The Wealth Effect
Economists universally agree that if you give the consumer money, they will spend it. I can recall the government response during the GW Bush Presidency to a period of economic weakness was a $65 billion one-time check sent to the U.S. consumer. Yes, those feel like simpler times. The economists suggested that $65 billion spent quickly, with the money multiplier effect, would stimulate the economy by 3-4x that amount. Recently, we witnessed trillions pumped into consumer bank accounts during a pandemic and a Fed that hardly knows what is the proper neutral interest rate, not stimulative or restrictive? We sit here today with an economy that is doing splendid despite what Chair Powell believes is very restrictive interest rate policy. How can 5% fed funds be restrictive and have no effect on the economy in contraction terms as we witness strong GDP growth, low unemployment and inflation receding? It cannot and I believe there is a mitigating factor at work. The Wealth Effect.
Who cares about all of that Rob, just tell me if Nvidia’s stock will get to $1,000 (or more) and announce a stock split, right? Nvidia has 2.5 billion shares outstanding and the stock had over a $100 swing Friday from top to the after-hours bottom. This means the market capitalization, and wealth of its shareholders, moved over $250 billion on Friday alone. For context, Tesla’s fall from grace from $300 to $175 per share was about a $375 billion drop in market capitalization over a 9 month period. These market capitalization moves are jarring and create disequilibrium’s, at the margin. Take BTC, more than doubling from last year and adding over $600 billion in “market capitalization”. Equally, Paypal had a $300 billion market cap at its pandemic peak and now trades for $63 billion. These are not small amounts of wealth being created (and destroyed) and finding their way into the economy via the Wealth Effect.
Yes, the Fed rate hikes have stunted housing affordability for many, but the offset is higher interest rates have made money market funds great again (MFGA)? Historically such high interest rates would compete favorably with equity market returns, hurting stocks, raising the overall cost of capital for corporations and help the Fed slow down economic growth and price inflation. I am sorry to say but that set of economic “rules” has been blunted by zero interest rate policy for an excessive period of time. Owning stocks, a winner. Owning bonds, a winner. Being in money market cash, a winner. The next recession I predict will occur coincident with the stock market correcting, a self-reinforcing mechanism. The stock market will not predict the recession, as historically it has, but rather cause it—by draining the Wealth Effect from the consumer.
I spend a lot of time modeling companies, thinking about growth rates, margins, their sustainability and how to value different types of businesses. This is old school. This type of work used to give you an edge in knowing the levers that move in determining company and stock performance. Not so much today. Do you remember periods of massive market correction, even as recently as the December 2022 month where the Nasdaq 100 was down 10%? The comments from the masses that they did not want to even look at their account statements. It is during those periods of sheer disgust when fundamental analysis becomes incredibly fruitful. Equally, when you hit inflection points in businesses, such as the slowing growth at many software companies right now, analysis and doing the work proves prescient. At the moment, we remain in a rolling bull market with “narratives” being more important than analysis.
We can debate AI, its future impact on the economy, the winners and losers and even in what inning of this data revolution we are. Irrelevant! What matters right now is the stock trades over 100m shares per day, in wild swings, has a 2x long ETF NVDL and a 1.25x short ETF NVDS and it can literally trade at any price and I could tell you the story that fits the action. It is 5% weighted in the S&P500 and 6.21% in the Nasdaq-100 and investors are being forced to take an overweight or underweight stance in their benchmarking. Throw in the mix massive daily options buying, calls and puts, and you really are entering a daily casino M-F 4:00AM (pre market trading)-8PM (after hours close). I suspect NVDA isn’t “overvalued” at 30 times next year EPS as long as the growth continues and is sustainable. I can see Jensen driving over the cliff with optimism as he has done in the past. Or, perhaps this is an accelerated computing revolution in its infancy? As I wrote last week, I think the answer lies in what the hyper scaler LLM builders do with their GPU farms upon completions and the amount of spend beyond the data center on inferencing such data.
Take Palo Alto, for example. The company missed billings last quarter and the Street (sellside and buyside) were able to dismiss this as a metric to ignore. This quarter they fessed about a new problem known as “spending fatigue” and cut estimates. This is well known by those fundamental analysts (referenced above) as the cockroach theory. Once you see one, there are many behind. At 65x earnings at its peak PANW was absurd for mid teens growth. At 50x currently, it is just silly but not absurd. How about Snowflake? A 23% revenue grower (lowered from 30%) with sudden product transition issues as well as competitive ones still masquerading as a triple digit P/E for what reason other than the market reluctance to see the cockroaches? Know this company Broadcom or Marvell who are “AI beneficiaries” seeing their overall revenue growth less than 10% annually overall trading at software multiples? If not now, then when for the growth rates in AI (cannabilization perhaps)? How about the SPAC, turned AI darling Vertiv Holdings with its 11% revenue growth in 2024 trading at 30x earnings? The company bought a cooling system for AI data centers technology which is less than 2% of sales. If customers pause spending one iota on data centers or timing is thrown off, I predict, the stock could get cut in half. When the bartender is serving up not just glasses half full, but ones filled to the tippy top, look for sharp edges (also known as the exit with one eye on the drink and one on the door).
So, my hot take? The music is still playing in the markets and the economy. I do believe they will move, hand in hand, as my basic premise given the Wealth Effect. I do not have the ability, nor does anyone else to predict what NVDA will do between news cycles or earnings reports. “Some” well followed numb nuts on X are yelling fire that NVDA’s Friday bearish engulfing candle means NVDA (and I guess the market since it is such a big member of the indices) are due for a correction. Perhaps, but maybe only from 4AM til 11AM on Monday? Then, if it reverses, those same prognosticators, throw in Cramer and the like, will claim the market is heading higher. I have no idea! I have a better sense for SNOW and PANW being broken overvalued and over owned stocks than I do guessing if NVDA will go down based on Japanese candlesticks or excess optimism. My advice? Have a view, have a plan (when something is working or stops working), stick to it and adjust if need be. But, look out for the reverse Wealth Effect when the pain does come, as it always does, because the next true down move will be vicious!
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Rob’s Educated Guesses