasdaq is down 3.0%. Only the Russell 2000 has moved much, falling 6.4%. The sectors underneath the S&P 500 have been choppier (chart). Health Care has gained 16.4% since August 3, and Consumer Staples is up 10.8%. Communication Services is down 11.3%, and Industrials is down 7.9%. Information Technology, at the center of the AI selloff, is down 3.5%. The Information Technology sector has also been extremely turbulent below the surface (chart). The Semiconductor Equipment and Semiconductors industries are down 23.9% and 13.6% since August 3. Meanwhile, IT Consulting is up 22.3%. Application Software and Systems Software are up 12.0% and 4.5%. The crosscurrents have largely offset each other. The Magnificent-7 stocks have diverged too (chart). Nvidia’s market cap has dropped to $3.92 trillion following news of CEO Jensen Huang’s resignation. Apple’s market cap is at a record $5.18 trillion. Alphabet’s fell after reporting earnings but has since stabilized at $3.62 trillion. II. Stock Market Earnings Industry analysts are usually too optimistic about the earnings of the companies they follow. As quarterly earnings reporting seasons approach, they are often forced to cut their estimates. That's evident in their annual consensus "Earnings Squiggles," which tend to start high and then fall to the reported results (chart). This time, the annual Earnings Squiggles for 2026, 2027, and 2028 all are rising. That’s highly unusual. It might reflect some irrational exuberance among analysts. Then again, they've gotten more optimistic as actual earnings have come in stronger than anticipated in recent quarters. The recent market turbulence hasn’t dented S&P 500 operating earnings-per-share estimates. The 2027 consensus rose to $427.01 last week, and the 2028 consensus rose to $496.24 (chart). Both are new highs. Forward earnings hit another record high at $420.15 per share, edging closer to the 2027 estimate. We are estimating $425 for next year. Q3’s consensus earnings growth estimate rose again, to 26.9% y/y from 25.9% a week earlier (chart). Q4’s estimate edged up to 29.8%. The Q2 actual earnings growth soared on mark-to-market accounting gains. Without them, earnings rose about 25% rather than 50.4%. III. Stock Market Valuation Valuation multiples continue to fall. The S&P 500’s forward P/E is down to 18.0, while the Magnificent-7’s is down to 21.4 (chart). We think the contraction may be close to a bottom. Our year-end S&P 500 target implies a forward P/E of 18.6. Multiples usually shrink on recession fears. We don’t see a recession coming. Expectations of a slowdown in the AI buildout may be weighing on valuations. In our view, the slowdown constitutes speed bumps, not roadblocks. Only 36.1% of S&P 500 stocks now trade above a forward P/E of 20, down from nearly 50% earlier this year (chart). That’s a healthy development, driven by the air coming out of the AI bubble, which is now less likely to burst. The multiple correction has been centered in S&P 500 Growth, not Value, stocks. The S&P 500 Growth forward P/E has dropped 27% to 19.0 from 26.0 at the start of this year, while Value is at 18.0, about the same as at the beginning of the year (chart). The spread between the Growth and Value forward P/Es has narrowed to just 1.0 point, the narrowest since 2010 (chart). Investors aren’t paying up for growth anymore. Only three sectors have gotten more expensive this year: Real Estate, Consumer Staples, and Health Care (chart). Information Technology’s forward P/E has dropped from 26.5 at the end of last year to 17.2. Communication Services’ forward P/E is down from 22.1 to 17.0. IV. Credit The 10-year Treasury bond yield jumped to 5.10% after October's CPI and PPI reports (chart). That’s still below its October peak above 5.30%. The 10-year yield is hovering near the top end of the 4.00%-5.00% range we consider normal (chart). The latest increase in the 10-year nominal yield has been attributable to the 10-year TIPS yield. The spread between the two, which is a proxy for 10-year expected inflation, remains low at 2.21% (chart). That's surprising since the recent yield rise followed the hotter-than-expected CPI and PPI reports. Credit default swap spreads rose in recent months on concerns about the debt of CoreWeave and other AI borrowers but have since narrowed (chart). We don’t see broadening credit stress. V. Commodities Commodity prices are signaling less inflationary pressure. The FIBER Commodities Spot Price Index is looking toppy (chart). The S&P GSCI Energy Spot Index also seems to be topping out along with oil prices (chart). Even diesel prices have come down substantially. The Gulf Coast spot price fell to $4.11 a gallon from a peak above $5.00 earlier this year (chart). Agricultural prices have also eased from their summer highs (chart). The copper price has been getting hit along with the AI trade. It has fallen to $6.08 a pound from its recent record high above $6.80 (chart).
Double Feature: The Spy Who Loved Me & To China With Love
I. Jensen Versus The AI Trade Charlie Munger famously warned that there are three ways smart men can go broke: "Liquor, ladies, and leverage." NVIDIA co-founder and now former CEO Jensen Huang has run into trouble with the second of Munger's three L's. He won't go broke, but he is out of a good job. On Thursday, NVIDIA announced that Huang had resigned as CEO after 33 years at the helm of the company he co-founded in 1993. His departure followed revelations of extramarital affairs, including a reported relationship with a Chinese businesswoman suspected by US intelligence officials of spying for Beijing. Her Singapore-based company, Megaspeed, allegedly purchased NVIDIA's high-powered GPU chips and re-exported them to China, violating US export restrictions. The longtime CFO Colette Kress was appointed interim CEO while the board searches for a successor. Huang's departure rattled the AI trade, with NVIDIA shares plunging 4.3%, sending its forward P/E to 11.7 (charts). We promised you buying opportunities after the midterm elections. There were a bunch last Thursday and a few more today. Competitors AMD and Broadcom advanced 5.9% and 5.5%, respectively, on expectations of market-share gains (chart) As a result, the Nasdaq Composite held up relatively well, falling just 0.4% today (chart). Neoclouds also tumbled, with CoreWeave down 6.7% and Nebius down 16.8%, amid concerns about NVIDIA-backed financing (chart). Nebius was additionally pressured by disappointing revenue guidance and rising capital spending. Despite the latest AI jitters, the two-year Treasury yield rose 15bps to 4.87% this evening, remaining well above the federal funds rate and signaling that further Fed tightening is warranted (chart). The 10-year Treasury yield is back above 5.00% at 5.13% this evening. Yields rose on higher oil prices, with Brent crude up 3.1% to $95.66 this evening, after President Donald Trump dismissed the need for an Iran deal, and on hawkish Fed commentary following October's hot CPI report (chart). Markets now price a 100% probability of a December Fed rate hike: 84.7% for 25bps and 15.3% for 50bps. Futures imply more than 3 rate hikes over the next 12 months (chart). The combination of higher Treasury yields, driven by rising oil prices and hawkish Fed commentary, and renewed AI jitters weighed on the broader stock market. The S&P 500 fell 0.4%, its equal-weighted counterpart declined 0.9%, and the Russell 2000 lost 1.7% (charts). II. Nvidia: The Bear Case We can assess the risks Jensen Huang's departure poses to the broader AI trade with our familiar framework of three constraints on the AI investment boom. (1) Financial constraints. NVIDIA has been described by many as the central bank of the AI trade, conducting its own version of quantitative easing by helping finance the expansion of AI computing capacity. The company spent $42.2 billion purchasing equity securities during the first half of its current fiscal year, compared with just $1.2 billion a year earlier. The fear is that Huang's departure could slow or even end these financing activities, tightening financial conditions for an industry already facing questions about the returns on its enormous capital expenditures. (2) Political constraints. Huang has also been the AI trade's biggest cheerleader, tirelessly promoting its economic benefits and defending key players. During October's AI jitters, for example, he publicly defended CoreWeave's financial health amid a selloff in its shares and bonds, helping restore confidence. His departure could deprive the industry of its most influential advocate and cheerleader. Additionally, NVIDIA reportedly intervened in the Commerce Department's investigation into Megaspeed, while Commerce Secretary Howard Lutnick reportedly resisted efforts to blacklist the company, which remains off the Entity List. Reports also suggest the Trump administration knew about Huang's relationship with a suspected Chinese spy. These allegations could invite tougher congressional oversight and undermine Trump's national security argument for building more data centers in the US, making the AI buildout harder to sell to the public. (3) Physical constraints. Washington could respond by tightening chip export controls and closing loopholes that allow Chinese companies to access NVIDIA-powered computing capacity remotely. If so, China might retaliate by restricting exports of rare earth minerals, some of which are crucial for building data centers. China has already warned Washington against using the controversy as a pretext for imposing tougher technology restrictions. III. Nvidia: Our Base Case Our base case is that NVIDIA's financing strategy remains intact. Colette Kress, NVIDIA's longtime CFO and newly appointed interim CEO, has worked closely with Huang since 2013 and helped oversee the company's strategic investments and financing arrangements. During NVIDIA's August 26 earnings call, she defended these investments against accusations of circular financing, stating, "We recognize the scale of this support, and we know some will call it circular financing. We see it differently." She argued that these investments would generate attractive returns while strengthening NVIDIA's AI ecosystem, suggesting continuity under her leadership. We don't expect political constraints to meaningfully increase as a result of the controversy. Nor do we expect another trade conflict with China to erupt. Even if some of the constraints intensify, they would likely turn existing speed bumps into bigger speed bumps rather than roadblocks to the AI investment boom. AI remains the latest evolution in the Digital Revolution that began with IBM's mainframes, and we expect the investment boom to continue without Huang (chart). We therefore view any resulting selloff as another buying opportunity for the AI trade.
On Semi Prices, Utilities & Better Knee Repair
It’s well known that demand for semiconductors is booming, supply is tight, and prices are soaring. The managements of two neoclouds, CoreWeave and IREN, confirmed that on recent earnings calls. But might the tide reverse? Jackie explores three headwinds gathering force that could cause semi demand and prices to sink. It’s a contrarian view, but one that IREN’s CEO finds feasible. … Also: Constellation Energy’s Q3 results suggest a bright market environment for electric utilities providers. … And in our Disruptive Technologies segment, a look at the less invasive alternatives to knee surgery under development in corporate and university labs.
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