Big tech rises on a promising AI future

Markets

The S&P 500 surged to an all-time high on Thursday following Nvidia's much stronger-than-expected quarterly results, which buoyed the broader tech sector.

Nvidia's stock soared more than 14.5% to reach an all-time high after the company reported a remarkable 265% year-over-year increase in total revenue, driven primarily by its booming artificial intelligence business.

Nvidia, the world's most important stock and, increasingly, the market's most crucial wealth-generating company, also forecasted another substantial revenue gain for the current quarter, surpassing already high expectations for substantial growth.

Other tech giants also saw gains, with Meta (formerly Facebook) and Amazon climbing more than 4% and 2.5%, respectively. Microsoft and Netflix also experienced increases of more than 1%. As one of the Mag 7 goes, the rest will assuredly follow. 

Still, over the past year, the unbridled enthusiasm for artificial intelligence has been a critical driver behind Nvidia's jaw-dropping rally and other major tech company's performances. Nvidia's outstanding quarterly performance will likely instill further confidence in the tech sector, benefiting the broader market sentiment.

The rapid ascent overnight has also been a function of call options, some of which we alluded to in yesterday's note, that have led to dealer short gamma positioning in certain upside strike levels. Market makers were squeezed to turn buyers of futures and cover quickly, adding to the velocity of the index moves. Over the past months, investors have been tucking into call options, driven by concerns about the potential for a significant upside move or a right-tail crash-up in the market. 

Indeed, the accumulation of call options and the subsequent rush to cover gamma have significantly fueled the upward trajectory of the S&P index overnight. As traders and market participants react to the dynamics of options positioning, it can create a feedback loop amplifying market movements, especially during heightened volatility and uncertainty periods. I'm not suggesting we would not be on the cusp of 5100 if it were not for call option positioning; I'm just saying we probably got there a lot quicker than many had expected.

Japan: Nvidia Ripple effect

Nvidia's strong results had a ripple effect across global markets, notably in Japan, where the Nikkei stock average surpassed its 1989 all-time high. The positive sentiment extended to shares of chip makers in South Korea, Taiwan, and China, which experienced significant jumps in their stock prices. Similarly, U.S. chip maker stocks also saw gains in response to Nvidia's robust performance and optimistic outlook.

Indeed, several dynamics are at play in Japan's markets. Still, the condensed version highlights that the Japanese economy has successfully overcome the deflation demon with reasonable valuations and generally sound corporate fundamentals. Additionally, the historically weak yen adds to the favourable conditions, suggesting significant potential for growth and investment opportunities in Japan's markets.

The yen and the Japanese stock market have a notable long-term inverse relationship. This relationship is predicated on Japan's economy relying heavily on exports, and a weaker yen benefits equities. However, the dynamics influencing Japanese stocks are more nuanced than just currency fluctuations.

Here is the kicker: Despite the recent rally, many Japanese stocks remain depressed, with reports that 37% of Nikkei members are trading below their book value, implying that investors could potentially earn more money by liquidating all the company's assets than by continuing its operations. While this indicates a lack of confidence in management, it also suggests significant upside potential if companies are managed effectively.

In comparison, only 3% of stocks in the S&P 500 trade below book value, while just one-fifth of stocks in the Stoxx Europe 600 Index fall into this category. 

The Nikkei breaking fresh higher ground is the culmination of a 34-year roller-coaster journey for Japanese shares, which transitioned from being the most highly valued in the world to among the most undervalued. Now, investors are setting their sights on the sky is the limit. 

 Equity strategists are likely intrigued by the factors propelling this current equity high. However, realists may caution against extrapolating from past economic trends when attempting to forecast future economic success.

Macro backdrop

The preliminary read on S&P Global's PMIs for the U.S. manufacturing sector indicated the brisk expansion at the fastest rate in 17 months in early February. This release came amidst a highly active backdrop on Thursday, with Nvidia's outstanding quarterly results competing for attention alongside the Nikkei's record-setting achievement.

The flash print on the manufacturing PMI stood at 51.5, up from 50.7 in January, marking the highest reading since September 2022. This figure surpassed the highest estimate from among 18 forecasters. Furthermore, the new orders subindex for manufacturing reached 53.5, its highest level since May 2022, while the employment gauge rose to a five-month high.

Yields once again perked up, and as they are so often wont to do on robust U.S. data, oil markets and the U.S. dollar turned bid.

However, the flash estimate for the services sector, at 51.3, was considered a miss compared to economists' expectations of 52.3, with the lowest estimate being 51.5. Additionally, the employment index for services slipped to 50.8. January marked the first instance since the previous year when the manufacturing headline print surpassed that of services.

While the services sector missed expectations, it's plausible to view this as a favourable outcome. Both sectors continue to expand, and the upside in the manufacturing gauge is particularly welcome given its prolonged downturn. A slight cooling in the services sector could help maintain the disinflation trend.

Initial jobless claims dropped to the lowest level in a month, with 201,000 claims recorded, below every estimate economists provided.

If you want to build a recession case for the U.S. economy, today's data suggests you are looking in all the wrong places.

Oil markets

Oil prices rose despite a slightly larger build in crude inventories to consensus. However, gasoline supplied to the U.S. market, which serves as a measure of demand, saw a modest increase of 32,000 barrels per day (bpd) to reach 8.2 million bpd, serving as the bullish offset. In addition, oil price increases could also be attributed to robust US PMI data and a resilient U.S. job market, which indicated strength in the economy and sustained demand for oil. This week, the stronger-than-expected U.S. economic data walks back some of last week's U.S. stagflation (sticky inflation and fall in retail sales) concerns that have been limiting oil price gains.