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Market Update
February 26, 2024

On The Cusp Of Something New

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Week Ending, 23rd February, 2024

A busy week for newsflow! We had:

  • Disclosure of the full, Fed minutes.
  • Flash Activity (manufacturing & services) data for February.
  • A lowering of -0.25% of the 5y LPR (Loan Prime Rate) by the PBoC (China’s Central Bank) to try and boost property purchases.
  • No signs of any let-up in the US job market as evidenced by the latest weekly jobless claims.
  • New highs set by Japanese stocks, with more to come even though they trade on just 14.1X forward PE (ratio of Price to earnings).
  • A scorching AI-led tech rally with NIVIDIA leading the way and setting new market-cap highs for itself!

Some thoughts on the above:

The Fed minutes not only reinforced the press statement issued by Powell at the end of the last FOMC (Fed Open Market Committee) but went a bit further in terms of expressing its determination to not do anything hasty until there are the clearest signs inflation is under control. It’s clear, the FOMC members do not feel we are there yet! The key points were (1) there’s no hurry to cut rates, (2) they expressed both optimism AND caution on inflation, (3) there would be no rate cuts until there was greater confidence inflation was receding, (4) they noted the risks of easing rates too quickly before inflation falls to 2%, (5) they judged the policy rate was likely at its peak for this tightening cycle. Taken altogether, it doesn’t strike me they are convinced they have won the battle against inflation. They are waiting for it to fall to 2% and remain data-dependent!

February Flash activity data (think of it as an advance reading, hence the word “flash” that is based on some 85% to 90% of all survey respondents received while final data follows about a week later) showed manufacturing activity for February showed some slight weakening. That said, there are signs of a pickup amongst some big European laggards such as France. The US also recorded strong gains. Services however remains robust with readings over 50 (indication expansion). France, US, UK and the EU Peripheries all registered increases in manufacturing; Japan, Australia, Germany all registered further declines.

While China lowered its 5-year LPR (a key mortgage rate setter), I think the benefit of this is more marginal at this stage – it will help some but, really, it’s more of an attempt to reassure buyers. For me, by far the bigger development was the announcement of a special mechanism to inject liquidity into the property development sector to the tune of over $17bn. It is known as Project Whitelist. The mechanism involves adjusting repayment plans and / or extending maturities. So far, 214 cities have set up the special mechanism recommending over 5,300 projects to banks. Of this, just over $4bn has been issued covering 162 projects in 57 cities. Banks that decline any loans to this “whitelist” must explain their decisions to the financial regulators. It goes on to report that the list distressed developers have also been granted loans by banks, local governments and financial institutions! I think this is the first, specifically targeted step directed at injecting life back into the flagging property developer sector. Continuing doubts over property developers - and their perceived inability to complete projects – is the real reason consumers are lacking confidence on the property market, not the level of interest rates. Otherwise, don’t expect Beijing to be in a hurry – it seems quite content to let things pick up slowly – which they are. To smooth over volatility, they have introduced – at least temporarily – a ban on major institutions reducing their equity holdings at the open and close of each trading day on a net basis. That will help – though it’s not a panacea.

The jobless claims showed a reduction again of people claiming benefits. It’s a good lead indicator and, when taken together with nonfarm payrolls and total jobs listed, points to a strong job market in the US. That’s a headache for the Fed – as shown in the minutes.

The Japanese stock market has been and will probably continue on tear! It set a new high – and it took 35 years to do it! Corporate earnings remain robust with the Nikkei and Topix up over 10% YTD. Banking, Electronics and Consumer stocks have led the way. As commented on last week, corporate Japan benefits from a weak Yen. Consumers don’t because it means rising prices. Governor Ueda warned that the inflation battle is not over as rising wages are going to be felt. He seems quite bent on removing Yield Curve Control (a cap on how far government bond yields can rise). If he does, then logically the Yen should rally. For an overseas investor, that a further boost on returns. Meanwhile, Japan is still cheap on just a 14.1X forward PE ration. The S&P 500 is well over 20X. The tech sector is close to 30X.

…..which brings me on to AI, NIVIDIA (NVD) and the gang. NVD reported blowout results: net income was up +769% y/y ($4.93 per share from $0.57 per share). Revenues rose +265% y/y based on strong sales of its AI chips for servers – especially its “Hopper” chips such as the H100. I have been asked several times – is this a bubble, does one buy, is this all over again, etc?

Here’s my response:

NVD’s share of the global AI chip market is estimated to be anywhere between 70% to 90%. I am no geek but, apparently, their chips are the mother of all chips to drive high-powered graphics with which you can train AI models and put them to work. This, I am told, puts them in a league of almost their own. If this level market dominance is correct (i.e. 70% to 90%), then the first question is who are their competitors and how close are they to catching up? Intel and AMD are amongst the rivals and have both made advances. So too are Microsoft, Google, Amazon, Meta. NVD is a specialist AI graphics accelerator (as is AMD) while Intel is a jack-of-all-trades. There’s a risk AND a benefit to this. Right now, while they have a lead time in the global rollout of AI which itself is in its early stages of take-off, it’s a big advantage…..and they are well ahead of their rivals, for now. Lead times, in tech, are deceptive. You can be a laggard one moment and, on the flip of a coin, suddenly you can be ahead. However, given their sheer scale of dominance in terms of market share, it will be a good two years for its nearest competitors to eat into this share in a material way. This assumes of course NVD doesn’t go down the pan through bad management. Inventing the tech is one thing – taking market share away from your biggest rival is another! It has taken NVD many years to get to this stage so I don’t think they suffer from a lack of patience and strategy. At some point, they will see a slowdown in the growth of their revenues and earnings as the market for AI-led chips matures – or changes. We’re only at the beginning of the global AI rollout so that’s some way off.

The valuation stats are eye-watering based on what we know of the market in general: its market cap is $1.94tn, it trades on a forward PE ratio of 43.70X (twice that of the tech sector. Generally, 10X to 25X is considered good), its forward Price/Sales ratio is 23.76X (usually, anything over 4 is a warning sign a stock is overvalued) and its Price to Book ratio is 45.14 (under 3 is generally considered desirable). These metrics are far higher than the US Tech sector. They are in a different world if you compare them to the S&P 500. Valuations estimated by various entities as to its “fair” valuation are illustrated below (courtesy of Currently, the stock price is just shy of $790 per share. Peter Lynch (ex-Magellan Fund) had its fair value at $191 per share which would imply a downside of over -75%! A comparison to the era is totally unreasonable because back then so many companies were nothing more than a cash burn and grossly unprofitable. By contrast, so many of today’s tech names are smashing it in terms of profitability. NVD is no exception. When a fundamental investor buys a stock, they do so taking account of (1) its brand, (2) its relevance to the market, (3) its size/dominance, (4) its financial position/stability and (5) its growth prospects. What no one has fathomed yet is the full power of AI and how it’s going to change the way we work at all levels of society. It will impact consumers and businesses at so many different levels – productivity, work enhancement, lifestyle changes, resource management, etc. How does one even begin to quantify this? AND TO MAKE IT HAPPEN, WE NEED THE LIKES OF NVIDIA!

In summary, I have no clue whether it’s overvalued, undervalued, fairly-valued. When we are on the cusp of something new, valuations are almost irrelevant. Try and look to the future and ask yourselves how big this thing (AI) can be. If you believe it’s massive, then NVD has got legs – as do its rivals. Just how volatile it will be is entirely a function of macro. Markets do not mind steady changes (inflation, rates, FX). What they can’t stomach are dramatic changes. This is what happened in Feb. 2022 when Russia invaded Ukraine and inflation spiralled. So, geopolitics aside, as long as the PATH of rates and inflation are steady, AI plays will be a hedge for portfolios for the productivity an efficiency they bring.


Source: LSEG Datastream/Fathom Consulting
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