Market Thoughts for Barron’s Interview

Summary

1. We became short-term bullish on August 18th
2. Our favorite stocks are AI related including $NVDA $INTC $GOOGL $AMZN $META $ORCL.
3. Student loan repayments restarting in October and “excess savings” being depleted will make Q4 more challenging
4. Inflation, the Fed & Bond Yields may stay higher for longer than expected
5. The S&P valuations is on the higher side at 21x versus 19x when inflation has been at these levels
6. Our fund is meant to be an “all weather” fund. The fund was profitable last year with the S&P total return down 18% but also this year with the S&P up 19%. We were also up in the month of August despite the 2% decline in the S&P.

Recent Events

On August 18th, we posted how we were covering over half our shorts and expected a short-term bounce based on the bond market stabilizing. In fact the S&P did bottom on 8/18 at 4370 and 10 year yields peaked the next day at 4.34%. This past week saw a 4 day rally in the S&P through (8/30) after having no consecutive up days in the month of August.
https://twitter.com/DanielTNiles/status/1692581872625398214?s=20

The S&P is up 3% from its close on 8/18 with Nasdaq up 6% while 10 year yields have now dropped by 17 bps from 4.34% at their peak to 4.17%.
Jerome Powell’s speech on Friday 8/25 was marginally positive followed by data of a slowing labor market this past week while PCE readings were inline with expectations

1. On Tuesday, JOLTS showed job openings at their lowest levels since March of 2021 on Tuesday along with lower than expected consumer confidence
2. On Wednesday, ADP said private employers added 177K jobs this month vs 200K expected
3. Core PCE on Thursday was inline with expectations at 4.2% though up from 4.1% in June
4. Bond yields after reaching levels last seen in 2008 on August 19th, dropped sharply this past week on lowered expectations of the Fed needing to raise rates

Stock Picks

Our favorite large cap technology names with an AI angle to them.

1. Nvidia (THE AI enabler in chips) & 15% below its historical PE for its forward 12 months
2. Intel (foundry biz gaining an AI customer like Amazon or Nvidia before year-end and trading at just ~1.4x book value excluding MobileEye)
3. Google (#3 AI cloud enabler with more information than anyone else for training AI and trades at a 24x PE)
4. Amazon (#1 AI cloud enabler & retail profitability ramping)
5. Meta (AI beneficiary for video recommendations & ad placements and trades at just a 22x PE)
6. ORCL (becoming a credible #4 cloud infrastructure competitor and at 22x PE, it trades near a market multiple of 21x vs Microsoft at 31x)

 
$NVDA beat revs by 10% in their April quarter and guided 53% above the street for their July quarter when they reported on May 24th. This was the fuel for a surge of 8% on the S&P from ~4200 to ~4400 from (5/24-8/23) with NVDA up 54% during that time and Nasdaq up 10%. 
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The AI optimism remains alive and well as NVDA on August 23rd beat revenue consensus for their April quarter by 21% and guided revenues 27% above the street for their October quarter. Since Nvidia’s latest results, the S&P has gained 2% from ~4400 to ~4500 from (8/23-9/1) with NVDA up 3% during that time and Nasdaq up 2%. 
The good news is that Nvidia’s stock on a forward twelve months basis is actually ~15% below its average PE over the past 5-7 years as estimates have gone up faster than the stock. We still think we are in the early innings of the ramp in AI but obviously at some point in 2024, supply will catch up to demand and the double and triple ordering we are seeing from customers today will have to normalize. 
 
But just because every technology company says AI 50 times on their earnings calls does not mean that all companies are going to benefit. “In the year of efficiency” to borrow a term from Mark Zuckerberg, spending on AI is in many cases coming out of spending in other areas. We would note that most big ad agencies have missed their revenue forecasts. Most big networking related companies (such as Juniper, Commscope, Nokia, Ericsson) have missed (with the exception of Arista.) Many big IT services vendors have missed like Accenture, IBM and Infosys. And now even software security seems to be feeling the pinch as seen by Fortinet results. Even in semiconductors, TSMC, the foundry for Nvidia, had to cut their numbers while AMD also saw an estimate cut. Even Microsoft which is a big shareholder in OpenAI which developed ChatGPT saw their Azure estimates get cut slightly. Market multiples are too high for stocks not to feel pressure if this continues.
 
We think our top AI picks will be able to withstand the economic pressure between now and year-end on discretionary spending

1. Student loan repayments for 40M restarting after being on hold for 3 years.
2. ~$1 trillion in excess savings (vs $2.5T at Covid peak) will be nearly gone by year-end.

Inflation, the Fed, Bond Yields & Valuation

With solid US GDP growth, higher energy prices and a still solid labor market, inflation & therefore the Fed and 10 year treasury yields may remain higher than investors expect:

1. The easiest inflation compares of 9.1% peak CPI in June of 2022 are behind us.
2. Oil has surged from a low of $67 in mid-June to over $80 today putting upward pressure on the most important commodity for inflation. 
3. Wage growth remains at 4.4% with 50% more job openings than people unemployed and unemployment at a low 3.5%. 
4. Japan moving their YCC target to 100 bps also puts upward pressure on global bond yields. Their 10 year yields are at the highest levels since 2014 at 0.65% and were flattish to negative from 2016 to 2021 which acted like an anchor on bond yields across the globe.
5. The Fed also has to issue over $1 trillion of Treasuries in Q3 and $850 billion in 4Q23 as it rebuilds cash reserves from the debt ceiling crisis and supports greater than expected gov’t deficits. This should put upward pressure on bond yields.

 
19x is the average multiple for the S&P over the past 70 years when headline CPI is between 2-3% vs a 21x multiple today with the CPI at 3%. So valuations are on the higher side.