All is calm ahead of Nvidia

The AI sell off has paused ahead of Nvidia’s much anticipated earnings release later tonight. The Nasdaq is higher by 1.5% and the S&P 500 by nearly 1% on Wednesday as market angst about tech stock valuations starts to ease.

The top performers in the S&P 500 include communications and tech, with a large jump in Google shares, which are higher by 6%. Nvidia’s share price is surging into tonight’s earnings report, and is up by 3.2%. Tesla and Broadcom are also higher, and Oracle is higher by nearly 3% today, as market concerns over valuations and capex spend are put to bed for now.

Corrections are normal at this stage in rally

Concerns about an AI bubble have been over-blown in our view, and the price action in November, which has included a large sell off in tech stocks, is completely normal. Investor anxiety has been high in recent days, however, this is not a rout. Global stocks have had one of the strongest 6-month runs since the 1990s, so a correction at this stage is completely normal.

AI needs to get sensible to rally into year end

Of course, the frothiest parts of the market are hit first: crypto has been decimated, so have some of the hyperscalers including  Meta. Mark Zuckerburg’s plans to use AI to generate digital communities for users, complete with AI bot friends, is whacky and it is no wonder that investors are questioning if it’s worth the billions of dollars in capex, and the debt issuance to achieve this. Added to this, some AI stocks’ valuations, including Palantir and Tesla, are too high. When CEOs like Elon Musk get potential $1 trillion pay deals, this also causes investors to take notice, and potentially to scale back positions. AI needs to get sensible to rally into year end.  

The froth has come off the market, the question now is, will there be more to come? Palantir, whose earnings report in October triggered investor angst over stretched valuations, has seen its 12-month forward P/E ratio fall from over 230 to 177 today. This is still high, and the upside for Palantir’s stock price could still be limited as investors’ animal spirits are scaled back.

Hyperscalers cannot be Nvidia’s only demand source

However, Nvidia’s P/E ratio, at 31 times future earnings, looks like a steal. It’s expected monster earnings report tonight could also trigger a deeper recovery, especially if demand remains strong. However, future demand cannot be made up of hyperscalers alone. For the AI trade to come roaring back into year end, investors will want to see a range of clients fill their boosts with Nvidia chips including sovereigns, and a broader array of cloud providers.

$55.1bn in revenue for last quarter is spectacular, and if Nvidia can deliver sales growth in the 55% mark, and margins in the 70-75% range, then all may be forgiven, and the AI trade can roll on.

It’s worrying when one company means so much to so many, but that is the world we live in.