NVIDIA - The Moment of Truth Is Approaching, America vs. Europe - The Winner Is...

Chart of the Week

The chart shows the market capitalization of the three major technology stocks Apple, Microsoft, and Alphabet (Google) compared to the total market capitalization of the markets in the Eurozone (SX5E), the United Kingdom (UKX), and Switzerland (SMI).

Why This Matters

We are often asked why we invest 60–70% of assets in America. The chart above gives a sense of the enormous size differences between the markets. Three of the best-known stocks in the U.S. have a larger market capitalization than the entire European market!

The global equity index MSCI World, which is weighted by market capitalization, has a U.S. weighting of approximately 70%.

But in terms of returns as well, an overweight position in the U.S. is worthwhile. Almost all technological development in the internet and IT sectors is dominated by U.S. companies.

The chart compares stock valuations in America (S&P 500, P/E) with valuations in Europe (dark blue representing the index weighting and light blue representing an equal-weighted version). Over the past 35 years, Europe has never been as undervalued relative to America as it is today — by approximately 35%.

The chart shows the impressive outperformance of the U.S. (S&P 500, purple) compared to Europe (EURO STOXX, blue) over the past 15 years. Those who did not have U.S. investments in their portfolio earned very little.

Is this now the time for a trend reversal? Will Europe become the outperformer of the next 20 years? We have our doubts. The war in Ukraine continues to create major uncertainty, and the entire current trend in artificial intelligence is being driven almost entirely by the U.S.

In classical economics, a company’s value is calculated by discounting all future profits back to the present. That is why we never tire of emphasizing how important the development of corporate earnings is.

The chart shows “earnings revisions” — in other words, changes in analysts’ expectations for corporate earnings. In the U.S., these expectations have been continuously revised upward over the past two years (blue line), whereas in Europe (green line) and China (orange line), they have been steadily revised downward.

A catalyst is needed for a trend reversal to occur. At the moment, however, we do not see such a catalyst. We are therefore maintaining our high weighting in U.S. investments.

NVIDIA Determines the Direction of the Market

There are two ways to calculate market breadth. One can compare the number of stocks trading above their 200-day moving average with the number trading below it, or, as shown here, compare the usual market-capitalization-weighted S&P 500 with a version in which all 500 stocks are equally weighted.

The result is the same using either calculation method. We are seeing the lowest market breadth since 2009. Typically, declining market breadth is a sign that the trend is reversing.

Last year, and again this year, the U.S. stock market has been dominated by seven stocks that generated nearly all of the returns and currently account for 25% of the S&P 500’s market weighting. And among these seven stocks, one stands out in particular: NVIDIA.

NVIDIA’s stock rose 300% last year and is already up 56% this year.

In 1848, California experienced a massive Gold Rush. Thousands moved to California in search of fortune. Only a few found it and became rich from gold. But those who truly became wealthy were the manufacturers of shovels and tents.

In 1900, Texas experienced an oil boom. Once again, thousands set out in search of fortune, and once again, only a few found success. Those who became wealthy were the barrel manufacturers and transportation companies, because the oil was not consumed where it was extracted.

NVIDIA is the shovel and barrel maker of the artificial intelligence trend. No service provider in the sector can avoid using NVIDIA’s products. They are the best optimized for this purpose.

NVIDIA was long known as a manufacturer of graphics cards for computer gaming. But it soon became clear that this was also exactly the type of computing used for Bitcoin mining. That was the first major trend from which NVIDIA benefited. Then it turned out that these were also precisely the calculations relevant for artificial intelligence computing.

Part of it was certainly luck, but NVIDIA understood these trends and consistently aligned its products toward them at a time when no one else believed in Bitcoin or AI. Now they are reaping the rewards.

NVIDIA is the benchmark for the artificial intelligence trend. On Wednesday after the market closes, the company will publish its financial results for the fourth quarter of 2023 — and perhaps even more importantly, its outlook for 2024. If NVIDIA fails to meet expectations, it could drag down the entire AI industry and potentially trigger a trend reversal in the broader market.

Expectations are extremely high. An EPS of 4.18 is expected. In each of the previous four quarters, NVIDIA exceeded estimates by 25% to 45%. The same is also being expected in the current unofficial estimates — the so-called whisper estimates.

The overall market is currently valued at a P/E ratio of 23.3. Revenue growth of 418% is expected.

NVIDIA is trading at a P/E ratio of 95.8 — meaning nearly 96 times annual earnings. If someone were to buy the entire company today, it would take at least 95 years of current profits to recoup the purchase price. For comparison, 95 years ago, there were no computers, no internet, and no mobile phones.

When Is Too High, Too High?

It is not as though we have never seen something like this before. The chart shows the stock price of Cisco (black) from 1996 to 2002 and the stock price of NVIDIA (red) from 2020 to today.

Cisco was the shovel and barrel maker for the internet era. The entire world had to be connected, and Cisco was the only company with the products to make it happen. Then came what had to come — in 2000, the dot-com bubble burst. Cisco still exists today and remains a highly profitable company. However, an investor who bought at the peak price of 78 in 2000 had to wait 16 years just to break even.

The companies in the energy sector of the S&P 500 supply the entire country with energy. They form the foundation for all economic development. This sector includes companies such as ExxonMobil, Occidental Petroleum, and Chevron. NVIDIA’s market capitalization (blue) is now higher than that of the entire U.S. energy sector (black). Another indication that NVIDIA’s valuation may be excessive.

Optimists counter all of this with the following stock market saying: “The Trend Is Your Friend.” Trends usually last longer than people expect. A typical example is Apple.

NVIDIA’s press conference on Wednesday evening promises to be highly dramatic. Cautious investors may want to buckle up.

If NVIDIA does indeed manage to surprise everyone once again, the artificial intelligence trend could continue for another 3 to 6 months.