Posted by George Smith, CFA, CAIA, CIPM, Portfolio Strategist
Thursday, August 24, 2023
Additional content provided by Kent Cullinane, Analyst
- Much was riding on NVIDIA’s earnings report last night and the company didn’t disappoint with better-than-expected top and bottom line results and a big guidance raise.
After having its price targets ratcheted up seemingly on a daily basis, much was riding on the NVIDIA’s (NVDA) earnings report following yesterday’s close. The company didn’t disappoint and reported sales and earnings results that blew past expectations, fueled in large part by artificial intelligence (AI) driven sales.
NVDA’s blowout first quarter earnings season guidance propelled this AI star to even greater stardom to the point where there’s been an ongoing debate on whether NVDA is even more important to the broad trajectory of markets than Federal Reserve (Fed) Chair Jerome Powell’s comments at Jackson Hole this Friday.
NVDA is the largest producer of graphics processing units (GPU) that power AI applications, like ChatGPT, in the world, making them one of the few “pure-play” large-cap AI stocks out there and a bellwether for the rapidly expanding AI industry.
As shown in the chart below, NVDA has outperformed the broader technology sector and stock market by a significant margin this year, rising 222% (as of yesterdays close) compared to the technology sector’s still impressive 38% increase and the S&P 500’s 17% recovery. NVDA is the top performing stock in the S&P 500 year to date and has contributed meaningfully to the S&P’s rally this year. The semiconductor industry as a whole has benefitted tremendously from the hype surrounding AI, along with easing inflation and a constructive technical backdrop.
Year-to-date performance of the largest stocks by market cap in the semiconductor industry has been driven more by price multiple expansion than actual earnings growth. For example, NVDA, the largest stock in the Philly SOXX Semiconductor Index, at more than a 9% weighting, currently trades at a forward price-to-earnings (PE) ratio of over 56, much higher than the broader technology sector’s PE of 29 and the S&P’s PE of 23 (based on 2023 estimates). As shown in the chart below, when breaking the technology sector into quintiles by PE, the stocks in the top quintile (highest PE) trade at significantly higher valuations than the remaining four quintiles, hence having an outsized contribution to the elevated sector PE.
So where does the technology sector go from here?
Technology stocks have underperformed the market in July and August thus far, but remain well-ahead on a year-to-date basis. Earnings continue to exceed expectations with the technology sector reporting a 1.1% increase in year-over-year earnings for Q2 compared to consensus estimates of a 3.5% decrease as of June 30. Additionally, more than 90% of stocks in the technology sector have reported earnings that have exceeded results, beating the 5-year average of 77% of stocks in the S&P.
While AI-fueled optimism continues to drive the sector higher, there is also technical support within the sector. Nearly 80% of stocks in the technology sector are trading above their 200-day moving averages, well above the S&P’s 59%. In addition, the relative trend of the technology sector compared to the S&P 500 remains positive, with the sector hovering above support levels from December 2021 highs. However, the MACD indicator is trending lower, with the indicator now below neutral, signifying potential for short-term weakness ahead.
Our Strategic and Tactical Asset Allocation Committee (STAAC) remains neutral on the technology sector, as lofty valuations and risk of additional upside to interest rates keep us from a more positive view despite insatiable demand for AI chips and an ongoing uptrend in the sector’s relative performance despite the latest pullback. We continue to monitor the evolving landscape for AI while watching for potentially lower interest rates or another leg up in earnings, which could help keep valuations in check.
IMPORTANT DISCLOSURES
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.
Not Insured by FDIC/NCUA or Any Other Government Agency | Not Bank/Credit Union Deposits or Obligations | Not Bank/Credit Union Guaranteed | May Lose Value
