For those of you who would prefer to listen:
The AI race is upon us. It’s been escalating ever since ChatGPT made its appearance in the Fall of 2022. Nvidia has been the undisputed leader in the race. Companies, both at home and abroad, have scrambled to get their hands on Nvidia’s chips. Demand significantly outstrips supply. That sends prices higher. You remember that from Econ 101. That has propelled Nvidia’s revenues and profits, which helps explain its stock performance. Earnings drive stock prices. Nvidia reported its Q2 earnings this week. Nvidia is the most valuable American company in history. It has a $4.5 Trillion value. 8% of S&P. It’s a big deal.
Nvidia reported another stellar quarter with earnings that grew 61% on the back of 56% revenue growth. This is explosive growth. Demand is still white hot for Nvidia chips. Importantly, there were no H20 sales to China in Q2. The company is not modeling any future sales to China either. Politics and national security are driving that. More on that later.
Nvidia missed expectations for datacenter revenues, though ever-so-slightly. They grew a whopping 56%. That kind of growth is the envy of the world. But it wasn’t enough for the stock to keep soaring. On Wall Street, a miss is a miss. It was the first time that happened since the debut of ChatGPT. And it happened while Microsoft, Google, Meta and Amazon keep spending on AI infrastructure. It was a big surprise. What’s more, it was reported that just 3 customers now represent 56% of Nvidia’s accounts receivable. That’s some serious concentration.
What’s more, the company guided Q3 Revenue to be $54 Billion. That would be 15% sequential growth which is excellent. The problem, the whisper on Wall Street was $55.5 Billion. The Stock Market is all about expectations. Nvidia’s stock ran in anticipation of the strong growth. It sold off when the expectations were not met. The selling didn’t last long, as has been the case all year, the dip got bought Thursday. Sellers stepped back in Friday. But it’s still pretty clear, the Bulls remain in charge.
China is the second-largest computing market in the world, behind the United States. It is also the home of about 50% of the world’s AI researchers. The vast majority of the leading open-source models are created in China. The United States wants to dominate the global Tech stack. China wants its companies, and the rest of the world, quite frankly, to use Chinese semiconductors and AI models versus US technology. Competition is fierce. It is critical that Nvidia competes in the Chinese Market. Both the US and China are in it to win it. The AI race is on.
Earnings Season is coming to a close. The blended growth rate for Q2 stands at 11.7%. That is well above the 4.9% expected. AI remains the dominant theme. Last year, the Tech Titans accounted for 52% of total earnings growth for the S&P 500. In Q2, these 7 companies reported earnings growth of 26%. The other 493 companies grew earnings by just 4%. The Tech Titans are the clear players in AI. But growth seems to be expanding. Corporate America appears to be in solid shape.
Over 80% of the S&P companies beat Street expectations this time. Goldman Sachs pointed out that 58% of the companies raised their guidance for the rest of the year. That is twice as many as did so in Q1. What’s more, Wall Street raised its estimates in most sectors for the second half of 2025 and all of 2026. That’s bullish. The number of companies lowering revenue guidance was just 14%. That tied for the fewest in the history of the firm’s tracking. We say it all the time, it’s earnings that drive stock prices.
Before Nvidia, there was Intel. It was THE semiconductor company. Nobody else was even close. Intel used to be an American icon. It was a peerless leader in Silicon Valley for decades. Its hallmark slogan of “Intel Inside” reflected its dominance in personal computers. But its dominance didn’t last. The company stayed tethered to PCs when the world moved to mobile and the cloud. Intel struggled for years. The company missed out on mobile devices and AI. Intel is not in the iPhone.
Intel has a new shareholder. It’s the United States Government. Word of that sent shockwaves through the system. Free-market capitalists were sounding alarm bells. I immediately thought of Ronald Reagan and his statement of the 9 most terrifying words in the English language: “I’m from the government and I’m here to help”. This was big news; Bigger than the Market reaction. Intel needed the money to shore up its balance sheet, that much was certain. The Market seems to like it, as Intel went up on the news. This is a great departure from the norm. Or is it?
Politics are increasingly driving every segment of our society. Our country is sorely divided. It’s been building throughout this 21st century, starting with the controversial outcome of the Bush-Gore election in the year 2000. The divide has grown deeper ever since. Cable news and social media embody it. The vitriol is everywhere.
I have no interest in getting political. That’s not my role. I won’t do it. But I do have to acknowledge developments in Washington in order to explain Market activity. That often has me facing that third rail which is American politics. It’s definitely not fun, but it’s necessary to find truth. I’m in constant pursuit of the truth. The way I see it, that’s where understanding lives. And understanding leads to better decision-making.
So, what exactly is going on here? Despite its struggles, Intel is clearly not too big to fail. That was the call to save the banks during the Financial Crisis. At $100 Billion valuation, Intel is barely 2% the size of Nvidia. The issue is, Intel is seemingly too important to fail. The US Government is the regulator, a customer and now a shareholder. Our sources confirm what has become quite evident; Republicans are terrified to cross Trump. This is clearly not the Party of Reagan.
The Trump administration didn’t take new money and buy Intel shares. It re-directed proceeds yet to be paid from the CHIPS Act, passed under the Biden administration, and exchanged it for 10% of the company. The White House says it will have no control over the operation. Its shares are said to be non-voting. That’s basically all we know, if we even know that.
At this point, there are far more questions than answers. Does this mean now Intel will receive favorable treatment? Is the Federal Government officially in a position to pick winners and losers? Did the Intel CEO save his job by selling to the US Government? Will this lead to more government ownership in areas of national security, such as Agriculture, Aerospace and defense, and Health Care? On the flipside, what does this mean for the strongest companies that don’t need government funding? Strong-arming them to force acquisition? Where would it end. Again, far more questions than answers.
The White House sees this as a matter of national security. Advanced semiconductors are vital for both civilian and military technology, and the United States has long been dependent on overseas suppliers. This from the Trump administration: “We can’t afford to let China dominate this industry. This investment makes sure production stays in America and that our supply chain is secure.”
Supporters argue that this is exactly how industrial policy should work. If government Dollars are going to help a company, the public should benefit when the company does well. Even famed entrepreneur Mark Cuban is on board with the plan, saying the public deserves to share in the gains like private investors. OK, it’s a compelling argument.
The detractors see it as a violation of the principles of the Free Market. The strong belief is that the government should not own private companies. Of course, that’s precisely how China does things. That’s why many companies and countries are so skeptical of doing business with China. America’s embracement of free-market capitalism is what ignited the economic power. Intel has concerns that partners overseas might view it as a political arm of Washington rather than an independent global manufacturer. The concerns are legitimate.
This from one of our Washington sources:
“Even if the Trump administration is sincere when it says that the government’s stake will not include voting rights, things can change over time. A passive stake can morph into an active one later. When that happens, certain customers can receive preferential treatment, and innovation can suffer if political influences are prioritized. The previous administration apparently nudged banks to avoid certain customers and industries. Debanking could possibly spread to other sectors.”
Free markets thrive on supply and demand, innovation and proper incentives. The system is rule-based and functions best with predictability and stability. Risk takers should be rewarded for success. Those who aren’t successful suffer consequences. Failure is part of the deal. The Federal Government has played an active role throughout the years.
You may recall, back in 2008, Congress passed the Troubled Asset Relief Program (TARP) in response to the Financial Crisis. What you might not remember is, after the regulators established a capital injection program for the banks, Congress retroactively changed some of the terms in 2009. So that can happen. Even if the Trump administration does not change the terms on these investments, that does not mean that a future administration or Congress won’t change them. I was reminded of a Darth Vader line in Star Wars when he wanted something done. “I am altering the deal. Pray I don’t alter it any further.” May the force be with us.
The Federal Government bailed out General Motors in 2009, something they no doubt regret. The Treasury Department spent $50 Billion on the investment. Taxpayers lost $11 Billion on the deal. The Federal government made favorable loans to the solar company Solyndra which ultimately defaulted and filed for bankruptcy. Taxpayers lost $500 Million on that deal. The recent history isn’t great, although we taxpayers did ultimately turn a profit on TARP.
China has a tight grip on its companies. China’s Tech leaders are effectively run by Beijing. They embrace free markets but play by their set of rules. That is well known. But did you know that European governments also have equity in companies? The French government owns a sizable portion of Air France, just under one-third. It also owns 10% of Airbus, which competes directly with Boeing. The British Government used to own British Airways but privatized it in the 1980s.
Though the United States Government didn’t nationalize private companies during World War II, it mobilized private enterprise and directed its manufacturing for the war effort. The Second War Powers Act of 1942 empowered the government to force businesses to accept war production contracts. It ensured critical materials were supplied. The War Production Board exercised substantial control, allocating resources and could even seize facilities if companies resisted. Most companies participated willingly. Beyond the natural patriotism, they also benefited from large and generous contracts. Collaboration evolved over time, but, during the war, the government’s control over production was intense, reducing consumer goods production and prioritizing military output. The American people were forced to ration.
The government initiative spurred innovation. The first Jeep hit the road in 1941. Duct tape and synthetic rubber emerged out of necessity. On the sweeter side, the Mars Candy corporation developed and patented M&Ms with a shell coating to withstand heat. It was exclusively sold to the military at first. Hormel developed and shipped Millions of cans of SPAM and other canned goods to our troops. Over 90% of its products went to military use.
Coca-Cola played a major role as a morale booster for American troops, producing and delivering over 5 Billion bottles for military personnel. The company built bottling plants close to the front lines across Europe and the Pacific. The US government gave Coca-Cola special permission to import sugar during rationing. Coca-Cola’s president, Robert Woodruff, declared that every American in uniform should have access to a Coke for 5 cents, no matter where in the world they were stationed. The goodwill was greatly appreciated. Demand for Coke skyrocketed across the globe and it hasn’t looked back.
Those examples of partnerships between the Federal Government and Corporate America were clear successes. That was wartime. Importantly, many American innovations have come from government funding. There is something to be said for the American people participating in those advancements when the taxpayers provide the seed money.
This AI race has created a Cold War-like standoff between China and the US Dominance in the Digital Age will impact all things economic, political, geopolitical and social. It’s big. There is a key difference between the Cold War with the Soviets and whatever these strategic tensions are called with China. The Soviets were a military and geopolitical threat but not an economic threat. The Soviet Economy was backwards and dated. Conversely, China is an economic power. Its authoritarian leadership is seemingly fixated on eclipsing American superiority. So, does America’s future success rely on government-private partnerships in the AI race or is it best if Corporate America is left alone? It’s an unanswerable question right now, though smart people on both sides have strong opinions.
There are plenty of other industries that have relationships with the Federal Government that could be used to rationalize similar investments to those of Intel. The administration is said to be looking at the defense industry, and future investments in sectors such as Agriculture, Pharmaceuticals, Cybersecurity, Telecommunications, and Financial Services are all possible. Each of these industries has companies that do business with the Federal Government or rely on government programs to some degree. Once the precedent is set, it is easier to follow up and make more investments in the future. The fact is, none of these investments are risk-free for the companies or their investors.
Risks are everywhere, whether we like it or not. It’s easy to argue both sides of the issue. On one hand, US Tech supremacy needs to be maintained and expanded, and the only way that happens is with strong support from the Federal Government. On the other hand, there’s an argument that this administration is merely power hungry and wants to control everything. I suppose there could be some truth to both. We definitely need stronger checks and balances. But the situation is much more nuanced. I don’t profess to have the answers, but I wanted to expand my thinking on the subject to try to better understand what’s happening today and why it’s happening so that we can make better decisions for tomorrow. I hope this triggered some critical thoughts and perhaps an aha moment for you too. Knowledge is power. It’s best to keep seeking.
Back to the Market:
Labor Day marks the unofficial end of Summer. It sets up the final push to year-end. Market activity picks up. Historically, September is the worst month of the year for the Stock Market, with the S&P on average declining 1.5% on the month this century. That’s the average. September hasn’t always been red. It declined only 13 of the last 25 years. But when it did, it often was substantial. It’s been a great year for investors, something that perhaps has come as a shock considering all the risks out there. We expect September to bring back some typical seasonal volatility. Corrective price action is healthy. In fact, there’s been a bit of rotation beneath the surface, broadening the rally beyond just Tech. Despite the Friday sell-off, there was quite a bit of green on the screen. That’s inherently a really good thing.
Have a nice weekend. The Market will be closed on Monday in observance of Labor Day. Our office will be too. We’ll be back, dark and early on Tuesday.
Mike
