Growth Stocks: NVIDIA

Shares of Nvidia (NVDA.US) staged a strong intraday rally of 14% on Thursday after new CPI data showed a more moderate-than-expected rise in October that heralds a possible "dovish response from the Federal Reserve on the same level."

Recent gains in stocks as a result of mitigation strategies taken against recently imposed export restrictions on China are also good news, underscoring investor confidence in Nvidia's long-term prospects.

However, growing macroeconomic uncertainties remain a major drag on near-term stock performance, with renewed concerns that a downturn in the cryptocurrency market will add complexity to the outlook for Nvidia shares.

The following analysis will review some of the latest developments in Nvidia's operating, macro, and regulatory environment, and gauge their respective implications for near-term stock performance.

The better-than-expected CPI report for October sparked a rally in stocks on Thursday (Nov 10), with the Nasdaq Tech Index (US100) adding nearly 1$ trillion (yes, 1$ trillion) in market capitalization over the course of a session. Nvidia was one of the biggest gainers, posting an intraday rally of 14% to outperform the PHLX Semiconductor Aggregate Index (SOX).

Signs of easing financial conditions are currently a central factor in investor sentiment, which is borne out by the strong intraday gains seen during the Thursday session. However, the overall market climate remains fragile as the Fed's tightening path has not yet peaked,
And for Nvidia specifically, the company also faces operational challenges from worsening geopolitical tensions, though its recent rollout of A800 GPUs for its Chinese market-only data centers in compliance with US regulatory requirements is a step in the right direction. But renewed contagion fears from crypto market behavior are now raising fresh concerns about the near-term performance of Nvidia's GPU segment, which is already reeling from a broader correction in global PC demand this year.

However, regardless of near-term and industry-specific macroeconomic headwinds, Nvidia's strong one-day gain on Thursday underscores the strength of investor confidence in the stock, given the upside potential of the underlying business to benefit from long-term advances stemming from its huge market share in the high-growth vertical integration of high-performance PCs (or HPCs) to breakthrough innovations in AI for both autonomous vehicles and the metaverse. With market conditions still choppy in the coming months, the latest rally in Nvidia stock is likely to falter, creating more compelling entry opportunities than its current valuation.

 

Macroeconomic Summary

The Federal Reserve maintained a hawkish tone after raising 75 bps for the fourth time in a row this year in November, as inflation remains far from the desired 2% target. With October inflation better than expected, market participants are becoming more optimistic that the worst of this year's rapid price rises is over, fueling desires for a more dovish monetary policy path and therefore an improvement in the financial conditions that are to come.

Headline CPI for October came in at 7.7%, below the consensus median estimate of 7.9%, marking the “small year-on-year advance since the start of the year”. Meanwhile, core inflation, which strips out the impact of food and energy price volatility, came in at 6.3%, also a welcome improvement from the consensus forecast of 6.5 %. Stocks rose across the board in response to softer-than-expected inflation as it points to the first signs of a structural slowdown in price increases the Federal Reserve has been looking for before considering easing its plans in monetary policy adjustment. The latest improvement in price increases supports the Fed's planned 50bp rate hike in December, possibly marking the first slowdown in the pace of tightening since June.

However, any chance of a sustained rebound on signs of easing inflation and a potential Fed pivot remains remote. At 7.7%, current price increases remain well short of the Fed's desired 2% target, which aligns with Fed Chairman Jerome Powell's comment earlier this month that the terminal rate could end up being higher than previously anticipated as the tightening continues in tight territory to lock in inflation. The comments were further reinforced by Dallas Fed President Lorie Logan on Thursday (November 10):

“The current economic conditions are complex, but they can be summed up in five words: inflation is too high. Inflation is not only well above the FOMC's 2 percent target, but as aggregate demand continues to outpace supply, inflation has repeatedly been higher than forecasters expected. The CPI [Consumer Price Index ] data this morning was a welcome relief, but there is still a long way to go.”

Source: Federal Reserve Bank of Dallas

What this effectively means is that Nvidia's demand environment will continue to weaken, affecting its near-term fundamental prospects. The valuation outlook for the shares in the coming months will also remain volatile due to changes in interest rates, which has a direct impact on the multiples that dictate the future outlook value of the underlying business.

Specifically, on the fundamental front, continued rate hikes and “too high” inflation imply tighter financial conditions in the coming months, especially as the continued deterioration in consumer confidence this year now materializes in a real decline in consumer purchasing power. Average personal savings in the US have declined from 3.5% in the second quarter to 3.1% in the third, a far cry from the “pre-COVID five-year average of about 7.7%”. Consumers are also increasingly relying on credit card debt to sustain spending as purchasing power wanes due to rising inflation: Consumer credit card debt is now approaching the "previous peak to the pandemic of $916 billion in September," while "real median hourly earnings declined in October and were down 2.8% from a year earlier...falling every month since April 2021" after adjusting for inflation.

For Nvidia specifically, the weakening in consumer spending is largely reflected in significant underperformance in its consumer-focused gaming segment during the fiscal second quarter. And conditions are likely to have remained subdued or worsened in the fiscal third quarter, as global PC demand continued to decline rapidly while discretionary purchases of consumer electronics remained stagnant.

And on the business front, previously seen as relatively resilient to recession compared to the consumer end-market, spending has also become more conscious based on feedback during the latest third-quarter earnings season. Even resilient corporate cloud investments are showing signs of a slowdown or lag on rising macroeconomic uncertainties, which risks weakening data center investments in the near term, hurting performance in the flagship segment of cloud computing. Nvidia.

And on the valuation front, continued rate hikes are likely to weigh more heavily on multiples. The value of high-growth companies like Nvidia, with much of its prospects still "far in the future," is becoming increasingly susceptible to deep discounting as a result of rising capital costs. These do not recall that any rally in Nvidia stock seen as a result of the latest October inflation will likely fade as the double whammy of valuation and fundamental challenges continue in the coming months.

 

GPU Implications for A800 Data Centers

Moving from broader market headwinds, Nvidia also faces industry-specific challenges stemming from the intensification of US-China relations of late. The latest US government ban on exports of advanced semiconductor technologies to China further complicates the operating environment for chipmakers like Nvidia, which is already reeling from slumping demand this year. . The company had previously reiterated that it does not expect a material impact on its business as a result of the recently imposed restrictions, although the implementation of such an export ban could result in a $400 million drag on fiscal third quarter results.

In the latest development, Nvidia has confirmed the production of A800 data center GPUs made exclusively for the Chinese market in response to US regulatory requirements. The A800 chips will be a drop-in replacement for the A100, which exports to China has been effectively prohibited. The A800 chips, which are also based on Nvidia's Ampere architecture, will include three variants that offer the same specifications as the A100 chips. However, the implemented "NVIDIA NVLink" technology, which enables "high-speed and seamless communication between each GPU" within a system to facilitate the computing demands of increasingly complex HPC and AI workloads, will be reduced from the standard 600 GBps for the A100 to 400 GBps for the A800.

The A800 received US regulatory clearance for export to China, with the processing speed of non-programmable hardware to exceed the 400 GBps limit and thus "limiting its usefulness" in HPC applications to restrict China's military advances. However, the company has yet to provide any immediate relief from restricted sales of upcoming H100 Grace data center CPUs to China as a result of the new rules, which are also based on next-generation NVLink technology capable of at least 1.5 times more performance than the existing one. Which are amp based processors.

 

Valuation

Market consensus gives Nvidia a base-case 12-month price target of around $150 and a bull-case 12-month price target of $160 as a result of recently imposed export restrictions, plus to consider macroeconomic challenges. And the recent relief brought by the introduction of A800-only chips to the Chinese market, the biggest source of demand for semiconductors, is seen as a positive development to support the stock's potential jump beyond the base case price target and focus. towards the short-term bullish case. This is further corroborated by the shares intraday jumping as much as 4% to hit the $150 level on Nov 8 following the A800 chip announcement which started rolling out in the fiscal third quarter, which was organic to sentiment. investor sentiment on the news, even setting aside any positive macro developments.

However, the complete elimination of Chinese demand for Nvidia's best-selling A100 data center GPUs and H100 data center CPUs will continue to be a drag on the company's short-term fundamental performance. China remains the largest buyer of chips, and with Nvidia heavily reliant on HPC/data center sales to offset the near-term downturn in its consumer-focused segments, the company is still missing out on a share of the market share that it would otherwise have been able to capitalize on were it not for the new rules imposed. However, the market sees the A800 as a positive development that will not only provide partial relief to Nvidia's near-term fundamental performance, but also an indicator of a potential equivalent to the company's new foray into data center CPUs. data with its “Hopper” architecture. This is seen as a likely implication for a potential recovery of revenue losses that were previously thought to be permanent due to US-imposed export restrictions, which would boon near-term valuation prospects from Nvidia.

 

Implications of a renewed bad cryto sentiment

Persistent cryptocurrency headwinds generate another glut that is harder to measure in Nvidia's short-term performance. Recall that an undisclosed portion of Nvidia's gaming segment sales is driven by demand for GPUs for cryptocurrency mining, which saw a material slowdown this year after the demise of Luna/Terra (UST-USD/LUNC-USD/ LUNA-USD) in May, as well as Ethereum's “The Merge” that took place in September.

While cryptocurrencies saw price relief in late October, hopes of avoiding a crypto winter were dashed by the latest to go, the FTX bankruptcy. It has been a tumultuous week for cryptocurrencies. The dispute escalated this past weekend between Binance (BNB-USD) founder and CEO Changpeng "CZ" Zhao and FTX founder and CEO Sam Bankman-Fried following the former's decision to liquidate their FTTcoins (FTT-USD) holdings of the latter, had quickly become a dispute. A liquidity crisis for FTX, which then looked like there would be a bailout by Binance. And within 24 hours, the deal fell through with Binance withdrawing from the non-binding bailout agreement and FTX declaring bankruptcy. Contagion fears are also spreading like wildfire again, with BlockFi being the latest to present an FTX-like situation.

Cryptocurrencies have plunged this week as a result of the latest drama unfolding in real time within the digital asset industry. Even Thursday's relief rally due to easing inflation signals failed to restore confidence in the risky asset, with Bitcoin prices dipping below $15,500 at one point. Many Bitcoin miners have already sold their coins or mining equipment to raise the cash needed to weather the crypto winter, with some expansion efforts even halted as a precaution against mounting liquidity pressures:

While the latest launch of Nvidia's A800 chips and the broader market rally on signs of lower inflation this week have largely overshadowed potential contagion risks to demand for its GPUs for gaming and cryptocurrency mining, , the latest correction in the crypto market is seen as a new challenge in the chipmaker's already stagnant gaming segment. As mentioned in the previous section, Nvidia's gaming segment has already seen a significant decline in sales as a result of "weakness in Europe related to the war in Ukraine and COVID lockdowns in China" which have been exacerbated. by "lower units and lower ASPs." due to deteriorating macroeconomic conditions and by extension to consumer demand.

Technical analysis

The NVIDIA share has accumulated a 68% drop from its all-time highs at the end of 2021. Highly influenced by the evolution of the crypto market and by consumer expectations. Since the last upward momentum developed in the second quarter, the listed company reached a technical floor identified by the extended retracement of this movement at 161.8% fibo ($108.98 per share).

source: xStation

Since then, the company has returned to key reference levels at $162 per share, the high zone for the second quarter of 2021, from which the movement that triggered the all-time highs of $246 per share continued. This level, which corresponds to 61.8% of the structure, is key and a continuity of increases marks the next target at $192.5 per share, the closest relative maximum level.

 

Final considerations

From what we have been able to observe, it rains and a lot on the roof of Nvidia. The company's near-term operating environment remains challenging, and the market environment for the stock's near-term outlook remains turbulent. While the latest macro development related to signs of declining inflation is a positive point for valuation multiples, it is too early to tell if the related rally is sustainable as price increases remain far from the target of 2% of the Fed. The Fed's continued tightening of monetary policy into tight territory to ensure inflation is under control forever means further deterioration of financial conditions going forward.

And while Nvidia's recent unveiling of the A800 is a step in the right direction to mitigate the impact of fraying US-China relations, there is still work to be done to recoup most of the lost revenue from other business units as a result of the latest export restrictions. The latest cryptocurrency turbulence with FTX is also bringing renewed pressure on the company's gaming segment.

Despite cautious sentiment on Nvidia's near-term prospects, the company remains well-positioned to capitalize on high-growth opportunities driven by organic demand in multiple segments it specifically serves over the long term. Nvidia's offerings remain a critical backbone for nearly every technology used in every environment of daily life today and tomorrow, from HPC applications meeting the demand for cloud computing to AI applications addressing nascent developments such as Autonomous mobility and the metaverse. Firm confidence in the company's long-term optimism is further evidenced by massive gains in Nvidia's stock on Thursday after the CPI. While further declines in the stock are expected in the short term, they are nothing but attractive opportunities with a high risk-reward ratio for the long term going forward.

After Wall Street close on the 16th, Nvidia will report its results. The market expects earnings per share of $0.7, and revenue of $5,784 million. Below the figure for the previous year of $1.17 (-40%) in earnings per share and revenue of $7.100 million (-18.5%).

 

Darío García, EFA
XTB Spain