Issue 100: NVDA Disappoints

This Week’s Highlights

• High bar for earnings finally hits NVDA
  Many investors saw last week’s second-quarter earnings report by AI chipmaker Nvidia as a test for this year’s tech rally. For most firms, 122% year-over-year sales growth would earn an A+, but with expectations perhaps a little too high, it turned out to be a failing grade.
• July PCE index furthers case for cuts
  Analysts got precisely what they expected with the BEA’s Friday release of data on personal consumption expenditures, as the Fed’s favored inflation measure came in spot-on consensus forecasts at 2.5% year-over-year: one more data point supporting September easing.
• July home sales index hits record low
  Even with mortgage rates falling as a Fed pivot approaches, tight supply and high prices make affordability a major issue for homebuyers. That’s hitting activity hard, according to the National Association of Realtors, whose home sales index hit its lowest-ever level in July.

The CIO’s Take:

• Although our models still like NVDA—and we’ve been rewarded for taking that view over the last year—the firm has arguably been too successful in convincing investors and analysts of its seemingly limitless potential. The stock’s reaction to overexuberant investors’ disappointment is a good reminder that fundamentals and valuations matter.
• We were happy to see PCE inflation predictably falling, in line with economists’ expectations. Despite consumers’ apparent concerns over a hard landing, we still like the US economy’s chances. CME Group data suggest that yield traders increasingly see it our way, with market-implied chances of a drastic 50-bps cut in September down to 30%.
• Looking ahead to a world after Fed cuts set in, we continue checking in on the US housing market for signs that declining mortgage rates might bring more buyers into the market. Unfortunately for sellers—but as we predicted back in mid-August—that’s a tall order as long as supply remains tight and prices show no signs of easing.

NVDA Disappoints

All eyes on Q2 earnings
Going into last week, it wasn’t a potentially decisive PCE inflation report captivating traders’ attention—though we will have something to say about that in the next section—but rather a single company’s quarterly earnings: Nvidia, which reported after the bell on Wednesday. Unfortunately, despite sales rising 122% year-over-year, net income beating analysts’ forecasts, and the company’s announcement of a $50 billion share buyback, Wall Street apparently was not impressed, lopping over $150 billion off the firm’s market cap by the end of the week.

Expectations too high
To put things into perspective, even after taking a beating in the second half of last week’s trading, NVDA was still up 141% year-to-date, amounting to a $1.7 trillion increase in the company’s value. Indeed, the stock’s stellar performance over the last two years is a big part of the problem. The market has baked so much future growth into its price that it’s become increasingly hard for CEO Jensen Huang to deliver investors upside surprises. Along those lines, the size of beats has been declining and guidance—though still improving—isn’t jumping quite like in quarters past.

Growth inevitably slowing
Of course, this dynamic isn’t unique to Nvidia—it’s just garnering much more attention because of the company’s high profile. The bigger its sales and profits get, the harder it is to keep up insane growth rates witnessed in prior quarters. Is 122% growth in revenue a bad thing? Obviously not! But when you’ve posted three consecutive quarters of growth in excess of 200% (see below), it’s easy to see how this quarter’s otherwise envious number might feel underwhelming to investors.

Investors have concerns
Setting aside the issue of reality vs. expectations, there are legitimate risks looming over Nvidia’s future growth. Huang confirmed reported production delays afflicting its next-generation Blackwell chips, but played it down in light of continued demand for its current-generation processors. A bigger concern, in our view, is that customers like Microsoft, Meta, Amazon, and Alphabet—a group with expected capex of $200 billion in 2024—start to rein in spending on AI infrastructure. Sales in China are another risk, with economic weakness, regulations, and local competition weighing.

Consensus still bullish
Still, it’s hard to count the stock out. While we believe generative AI has been generally overhyped, there’s no doubt the technology has tremendous value, and Nvidia dominates production of the chips driving that theme, with low risk of any real competition in the near future. We’re not alone in recognizing that: Wall Street analysts took the quarter’s results in stride, actually raising price targets on NVDA shares, with 65 buys, 8 holds, and no sell recommendations among analysts surveyed by Bloomberg as of last Friday.

Data for the Fed

July PCE out last Friday
Next to Nvidia’s earnings, the biggest data point of the week was surely the Bureau of Economic Analysis’ Friday release of July’s Personal Consumption Expenditure (PCE) price index—which tracks a broader set of goods and services, with more frequent updates of the weights assigned to items in that basket—well known as the Fed’s preferred gauge of inflation. Not surprisingly, given how close the central bank seems to a policy pivot, traders were looking for a reading to confirm disinflation’s continued progress toward the Fed’s 2% target.

Prices still seen softening
Unlike Nvidia’s earnings, the PCE data did not disappoint, coming in 0.2% higher, month-over-month, and 2.5% higher, year-over-year, both dead on consensus estimates. Core PCE, which the Fed sees as an even better measure of inflation, given its exclusion of volatile food and energy prices, also increased by 0.2% from June, corresponding to a 2.6% year-over-year rise. While significantly above the Fed’s 2% target, that number was actually a tick below economists’ forecasts of a 2.7% annual increase. Consumer spending also rose 0.5%, as expected.

Insights from UMich survey
It’s not just actual inflation that matters to the Fed, interestingly: the central bank also frets over how much inflation consumers expect, since expectations can ultimately shape reality. On Friday, the University of Michigan gave us a window into consumers’ minds with its monthly survey of American households. That report showed August one-year inflation expectations down to 2.8%—the prior estimate was 2.9% (see below).

That’s more good news for an FOMC concerned expectations for hot prices could become ingrained. Consumer sentiment, also depicted above, came in at 67.9 versus a preliminary reading of 67.8. Despite that upward revision, this was still slightly short of economists’ expectation, at 68: a reflection of consumers’ continuing concern over a cooling economy.

Consumers having doubts
We often focus on how the Fed is likely to perceive macro information, but the plot above nicely illustrates how average Americans have experienced the last couple years of data. Clearly the last few months have reinforced a sense that inflation is coming down—slowly, to be sure—toward the Fed’s 2% target. But in confidence readings, you can also see that burst of excitement we observed at the turn of the year gradually giving way to anxiety, as consumers grow anxious over stretched budgets and the possibility economic softening could beget a hard landing.

Sinking Home Sales

Mortgage rates keep falling
Earlier last month, we checked in on the mortgage market, where rates were falling amidst growing optimism the Fed was gearing up to slash interest rates going into the fourth quarter. Since then, the average 30-year fixed rate on conventional mortgages has ticked down further, clocking in at 6.35% last week. According to Freddie Mac, that was the lowest rate since mid-May 2023. Assuming we keep seeing data—like last week’s PCE inflation—validating the ‘soft landing’ narrative, it’s reasonable to expect rates will keep coming down.

Home sales hit record low
Prospective homebuyers are, of course, closely following data on mortgage rates, and one might also reasonably expect as rates come down, purchase activity will pick up. Unfortunately, as we predicted in our last commentary on the US housing market, lower mortgage rates have not translated into more sales. To the contrary, the National Association of Realtors (NAR) reported on Thursday that its index of pending home sales in the US fell 5.5% month-over-month in July, marking a new low for the index since the NAR began publishing it in 2001 (see below).

In fact, the market was expecting a 0.5% increase in the index—presumably based on the intuition about how falling rates impact home sales we just described—making that record-setting decline an even bigger surprise. Year-over-year, home sales were 8.5% lower, the greatest decline experienced since last January. Home sales fell in all four US geographic regions tracked by the index.

Poor affordability to blame
Based on the data, it’s clear summer wasn’t the “recovery season” most analysts expected, despite labor markets’ modest cooling and still-decent consumer sentiment. Consistent with our outlook last month, NAR Chief Economist Lawrence Yun put softening sales activity down to tight supply and high prices. Affordability remains a challenge, underscored last Tuesday by the Case–Shiller index of US home prices, which set a new record, up 5.4% through June of this year. We imagine many hopeful homebuyers are also thinking ahead to better deals on rates after Fed cuts commence.