The $3.1 trillion monster that took over Wall Street

First it was the “Magnificent Seven” and then the “Fabulous Five”. Now, it seems, there is only “The One”.

Last week’s extraordinary Nvidia result – quarterly sales more than three times those of the previous corresponding period and earnings that were nearly nine times greater – almost single-handedly pulled the entire US market up more than 2 per cent in two days.

Nvidia founder Jensen Huang. The company’s rise was so spectacular, that it raises larger questions about the market and whether we are witnessing a sustainable boom, or a bubble.Credit: Bloomberg

Nvidia’s own sharemarket performance – its shares rose nearly 17 per cent, adding more than $US330 billion ($503 billion) to its market capitalisation, which briefly edged above $US2 trillion ($3.1 trillion) – was spectacular. Indeed, it was so spectacular, that it raises larger questions about the market and whether we are witnessing a sustainable boom, or a bubble.

The distinction between booms and bubbles, of course, can only be made with hindsight. The dot-com bubble of the 2000s, for instance, was once regarded as a transformative period for technology, industries and economies, but it ended abruptly and rather badly, with few survivors.

The Magnificent Seven stocks that largely drove the US market up nearly 20 per cent last year – Google’s parent Alphabet, Amazon, Apple, Facebook’s parent Meta, Microsoft, Tesla and Nvidia – are, however, quite unlike the companies that led the dot-com era.

Those tended to have no current earnings but wildly optimistic expectations of what they might generate in future. The Magnificent Seven are all highly profitable, have demonstrated track records of growing their revenues and profits and have dominant positions in their sectors.

Tesla and Apple’s recent slightly disappointing performance may have shrunken the leading group of mega techs to five and Nvidia might have supercharged their out-performance single-handedly this year – its shares are up about 64 per cent so far this year and almost 240 per cent over the past 12 months – but these are all very substantial and established growth companies.

What made the sizzle and intensity of expectation around Nvidia’s quarterly report last week so intense was the conviction that this would be a decisive moment, not just for the valuations of the mega techs, but for the market more broadly.

Ever since the launch of OpenAI’s ChatGPT late in 2022, there has been a growing layer to valuations of those big tech stocks most engaged in artificial intelligence that reflects the perceived potential of AI to transform industries and economies.

Nvidia, as the dominant provider of the AI chips used to train the large language models that underpin AI applications – it has a market share of more than 80 per cent – is the bellwether stock for the potential AI revolution. Its result, and foreshadowing of more to come, was a validation for those convinced AI will deliver massive gains for those companies best positioned to exploit it.

Nvidia’s remarkable sharemarket performance sent Wall Street surging. Credit: Bloomberg

If AI is as transformative as its most ardent true believers claim, trillions of dollars will have to be spent on the infrastructure to support its widespread deployment and trillions more by companies to take advantage of it.

Nvidia, whose dominance of the advanced chips used in video gaming provided it with a massive first-mover advantage, has been able to translate that sector leadership into dramatic increases in revenue and massive margins.

That advantage, however, may not be permanent.

The cost of Nvidia’s chips, and the tightness of supply – Nvidia can’t produce the chips fast enough to meet the growth in demand, hence its massive margins – is providing incentives for competitors like AMD and Intel and customers like Microsoft, Amazon, OpenAI and Google to develop their own chips. They are each spending billions to do so.

Anything other than a smooth transition to the AI era priced in could have unpleasant consequences for investors.

Moreover, most of the focus on AI to date has been on the training of the large language models that could be regarded as the infrastructure for AI. The next phase in AI’s development – and the next generation of chips required – will be is using those models to solve problems.

The chips needed for what is described by the sector as “AI inference” are less complex and cheaper to produce than those that have given Nvidia its dominance, although Nvidia has said that about 40 per cent of the data centre revenue that powered its December quarter performance came from AI inference.

Even if it is in a leadership position for those chips today, it will face a lot more competition from competitors both very large and start-ups and that will erode some of its margins and its growth rate.

If the pie is big enough – if AI does produce profound changes in industries and economies – then distributing smaller slices more widely shouldn’t undermine a market whose levels rest on the capitalisation of the early impacts of AI on those that will provide its infrastructure.

As Nvidia’s Jensen Huang said last week, a whole new industry and a new way of computing is being formed. There ought to be vast amounts of value to share.

What we don’t know, and what will only be known with hindsight, is if investors have factored in too much of that prospective value too early and then inflated their valuations further with an assumption that today’s relatively high-interest rate environment will be displaced by a low-rate environment the very near future. (Valuations that are predicated on long-term growth assumptions, as is usually the case with the mega techs, are acutely sensitive to changes to interest rates.)

Anything other than a smooth transition to the AI era priced in could have unpleasant consequences for investors.

There have been a lot of references to the “Nifty Fifty” sharemarket boom of the 1960s (regarded as a better comparator than the dot-com bubble) in commentary of the Nvidia phenomenon.

Dizzy multiples of earnings were applied to a big cohort of largely established and solidly profitable consumer product companies. Their share prices soared – and then plunged when inflation and interest rates rose.

Many of the Nifty Fifty and their investors were badly hit by a 60 per cent plunge in their collective value in the early to mid-1970s even though the core of the cohort – companies ike Coca-Cola, Proctor and Gamble, McDonald’s, IBM and Walt Disney – while dumped by investors during the 1970s sell-off, have, over the past half century, more than validated the growth assumptions embedded in the multiplies of earnings awarded to them in the late 1960s.

Timing, and external circumstances, play large roles in performance of participants in financial markets. AI, and Nvidia, look like glittering growth stories but how that growth should be valued today is not only in the eye of the beholder but hostage to both the way the AI story unfolds and the evolution of the macroeconomic settings along the way.

The Business Briefing newsletter delivers major stories, exclusive coverage and expert opinion. Sign up to get it every weekday morning.