Nvidia, market surge and a bubble burst?

In early January, in a column titled How Asian investors should look at US stocks in 2024, I noted that while 2023 was a great year for American stocks, led by Big Tech, with the S&P 500 up a whopping 26.4%, 2024 might turn out to be an even better year. I argued that US stocks were in a secular bull market powered by earnings growth and the advent of generative AI, or Gen AI.

Six weeks after the markets bottomed in October 2022, the start-up OpenAI unveiled ChatGPT, a Gen AI-powered chatbot. The market narrative changed from fighting inflation with interest rate hikes or impending cuts to prevent a looming recession to a structural shift with a new once-in-a-generation transformation powering a new growth cycle.

If you add dividends, the S&P 500 is up 15.4% ytd, or a 16.2% total return. It is up over 33% from the lows of October last year and up 55%, including dividends from the current cycle’s lows 22 months ago. The Nasdaq 100 is up more than 42% since last October and 86% since its own current cycle’s bottom in late December 2022. Those are clear signposts of a persistent bull run. The 19.4% US market downturn in 2022 now seems like a small bump along the road. The S&P 500 has had a total return of nearly 98% over five years.

Those are clear signposts of a persistent bull run. The 19.4% US market downturn in 2022 now seems like a small bump along the road. S&P 500 has had a total return of nearly 97% over five years, including reinvested dividends.

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Global synchronised bull run

Not since the tech boom in early 2000 has the world seen such a powerful, synchronised global stock market rally. The All-World Index is up 11.5% this year and 19% over the past 12 months. Just in the last few months, almost every major market, including Japan’s benchmark Nikkei 225, India’s barometer Sensex, London’s iconic FTSE index, Brazil’s gauge Bovespa, Australia’s ASX200, Taiwan’s Taiex as well as every major market in the Middle East and Latin America has seen its all-time or multi-year highs.

Before political issues began weighing on them a month ago, France’s CAC, Germany’s DAX, Italy’s IT40 and other European markets also touched all-time highs. The only laggards in the current bull run have been in East Asia — Singapore, Malaysia, Hong Kong, China, and a few esoteric ones, including those in Africa. The Straits Times Index is up 2.8% year-to-date, while Bursa Malaysia KLCI is up 9.5% this year. Neither has been close to their all-time highs in years.

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What is driving the US rally? Powerful corporate earnings. Earnings growth in the first half of this year has been around 9% annualised — way more than most market pundits expected. 78% of S&P 500 firms beat earnings expectations in the last quarter compared to a long-term average of 70% beats. Markets had vastly underestimated corporate America’s will to find a way to keep growing profits. US companies dug deep to find new levers to pull, slash costs, do layoffs, make themselves more efficient, invest in technology, become innovative and grow profit margins. At more than 21%, the average return on equity (ROE) for the components of the S&P 500 is the highest it has been since records for corporate ROE were first collected 100 years ago.

Is the market crazy overpriced? Consensus per share estimates for S&P 500 earnings are at US$255 ($346) this year and over US$280 next year. Earnings growth has been so strong that some pundits believe estimates will likely be revised upwards as the year progresses. With the index at 5,477 on June 26, the market trades at 21 times this year’s earnings and 19.5 times next year’s. That is not expensive if you believe that a broad economic recovery is underway and that we are still in the early innings of a structural bull market.

The new bull market began in October 2022. America deftly skirted a recession last year, with full employment and strong consumer balance sheets in the aftermath of pandemic-era fiscal stimulus, including generous handouts. Consumers and corporations gorged on cheap debt as the US Federal Reserve cut interest rates to near zero. Homeowners re-financed locking in ultra-low 30-year mortgages. Nearly 68% now pay under 3% for their mortgage, and many pay as little as 2.5%, even though the federal funds rate remains 5.25%. US firms also refinanced their existing debts to below 3% and took on more debts for future needs. 

Now, they are sitting on excess cash, which can earn 5% or more in short-term money market funds. Higher rates have only hurt new borrowers, who make up a tiny portion of total lending. And, oh, tech giants Microsoft, Apple and Google’s owner Alphabet are sitting on US$50 billion to US$80 billion in net cash each, despite burgeoning Capex spending, share buybacks and dividends.

So far, the Fed, which targets inflation of 2%, has resisted cutting rates because inflation remains sticky at around 3%. The market is pricing a 25 basis point rate cut this year — down from the seven initially forecast. Smart money on Wall Street is betting that the Fed will cut rates before the November Presidential election and again in December. 

Yet, the reality is that the market has not needed a cut in a long time. For one thing, robust earnings growth has surprised the upside over the last two quarters. Earnings guidance has been slightly less exuberant, but that’s because companies are managing expectations. Add to that strong structural stories — AI and GLP-1 obesity drugs — and you understand why the bull run has been so powerful.

Contrary to popular belief, more rate cuts will spook the market, which may be signs of a weaker economy. Torsten Slok of Apollo Global notes that money market funds will pay US savers US$500 billion this year in dividends, accounting for 2.5% of total consumer spending. Rate cuts will ironically hurt savers who have locked in low mortgage rates and put savings into money market funds.

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Magnet for global capital

How did everyone miss last year’s 26% rally and, again, this year’s 16% return? The stock market has vastly underestimated how corporate America can find a way to grow profits and total shareholder returns. Companies worldwide just can not seem to keep pace with the Microsofts and Apples of the world.

Little wonder, then, that the US has become a magnet for global capital. US stocks represent about 62% of total global market capitalisation, and S&P 500, or the top 500 firms, account for more than 80% of the value of all US stocks. Americans don’t invest in international markets because they can get as much global exposure as US firms. Nearly 42% of S&P 500 total earnings come from outside the US. By buying Asian or European stocks, US investors would essentially be underweighting their better-performing market.

Now, everyone is piling into equities. On June 17, Evercore ISI raised its year-end price target for the S&P 500 to 6,000. Until two weeks ago, its strategist Julian Emanuel was one of Wall Street’s biggest bears who expected the index to end the year at 4,750, or down 15% from current levels. He says US stocks still have plenty of room to run. “Gen AI’s potential in every job and sector is inflecting,” he argues. “[That is against] the backdrop of slowing inflation, a Fed intent on cutting rates and a growth-support Goldilocks” — or a “not too hot, not too cold” — economy. Indeed, he notes, the market is unlikely to take a breather next year and sees another 16.5% gain in 2025 as earnings continue to grow.

The US economy may be doing way better than Goldilocks’ description might suggest. “A Roaring ‘20s macro regime for the US is in play,” UBS said in a report last week. That means “a decade with GDP growth averaging 2.5% or better; inflation of 2% to 3%; 10-year Treasury yield around 4%; and the Federal funds rate at 3% to 4%.”

While various economic and geopolitical risks remain, “we believe solid economic earnings growth, the prospects of lower interest rates, and rising investment in AI should create a supportive backdrop for equities,” UBS said in a report this past week. Meanwhile, Citigroup downgraded European equities due to America’s “substantially higher growth tilt relative to Europe and more defensive nature in episodes of uncertainty,” its strategist Beata Manthey notes. “Potential US dollar strength should be more conducive to US outperformance,” she argues. Money is again flowing out of Europe and back into US stocks.

So, are global stocks in a bubble? And is the bubble about to burst? Nvidia’s huge surge following this month’s 10-for-one stock split has been silly, for sure, but even the AI chip behemoth at its current price is not half as expensive as the networking gear maker Cisco Systems was in early 2000 during the dot-com bubble. Nvidia now trades at 41 times this year’s expected earnings. Internet-era darling Cisco traded at nearly 120 times forward earnings at its peak. Indeed, long before its surge began a year ago, Nvidia stock traded at 60 times forward earnings. Nvidia has diversified from being a mere chip firm to one that controls an expanding and stickier ecosystem that includes services and its CUDA software. Cisco’s problem was that, at its core, it remained a hardware firm.

In a recent report titled How do bull markets end?, Bank of America’s strategist Savita Subramanian notes that narrowing leadership of the market rally, elevated valuations and restrictive monetary policy have worried investors. Of the 10 key indicators that typically precede market peaks, she notes, only 40% have been triggered compared to 70% before market peaks.

In other words, we are still far from the end of the bull market and close to the halfway point in a typical bull market. “We don’t see any reason for the S&P 500 to slow down,” says Thomas Mathews, a strategist with Capital Economics in London who argues that the AI bubble could continue to inflate further in the US and globally. The reason the market has fared so well, he says, is that valuations are not stretched. Should investors sell now and wait until the sale is over? “Remaining invested is generally superior to emotional selling,” Subramanian says. Paris-based Societe Generale believes the current AI-powered rally could mirror the Dotcom bubble, potentially propelling the S&P500 to as high as 6,666. In March 2009, in the aftermath of the financial crisis, the US stocks gauged bottomed out at 666. If the bubble inflates as much as the French bank expects it might,  the market could potentially deliver ten-fold gains to those who went bottom fishing for stocks 15 years ago. Clearly, the bulls are not about to run out of breath just yet.    

Assif Shameen is a technology and business writer based in North America