The U.S. stock market in 2024 has largely been driven by the now-infamous Magnificent 7 (credit as usual to CNBC’s Jim Cramer, ever the showman, for his progressively shifting designations of this set of market leaders over the years): Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla.
Adding some healthy excitement from GLP-1 superstars Eli Lilly and Novo Nordisk, plus the revived fortunes of a reawakening crypto market (helped along by the SEC’s grudging approval of spot bitcoin ETFs), and you have the big factors that have been driving stock market performance, stock market sentiment, and overall investor optimism. (Of course, the positive liquidity backdrop is the most essential component, the sine qua non.)
Many market observers have noted the extent to which the market is concentrated -- in terms of performance, market capitalization, and earnings growth -- on the Magnificent 7.
Source: Deutsche Bank Research
Apple alone generates nearly 60% of the profits of the entire universe of listed French companies, and over 50% of listed German companies. Collectively, the Magnificent 7’s profits are on par with the entire Japanese stock market. They’re positioned more like sovereign nations in terms of financial magnitude and profit generation rather than traditional corporates as we’re accustomed to think of them.
Hence, when these companies report earnings, what they say has greater significance, and not just for the company, but for adjacent businesses, whole industries and economic sectors. This earnings season, the last of the large cap tech stocks to report also happens to be the most anticipated and important.
AI has captured the imagination and enthusiasm of global investors, companies, countries, etc. The race to implement and use AI is a global war against obsolescence and inefficiency, and at this stage Nvidia is the largest arms dealer. Of course, there are many peripheral arms dealers, and many analysts are angling to find and pounce on as-yet unnoticed potential AI leaders. But NVDA towers above them all. In decades of market experience, we have rarely seen a company this well situated with near-monopoly status in an industry undergoing a once-in-a-generation technological shift that promises to transform much of the global economy (and not just the market economy; state-level actors will also be prime customers). This doesn’t mean NVDA can’t falter, or that its stock can’t experience substantial corrections, but it does suggest that such corrections would be opportunities.
The stock trading around NVDA’s earnings influences the overall direction of the stock market. As we began to write this before NVDA’s earnings report, the stock and the tech sector had been getting a pullback as people hedged their positions. A post-earnings dip would not have been surprising, given the stock’s strong performance over the past few months. For a bigger pullback to have occurred, all that would have been required was not enough of a beat, and the level of analyst attention meant that the margin for positive surprises had narrowed. By the time NVDA actually reported earnings yesterday, it looked like the selling in the previous few days had taken lot of speculative froth out of the stock and the AI sector. Then the numbers were reported: and by the time the management conference call ended, the market’s focus shifted to management’s discussion of AI hitting the “tipping point,” and noting that “demand far exceeds supply for next-gen products”. The result is that the frothy trading action has returned and NVDA shares are up 15% this AM. People are realizing this is more than a flash in the pan.
NVDA’s exponential growth in the past five quarters has now caused its market capitalization to exceed the entire gross domestic product of Canada, ranking it just behind MSFT and AAPL -- driven by a mix of investor enthusiasm for AI and solid company performance. Despite this, NVDA’s valuation at 35 times expected CY24E earnings remains attractive compared to its historical range… and considering its anticipated growth.
Source: Bank of America Global Research
This more than just a trading stock, as we anticipate sustained demand from hyperscalers, state actors, and enterprises, and view NVDA’s strategic positioning as robust. At some point, the growth will slow, but the shares should be fundamentally resilient in the face of any short term earnings related volatility.
What’s Up With Emerging Markets? EM Economies and Stock Markets Seem a Mixed Bag… At Best
We recently read an excellent summary from the redoubtable Jonathan Anderson of Emerging Advisors Group -- part of a series on emerging markets -- examining why it is that the large majority of emerging-market economies have failed to make significant economic progress in the last 60 years. It’s sobering information and extremely important for investors to understand, as it makes clear that in most cases, emerging markets are suitable only for tactical trading allocations and not for long-term investment.
Anderson first highlights that on average, emerging economies have not significantly closed the income gap with advanced economies, especially when adjusting for population growth (i.e., considering income per capita); this is exacerbated when the analysis excludes China, which stands as a notable exception due to its remarkable growth. (As we’ve recently written, however, we believe that this “Chinese exceptionalism” will be challenged by political trends and authoritarian retrenchment in the People’s Republic.) Periods of rapid expansion in emerging markets have been followed by stagnation, underscoring the highly cyclical nature of these economies’ growth.
There are very few durable “success stories” among emerging economies. Only a few have managed to sustain high growth rates that would enable them to catch up with Western standards of living. What differentiates the few successful emerging markets from their stagnating counterparts? Anderson believes, and we concur, that exports and property rights are the two key drivers of successful economic development. The importance of exports, particularly industrial exports, is stressed as vital for foreign exchange earnings and growth. Similarly, reforms that strengthen property rights are shown to facilitate private investment and economic expansion.
“Institutional Quality” As A Proxy for the Rule of Law and Property Rights Explains Much of Emerging Markets’ Success and Failure
Source: Emerging Advisors Group
One of the main reasons we have found Prime Minister Narendra Modi’s tenure in India hopeful is precisely his determined focus on these two factors. Slowly -- painfully slowly, it must be said -- he and his allies have pushed forward reforms (1) to make India more attractive as a hub for global manufacturers, and (2) to reduce corruption and make property rights more robust, transparent, and legally reliable. On the other hand, as China has retreated from its commitment to property rights, in favor of authoritarianism and oligarchy, and increased the kind of geopolitical belligerence that tends to stress bilateral trade relationships, we have started to anticipate the decline of the great Chinese growth engine that lifted so many millions out of poverty since the reforms of Deng Xiaoping.
The harsh reality is that most emerging markets are unlikely to achieve high growth rates, due to constraints imposed by geography and history, particularly in these critical areas of manufacturing exports and property rights reform. These constraints significantly limit the potential for many countries to replicate the success stories of the few.
Emerging economies with real potential for long-term development (and investment capital flows) include certain Asian and European countries with more skilled workforces, better demographics, and growing consumer economies; but many in Sub-Saharan Africa, South America, and the Middle East may be too dependent on commodity exports to attract meaningful investment capital flows. Some of the more interesting foreign markets include certain eastern European economies (Hungary, Poland, Czechia, Slovakia, and the Baltic states); and certain east and south Asian economies (Vietnam, Cambodia, Malaysia, Thailand, Indonesia, and of course, India). A few resource economies are positioned, thanks to geography, politics, and policy, to outperform the pack of resource exporters and eventually move up the ladder: countries such as Qatar, the UAE, Oman, and Saudi Arabia. Many of these markets are inaccessible to retail investors in the United States, though for some of them, index ETF products are available, and for a few there are more sector, industry, and theme focused ETF offerings.
Of course, as we noted above, while long-term growth prospects are critical for understanding economic development, they may not directly correlate with short-term investment returns, which are often driven by cyclical factors such as commodity prices and global trade dynamics. In short, most emerging markets are a trade, not an investment -- and it’s likely to remain that way.
Thanks for listening; we welcome your calls and questions.
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