For those of you who would prefer to listen:
Back in February of 2024, just 22 eventful months ago, the Stock Market was teetering. The 14-month rally was maturing and being tested. The AI-Trade was being questioned. Investor sentiment was sour. Things were looking bleak. The Market was in need of a spark. Earnings Season was coming to a close. However, there was one big hitter left. It was Nvidia’s turn at the plate. The company knocked it out of the park. Investors celebrated. The AI-trade was back on. Nvidia saved the rally.
I wrote this back then:
“Heading into earnings, Nvidia was on a 4-day losing streak, with the stock down nearly 10%. The S&P 500 was in correction mode, too. That trend reversed quickly. With another record quarter, Nvidia turbocharged the S&P to fresh, new highs. Nvidia alone accounts for 25% of the S&P gain in 2024. You read that right; one stock is responsible for 1/4 of the Stock Market gains. It also carried the Tech-heavy NASDAQ to a record high, finally erasing the losses since 2021.”
This week was a similar set-up. The S&P is again in correction mode. The Stock Market fell 5% from its all-time high. Calls for an AI bubble have permeated the investor psyche. Comparisons to the Dot-com days are everywhere. The undisputed leader of the AI-Trade is Nvidia. It’s become America’s most valuable company. Nvidia was the first to $5 Trillion. It alone accounts for 8% of the S&P 500. The stock fell 15% from its all-time high reached in October. It lost its $5 Trillion valuation. It got it back in early Thursday morning trading. But it couldn’t keep it. Nvidia reversed all the gains and closed in the red on the day.
The fact is, Nvidia reported another outstanding quarter, continuing the trend of exceeding lofty expectations. It raised its forecast yet again. At first glance, it looked and felt like Nvidia knocked it out of the park. It crushed its quarterly report. Futures were ecstatic with an overnight rally. It carried into the morning. This time, it wasn’t enough. The winds quickly changed. The fierce tailwind became a major headwind, knocking the stock down. It took the Market with it. The fence proved to be further out. Nvidia’s report only reached the warning track, failing to score runs for the Market. Management said fears of an AI bubble are misplaced. Despite putting up another record quarter, Nvidia couldn’t save the rally.
Though the S&P is slightly short of its all-time high, the uptrend is still in place. It’s been tested and will likely get tested again. Bull Markets need to prove themselves, especially when fatigue creeps in. Investor sentiment went from optimistic to pessimistic quite quickly. Corrections do that. Crowds go from Bullish to Bearish in an instant. There’s nothing like price to change sentiment.
Chief to the concerns around the recent declines are questions about the sustainability of the AI spending. Nvidia put those concerns to rest this week. The company reiterated what the Tech Titans said in their earnings reports: Demand is still strong. In fact, it keeps growing. Ok, so the spending will continue. But here is a new concern: The rise of debt – Financing the AI buildout. It’s no longer coming out of cash flow.
Silicon Valley has done something lately it hadn’t in a while. There has been big Bond issuance. The Tech Titans were quick to take advantage of low interest rates back in the early days of Covid. They didn’t need the capital, but it was cheap money. That’s smart money if you have a strategic plan. It certainly worked. Many of the Tech Titans accessed the Bond Market in recent weeks. Oracle started it. Meta followed. Next was Alphabet, followed by Amazon.
Importantly, demand for their Bonds was strong. There isn’t any concern about their creditworthiness. But bids for their stocks have stalled. Oracle could be that early signal. You may recall, Oracle’s stock spiked off the OpenAI deal announcement in September. OpenAI plans to pay Oracle $300 Billion over the course of the next 5 years for increased computing power. Oracle jumped nearly 40% in a day. This was a remarkable event for such a mature company.
But OpenAI currently only generates $10 Billion in revenue today. How’s it going to pay for it? And Oracle will need to spend heavily to build out the increased computing power. The company decided to borrow to grow. It sold $18 Billion in new Bonds. It also borrowed nearly $40 Billion in a private loan. Oracle’s Bonds are BBB-rated. That’s investment grade, which is considered high quality. But it’s at the lower rung of the category. The Tech Titans are all A+ credits.
There’s some active price action beneath the surface that bears watching. The price of Oracle credit default swaps has spiked. They doubled in just 2 months. That’s the cost to insure the debt against default. The Bonds are still holding in, acting fairly normal. That’s important. However, all those gains for Oracle’s stock have since been erased, and then some. Questions have been raised about the possibility of circular spending that might not result in the expansive growth being hyped. That was perhaps the beginning of the bubble burn off that’s taking place.
Retailers provided a clear look into the state of the Consumer. Accounting for 70% of America’s economic output, consumer spending matters more than anything else. Leading the pack is Walmart. The largest retailer continues to grow revenues and profits ahead of expectations. The company raised its outlook for the year for the second time. Total revenue grew 4.5% compared to a year ago, with double-digit growth in e-commerce. People are proving to be budget-conscious and price-sensitive. The Q3 report showed more high-end customers are spending at the Bentonville Arkansas behemoth. Walmart has gained Market share across incomes, but Management said the trend is “more pronounced in the upper-income segment.” That’s a big tell for today. It’s true what they say: America shops at Walmart.
Walmart continues to take share away from competitors. That was evident in Home Depot and Target’s reports. Home Depot’s struggles reflect the weak Housing Market as much as anything. Remodels and do-it-yourself projects have slowed. So have home purchases. Target Management called out the cautious consumer on its call, though Target continues to deal with its own isolated issues. The biggest takeaway is consumer spending is very selective. Walmart and Amazon continue to dominate the space. With the Holidays commencing next week, this will be a major test to see what and how much lands under the tree.
The biggest area of weakness in America’s Economy has been seen in jobs. The government shutdown delayed the data release. The September report finally came this week.119K jobs were created in the month. That beat Street expectations. However, the prior 2 months were revised down by 33K. August saw a 4K job contraction. The unemployment rate rose to 4.4%. That’s the highest since 2021. Further complicating the situation, the October Job Report might not be released at all. Data was reportedly not being tracked while the government was shut down. The trend for jobs has been decisively down, but we might not know to what extent until the November report release come December. The Fed has made it clear it is data-dependent. It is not operating with a full slate of data. That likely has them on hold at their December meeting. The Market isn’t liking that.
This situation is a bit reminiscent of 2018. As the year was coming to an end, the Market started quaking, calling for rate cuts. The Market thought the Fed was too tight then. It believes it again today. It took a sharp Market sell-off, concluding with the “Christmas Massacre,” to force the Fed to cut. It worked then. Hopefully, it won’t come to that this year. Lessons learned.
Bottom line, the Consumer is stretched. Inflation has eaten away at buying power. It’s important to understand that despite the slowing of inflation, prices are still going up. They’re just going up at a slower rate. A $30 bill pre-Covid is $50 today. People are feeling tapped out. And when they spend, they pay more for less. Everyone feels the stress. This, from a thoughtful friend this week after going to a local restaurant: “We drove here, sat down expecting something very nice, and then the meal is not quite what it used to be, and a high bill.” He’s not alone in that thought.
Wall Street has been enamored with AI all year. It’s been the primary driver for the Stock Market. Investors have embraced it with both hands. Not quite everyone. The Wall Street Journal had an insightful article this week pointing out the lack of enthusiasm by the masses for AI. A recent survey showed just 31% of responders are comfortable with Artificial Intelligence. 68% say they are not. Compare that to the Dot-com days when over 70% were enthusiastic about the advancement of the internet. An obvious reason, are machines going to take our jobs?
Two of the biggest minds behind the advancement of AI are Elon Musk and Jensen Huang. They both held court on a panel this week in Washington. Musk caught people’s attention when he said work will be optional. That was a head scratcher. Trying to envision a world where work would be optional seems unfathomable. Jensen Huang sees it differently; Artificial Intelligence is a tool that will make people more accurate and productive. I like to tell young people, don’t worry about AI taking your job. Worry about somebody that uses AI taking it.
The Nvidia Founder and CEO observed that life will definitely be different. But he emphasized that having access to so many new ideas, we as a people will be even busier in our professions. This, as long as we lean in and embrace the change. He used an example of a role that was initially expected to be replaced by machines, but the opposite has occurred. Radiology: More radiologists have been hired, not cut. Using the innovative solutions, radiologists are now spending more time studying disease and engaging with patients. The quality of care is improving, as is the experience for patients. That’s something. We need to hear more about these examples to counter the beliefs of job replacement.
Both Elon Musk and Jensen Huang announced a partnership to build a 500-megawatt data center in Saudi Arabia. To put it in perspective, 500 megawatts can power as many as 500,000 homes. The AI buildout is spanning the globe. Power is definitely an issue. That had the Tesla leader riffing on Space. Musk pointed out that Earth only receives 1/2 Billionths of the Sun’s energy. I had to stop and really think about that. When you think of a sliver, that’s a really small bit. The point is, Space can, and they say will, provide far more energy than any resource on Earth could even imagine. Electricity and power are already strained. In Space, computing would not need cooling, and it won’t require batteries. The Sun will provide the power. It’s always sunny in Space, he said. That’s the dream. Apparently, the dream is closer to reality than many think. It’s also investable.
Back to the Market:
The correction continues. The S&P 500 broke below its 50-day moving average. That’s a level that many on the Street look to for trend changes. The S&P had been above its 50-day since April. That’s the longest stretch above the moving average going back to 2007. A correction was more than due. It’s healthy. It’s just not fun going through it.
There’s been a much bigger correction in crypto. Bitcoin is down 30% in a month. Cryptocurrencies have generally been a barometer for risk appetite for investors. There’s some speculation circulating that some traders got over their skis in levered trades, which has the Brokers issuing margin calls. That forces selling. In that situation, traders have to sell what they can, not necessarily what they want. Tech is an obvious victim here. This could help explain a little bit about the frantic sell-off this week, which exacerbated the natural overbought correction.
The sell-off has been fairly orderly, but quick. The result is a 5% correction off the all-time high reached at the end of October. That was just 3 weeks ago. Remember, the path to those highs was basically straight up in a 40% rally off those April lows. But we mustn’t forget the S&P fell 20% in April in the wake of the tariff slaps to hit those lows. The good news is, those Beautifully Boring Blue Chips have caught a bid.
We don’t see a return to those April levels anytime soon. But we are prepared for lower levels ahead. 6400 S&P could be at play. That’s another 2-3% lower. We’re all over it.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
