Market Talk: 'Nvidia will deliver' on sky-high expectations | REUTERS

Key Concepts

• Nvidia's Market Dominance: Nvidia's significant influence on the S&P 500 and the broader market due to its AI chip leadership.
• AI Stock Valuations: Discussion on the high valuations of AI-focused companies and the recent sell-off.
• Investor Sentiment: Market jitters and anticipation surrounding Nvidia's earnings report.
• Hyperscalers: Major cloud providers investing heavily in AI infrastructure.
• Idiosyncratic AI Trade: The idea that not all AI stocks will perform similarly.
• Market Correction vs. Pullback: Distinguishing between a healthy correction and a significant market downturn.

Nvidia's Earnings and Market Impact

The market is keenly awaiting Nvidia's earnings report, as the company is now the world's first $5 trillion company. Nvidia is responsible for 7% of the S&P 500's value, indicating that its performance will heavily influence the overall market direction. There is significant pressure on Nvidia to demonstrate revenue that justifies its substantial investments in Artificial Intelligence (AI). The Nasdaq has already seen a decline of approximately 6% from its October high, reflecting market jitters.

Kathleen Brooks, Research Director at XTB, highlights the immense pressure on Nvidia. Despite expectations of over $55 billion in revenue for the previous quarter (a more than 50% year-over-year increase), the stock has faced pressure alongside other AI stocks leading up to the report. Brooks believes Nvidia will deliver strong results, but the market's interpretation of these results will be crucial.

Investor Actions and Fundamental Strength

The sale of stakes in Nvidia by prominent investors like SoftBank and Peter Thiel has raised questions. Brooks suggests that the market may have overreacted to these sales. She explains that SoftBank, which held a $5 billion stake, and Thiel, having invested early, were sitting on substantial profits and are likely seeking opportunities in smaller AI firms that could potentially rival Nvidia or achieve significant success. This profit-taking by early investors does not necessarily indicate fundamental weaknesses in Nvidia. Brooks anticipates that Nvidia's upcoming earnings will reaffirm its fundamental strength, given its dominant position in the AI chip market and positive sales outlook, supported by hyperscalers pledging to purchase more chips through 2026.

AI Stock Valuations and Market Divergence

Concerns about the high valuations of AI-focused stocks have been prevalent. Brooks attributes the recent sell-off, which began slowly after Palantir's earnings release last month, to fears surrounding these inflated valuations. While some AI companies, like Palantir, had extremely high valuations (over 230 times earnings for the next year), Nvidia's valuation of around 30 times earnings is considered more reasonable, though still higher than the market average.

This has led to a divergence in the AI trade:

• Nvidia: Has remained relatively flat.
• Meta and Microsoft: Have shown significant weakness, despite being major hyperscalers heavily investing in AI.
• Alphabet: Is outperforming due to a more sustainable and reasonable approach to AI investment, with successes like its Gemini AI model. Warren Buffett's investment in Google further supports this.

Brooks concludes that the AI trade is not dead, but concerns about valuations are leading to a more idiosyncratic performance among AI stocks, meaning they will not all move in the same direction.

Investor Outlook and Market Correction

The question of whether investors should brace for a broader market pullback hinges significantly on Nvidia's report. Brooks is confident that Nvidia will deliver a strong report, potentially exceeding expectations and providing robust forward guidance. However, a weak report or shaky guidance from Nvidia could trigger a significant pullback.

Brooks believes that the majority of the market's downward move might be over, especially for stronger companies. However, companies that rely on significant debt for infrastructure spending, such as Meta and Oracle, along with Palantir, are likely to face an uphill battle to regain their previous highs. She does not foresee significant obstacles preventing Nvidia from recovering and rallying towards the end of the year, as it remains the primary provider for AI infrastructure buildouts.

Regarding the "frothiness" in the market, Brooks agrees with sentiments like those from David Salomon at Goldman Sachs, suggesting that a correction is healthy. She notes that the market is currently experiencing a correction, with the Nasdaq down about 5% in November. The market's tendency to move too far too fast, exemplified by companies with P/E ratios exceeding 200, indicates that the AI theme may have become overheated. A pullback serves as a brake, preventing excessive market movements. Brooks anticipates that fundamentals will reassert themselves as the second half of November and December progress.