They say when a butterfly beats its wings, a breeze goes around the world. When Nvidia, the now $1.8tn company at the heart of the artificial intelligence (AI) revolution, reports its results, the response from investors is felt in markets across the globe. Indices that have a strong technology element such as the Nikkei 225 and the Stoxx Europe 600 (which includes chip equipment maker ASML) get lifted up. Those that don’t, don’t.
Nvidia chief executive Jensen Huang’s announcement that revenues had smashed through broker forecasts, that net income had hit $12.3bn – $2bn more than analysts expected – and that the company expects revenue in the current quarter of $24bn with demand showing no sign of slowing, propelled the company to a record valuation, and along with it the S&P 500, the Nikkei and the Stoxx Europe. Part of that exuberant response was relief at the confirmation that the AI phenomenon still has momentum.
The tech effect is not the only reason the Japanese and European markets have risen, but if a portion of stock market returns are now riding on the continuing success of a single company, what does this mean for markets such as London, and highly valued tech shares for the rest of the year? How should investors proceed in a skewed market?
The gnawing concern with big tech companies is that the extraordinary gains of recent years will slip away as easily as they arrived. But the tech darlings tick a lot of boxes – they have solid track records on profits and they invest heavily in R&D. A lot is riding on future AI productivity gains. But unlike in the dotcom era when valuations were propelled skywards in anticipation of transformed revenues, this time Nvidia and Microsoft are already benefiting from the AI phenomenon. They are delivering the tools and processes that could transform other companies’ futures, and their revenues are real, not expected. They are drivers not dreamers.
Analysts find little fault with Nvidia. Bank of America Securities acknowledges the indiscriminate investor “chase for all things AI” but believes it understates the company’s solid execution and earnings per share (EPS) revisions. Plus it sees the valuation as compelling. Our own view as outlined by Arthur Sants is that the company is a world-beater with further to run.
Investors who hold Nvidia and other tech stars shouldn’t worry unduly about staying invested for now. Those who don’t have exposure will assess them as they would any other investment, or wait for moments of weakness in the price.
A different conundrum faces investors in British companies. Apart from a handful of shares such as Rolls-Royce (RR.), few UK listed companies can say investors are falling at their feet. As Standard Chartered boss Bill Winters complained this week, it seems no matter how good the underlying performance, the focus is always on the downside concerns “and the share price is crap”.
Yet for all that Britain is straggling, it is nonetheless ranked third in terms of world investable equity market value, admittedly a long way behind the dominant US, as is second-place-ranked Japan. Capital Economics has noticed that large firms everywhere, including the UK, are increasingly outperforming their peers “despite not being obviously better-placed than the average stock to benefit from the AI revolution” as investors seek quality and profitability.
British firms across the market cap spectrum have lots going for them, not least of which is compellingly attractive valuations, those all-important D attributes (diversification and dividends) and the fact we are heading into an easing rate cycle. Shore Capital notes the ratio of positive surprises to negative ones improved during January, while reactions to any misses – especially on dividends – are probably larger than they should be. Expected weakness in the sterling/dollar exchange rate too should drive gains in firms with substantial earnings from overseas. In fact, the only missing ingredient may be the badly needed resumption of strong capital inflows into UK equities.
Above all, investors should remember two valuable lessons – highlighted in this year’s Global Investment Returns Yearbook by Professors Paul Marsh, Elroy Dimson and Dr Mike Staunton. First, since 1900, equities have outperformed bonds, bills and inflation in every market for which there is a continuous history, and second, the majority of long-run asset returns are earned during easing cycles. The annualised return on US stocks was 9.4 per cent (3.6 per cent for bonds) during easing cycles, compared with just 3.6 per cent (and -0.3 per cent) during hiking cycles, and data for the UK reveals a very similar pattern.
