3 Global Ideas in Search of Alpha

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0:56What can derail the NVIDIA train? Hi, everyone. Welcome to the Real Vision Daily Briefing. with me today is Eric Johnston, head of equity derivatives and cross asset at Cancer Fitzgerald. Hey, Eric, great to see you again. Maggie, how are you? I'm doing well. Yeah, it's a good day to be on. We're just talking about how busy you are because Eric looks across all asset markets and there's been so much going on. I really feel like it started even at the turn of the year, Eric, and it's just continued through. But we've been talking about volatile markets, good for business, a lot of opportunity, a lot of risk to sort through.

1:29But today, it looked like all the opportunity. US stocks up across the board, new records for S &P 500 and NASDAQ, led once again by NVIDIA. I mean, the momentum around this stock is incredible. Up nearly 4.5 % today and into the close, it was like jumping 0.5 % every half hour because I was watching it. 15.5 % gain in the last five days. And if you look over the last year, what it's like almost 300%. I mean, these numbers are just crazy. Um, I joked with you, do you, is this the thing that everyone asks you at cocktail parties? And yeah, it is. It is. I mean, can it continue? That's what we all want to know.

2:10I mean, can this thing continue like this? Uh, so it can continue, you know, they're, they're fundamentally, it's, it's very much like nothing we've really seen before in terms of the, you know, it's not just the stock price, but the exponential growth that's happening in their fundamentals, right? If you look at their revenues two years ago, right, they were doing the, you know, 25 million, their revenues have gone up exponentially. And there's a case to be made that this type of growth over the next, you know, six to 12 months, you know, the pace will slow down. But the magnitude of the recent beats can continue because they are the absolute epicenter of the AI infrastructure build out.

2:59And not in the entire semi-space to a lesser degree, but as part of this build out. And I think that as the market looks at AI, there are some things that are more certain than others. And right now we're in this build out of these models. And that is highly likely to continue for a long time to come. The variability will come around the products, the productivity gains, the impact on society. All these questions are huge unknowns. But for right now, it's all about the build, right? And so governments, the cloud providers, and everyone else are buying or gobbling up these chips. And at the moment, they're really the only game in town.

3:55And so they have 76 % gross margins, which is pretty epic. And they're probably going to be the only game in town for some period of time to come. Wow. I love the idea of the infrastructure build out because there is a tendency, and we always talk about recency bias, and it wasn't that recent. But for investors, everybody kind of thinks, oh, we're seeing these extraordinary games. It's like the dot-com blow up. That's what comes up all the time, right? It's all of these gains. It has to be a bubble. It feels like a bubble. But when you're talking about something like infrastructure build out and revenues that have increased so much, those are some fundamentals under what looks like it's also a really powerful momentum stock.

4:43That's a kind of different narrative to think about. Yes. I mean, there are some similarities, but mostly there's a lot of differences between this and the late 90s. Um, so I think it's, you know, when you, when your sample set of is so small of anything that's even close to this, right. You, the, the first thing you're going to go to is, um, is the.com, uh, bubble. Um, but you know, I think that this is, this is a much different situation because, you know, as you said, the fundamentals and the earnings are actually there as opposed to, you know, in the late nineties, some of the multiples were a lot higher and many of these companies were not profitable.

5:29And so, within the market currently, there is clearly speculation going on and there are companies that likely have prices and price to earnings ratios and expectations that are far out of bounds. But I think for someone like NVIDIA, the fundamentals have been there. And I think the real question going forward is, number one is, it's getting to be somewhat of a crowded trade, right? The momentum factor in the equity markets is crowded and it's very overbought. And so that does present from pure supply demand perspective, that does create some short-term risks where if you do get a term, then that could have some legs.

6:23So one thing I would point out is if you look at NVIDIA options. So right now, if you go three months out, the calls, the 25 Delta calls are about five vol points higher than the 25 Delta puts. That is highly, highly unusual, right? Because typically when you think about where the gap move can happen in a stock or in the market, it's typically the downside. And hence you're going to have people are going to pay up for that protection. In this case, right, the crash risk that people are worried about or are betting on is to the upside. And so that kind of gives you a sense. And if you look at a chart, it's the highest, about the highest it's ever been.

7:08If you, that gives you a sense around how people are currently thinking about it. And when, no matter what the stock is, whenever you get people that are thinking that in all in one direction, that does create, that does create a risk. Yeah, so that's really interesting. So the bull case, which seems like it's a little bit of a longer time horizon, the fundamentals that are supporting this, there are some fundamentals and there is a narrative, you know, about this infrastructure bull out, but from maybe a shorter term perspective or from a technical perspective, there is reason to worry that you could see that it's just that everyone's on the same page.

7:48Whenever that happens, if there is a down move, you're going to get a lot of people caught out on that. Is that what you're telling us? That's right. Exactly. And it could be nothing related to the fundamentals. It could be one small data point from another semi-company or something that's out there. Jensen gives a keynote speech on March 18th, which is expected to be very positive. But expectations are certainly very high. And so in the short term, that would be something that one can think about. And then, of course, in the long term, there's questions around, will they be able to maintain these types of margins?

8:28Will new competitors come in? And the big variable that we really don't know is the surge of buying going on of their chips to go into the data centers. it's very hard to predict, right? The path from here, right? We've had all these surge in orders, but what is that going to look like in six, 12 months? Maybe the surge continues, maybe you get some sort of, you know, slowdown along the way. Yeah, maybe they're hoarding, right? Maybe they're stealing from the future because they're worried about supply chains. I mean, we've seen that, you know. Yeah, that's a question. Yeah, that's certainly a question that's out there.

9:11But certainly, yeah, the fundamentals have certainly been there in a big way. Hey, everyone. We're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing. Join over 5 ,000 attendees for the largest AI event in Asia at Super AI Singapore, June 5th and 6th, 2024. Raoul Pal, Benedict Evans, Balaji Srinivasan, Edward Snowden, and over 150 others will join the industry's most influential to explore and unveil the next wave of transformative AI technologies. Singapore will become a vibrant AI hub for a week from June 3rd through June 9th with over 150 side events that will make for unparalleled networking opportunities.

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11:15So it doesn't, I mean, we never give financial advice. We can't tell anybody what to do because we don't know their risk profile and when they need the money, et cetera, with that disclaimer out, does it seem wise to take profits when you see this kind of momentum or is that kind of the wrong strategy? And do you need to think about sort of leaning into momentum? How do you think about dealing with a stock that's moving like this? So, you know, for NVIDIA specifically, you know, that's a hard question. That's a hard question for me to answer. I don't have a strong view. What I would say is that the momentum factor in general, I think is quite crowded right now.

12:00And you're seeing that, for example, in the SMH. SMH has gone parabolic. NVIDIA is 25 % of it. But semis in general have sort of gone also you know, parabolic. And to me, that presents some risk. And I think when the SMH does turn, the sell-off is going to be sharp, where because it is a crowded trade, and all of a sudden, it's going to be, you know, ticking up, ticking up, and then one data point can come out, and you can see a quick move lower. So I would be, you know, wary of that, for sure. It's a semiconductor ETF for those of you who are following. So when we're looking at, I want to stick with tech for just a minute because we all know the MAG-7, right?

12:51There's all this keen interest and there was a lot of worry, but it's been fueling this huge record ride. We've seen a change now because Apple, Tesla really struggling. Are we in a different environment now? Are we going to see a divergence between this sort of AI-related stocks and then maybe some of these other mega caps? Is that notable? Is it something we should be paying attention to? How are you thinking about Apple in particular? Yes. Yeah, I think it's a massive change. You know, our view has been, we've been bullish on the MAG-5 and have been negative on Apple and Tesla. I actually am of the view right now that Apple is a short-term buy, which we can get into.

13:34But correlation in the market overall has fallen sharply. It's down to about 22. And so there is dispersion that is going on across the equity markets, which we're very happy about, presents opportunities. But dispersion has gone up a lot. And so it's not only within the MAG-7, but really within the whole market, people are picking winners and losers. And so you have these secular growth themes, whether it be GLP-1, whether it be AI, or whether it is related to fiscal spending, so some of the CHIPS Act, et cetera. Then on the other side of the coin, you have those companies that don't have those secular tailwinds and maybe have higher debt levels, are smaller cap, are more cyclical, present more risk, or are selling products, particularly in tech, that could get, with a buying of the technology infrastructure in AI, could actually take away from spending elsewhere.

14:40And they could be hurt by that. So there's really a bifurcation going on in the market. To your question about the Mag 7, Apple has been under significant pressure. And they haven't come out with a AI strategy yet. They're scheduled to at the Worldwide Developers Conference in June. And the multiple has been very high, considering that their growth has been zero for about a year and a half. Their estimates have come down. And yet their multiple has been in the high 20s. And so finally, that has now re-rated lower. And so now you're talking about a multiple that's more 24, 25. They at least have announced when they're going to be talking about their AI strategy.

15:23But there's a lot of questions around, can they really have an impact? Are they really late to party? And then the kicker with Apple is that they've had data points coming out of China have been very weak. And Huawei taking share, there's some nationalism going on there and other factors. But the magnitude, I'll give you one stat, the magnitude of the sell-off is pretty historic. So if you look at Apple relative to the S &P 500, which that's the way we look at it, the RSI is down to about 12. So over the course of the last 30 years of Apple being around, that is the lowest RSI in its history. And just to give you a magnitude of how much of an underperformance this really has been from Apple.

16:23Wow. That's interesting. And that's going to make some people think, but it's hard, yeah, because we feel like we're in this environment where there is so much that's new coming with AI that, you know, can you keep getting the repeats of the past? A lot of people are kind of thinking about that Or is this a change in the guard? You know, that's a tough one. Yeah, it's also, I would also say Google has also been an underperformer. And, you know, there's going to be, when we talk about products, that's where, and I was mentioning earlier, the variability. We don't know what search is going to look like in, you know, one to five years.

17:02And Google has over 90 % market share in search and it's obviously quite profitable. And so now the market is starting to discount their, hit their multiple because of this uncertainty. Yeah, because the existential question is just because they're late, are they late and it's the beginning of a different era or are they just waiting and they're gonna get it really right because they have the right management and then they end up having the kind of killer, the killer app or the killer functionality and they've just been working on it behind their Silicon Valley walls. You know, that's the thing that I think we all flip around on, especially since both of them have a history of doing exactly that.

17:45But who knows, right? That's the crystal ball we don't have. When we're talking about dispersion and broadening out, I'm wondering, so obviously we've been talking a lot about tech and about MAG-5. It's where the momentum has been. A lot of people sitting in those names or have some exposure to them in their portfolios or their retirement. What about the broader S &P 500 or even the Russell? I think that you've been watching that. And we'll have people on who say that is an indicator for them, the performance of the Russell. And if they're participating or if they're moving higher, would you expect to see in the picking of winners and losers and all of that now, would you expect to see opportunity there?

18:29or is that just because of maybe the rate environment tricky? How do you think about the broader stock market? So I think around the Russell, we made a tactical bullish call about, I guess about two weeks ago. But I think it's really going to be a trading vehicle and can get trading bounces. But I don't think it's going to be something that you're going to want to be just persistently long relative to the S &P 500. So there's still a large portion of the Russell that is not profitable. It has higher exposure to financials, has higher leverage. And we can get into this, but I think that rates are gonna stay higher than the market would hope for, or that would be something that would be helpful to the IWM.

19:32So if you're going to have higher rates, which I think we are going to have, and you potentially have some cyclicality risk, then IWM is probably not where you want to be. Having said that, why do we make the tactical case? Because it's been a huge laggard. People are looking for, in a market where everything's rallying, people look at, okay, what hasn't moved yet? And also what is less crowded? So if we were to get a momentum unwind that I was speaking about earlier, that would actually benefit something like the IWM because that's not where positioning is crowded. That's not where people have piled into.

20:13And that could actually be helpful to the Russell 2000. Yeah. I think it's a great point about the leverage and the rate environment. So we do have employment numbers tomorrow, what is the rate backdrop? I mean, do you think that we had Powell saying today, you know, inflation's moved lower than we thought it was going to be going to, and that's been a surprise. He did keep the door open for rate cuts, but, you know, he keeps emphasizing that they're not in a hurry. What makes you think they're going to, they're going to be higher for longer? So it's interesting that he was, you know, fairly, you know, on the margin, dovish today.

20:49If you think about what's going on right now, If you look at inflation break-evens, so five-year inflation break-evens, which are right now about 2.4%, they're close to a one-year high. And you have financial conditions that are the easiest that we've seen in the last couple of years. You have gotten a couple inflationary data points, only one month, but that showed an uptick. And you still have an unemployment rate that's 3.7%. And you have an equity market that is showing a lot of exuberance with new highs, Bitcoin going parabolic, et cetera. So if someone just told you that environment and you didn't know anything else about what the Fed has said or what the rates market is pricing in, to me, it's not necessarily an environment that you would expect the Fed to be cutting rates.

21:51And so while they're talking about how restrictive policy is right now, as inflation comes down, that gap is widening, totally get that. But I think there is risk that as they go into cut mode, which they made very clearly, the first cut is really important because it's not just going to be one, right? It's a signal of a trend that once you get that going and you have this exuberant markets right now, that could be a very tough combination that I think presents risk of inflation moving up again. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

22:39Which is why it was interesting that he kept the door open on rate cuts. He could have easily just said nothing and just said, we're going to watch and be patient, which would have been a bit more hawkish. So I was surprised that he even introduced that idea because that's been the issue all along. You bring up a good point, though. We have seen stocks going up, Bitcoin going up, bond yields were down after Powell's comment. That doesn't seem consistent. Somewhere along the line, or can all these things rally at the same time? What does that tell us? Yes. So it's an everything rally. So literally everything from bonds to the other end of the spectrum, crypto, gold, stocks, credit is at its tights absorbing a significant amount of supply year to date.

23:31So it's been a buy everything. And I think that one of the factors that could account for that is that there is an expectation, which is certainly our view, that QT is likely going to tail off, that they're going to wind it down, start talking about it, possibly or likely in the March meeting, and that they will wind down QT over the course of the next six months. And so I think that winding QT to zero, the next step, not right away, but the next step is launching QE. Because ultimately, the reason why they are going to be ending QT is not because they necessarily want to, but because they have to based on the supply and demand dynamics that are out there in the debt market.

24:22And so I think that down the road, the market is also thinking not only are they going to end that, but they're going to have to start buying bonds to monetize the debt. So this is not end of QT, start of QE because of the economy or because of some financial break. This is because they have to manage the debt. That's right. I mean, the choices for getting our debt under control, raising taxes, cutting spending, or monetizing. And I think it's pretty clear that the first two are just not going to happen. Not anytime soon. So you're - No less than an election year. Right. Correct. Election year and certainly both platforms of the two leading candidates at the moment are for anything around touching entitlements or touching spending or anything of the sort.

25:15So it's going to have to be, the buyer is going to have to be the Fed because, you know, certainly our interest costs continue to rise. They will continue to rise. And there's no cut to spending. So against that backdrop, there is no reason to think anything has a pullback, right? Because we're looking at, and if we layer on that for global watchers a feeling that China is going to be forced to stimulate their economy, then why would any of these assets go down? So that's, I think, you know, over the long, that's a very fair question. And now these asset prices would go up in nominal dollars, would go, you know, would not perform as well in real dollars.

26:05But I think in the shorter term, you know, one of the things that you do have to worry about for equity markets are, there's a number of things, but one of them is the multiple. And the multiple has, you know, the average multiple is it's been in the mid teens going back since the beginning, the beginning of time. And it's been very rare cases where you've seen multiples of 21 times or greater, which is where we are now on forward earnings. And so going back to your point about the dot-com bubble is, you know, in 1997, we were about the same multiple as we are now. And so if you bought in 1997, you clearly did very well in 98, 99.

26:55But assuming that one just held on, which most people did, five years later, your investment was actually down in nominal dollars and was down a lot in real dollars five years later. This is exactly the fear that every single person listening has, Eric. You just explained why we all obsess. And I was joking, Eric's tortured at cocktail parties because this is the thing everybody wants to ask him. But it's true, I can imagine, because this is our fear that people are looking at these really nice gains in their retirement and just think this thing could go and I could just lose it all when I'm going to need it.

27:37Yes. I mean, even if we, and then, you know, it's always hard to know when to get out. So let's say that the S &P goes to, 5 ,700, 6 ,000 in the next year, year and a half. If we then have a correction, let's say is 20%, which is a normal sort of correction, especially with the multiples that we'd be talking about when we get to getting at 5 ,700 or 6 ,000, you get a 20 % correction from 6 ,000 and you're down to 4 ,800. And all of a sudden, you look up and your three-year returns while you had some years where you felt really good, ultimately, your returns three years later from where we are today are not good.

28:24And the reason was because your starting point was this 21 times multiple. Right now, we're trading, if you assume 10 % earnings growth in 24, 10 % in 25, and 10 % in 26. And I said, that's guaranteed. We're trading at 17 and a half times 2026 numbers. And so that's what really presents the risk where if you get any sort of shock, economy rolling over, et cetera, that that's where you really have risk. So that was my very next question. This is such a fascinating conversation because to understand the rally, you have to put the fundamentals aside and really focus on this monetization of the debt because that's what's driving it.

29:11The problem is you can't forget about the fundamentals because it sounds like what you're saying, fundamentals and or a shock could kind of force themselves back into the equation to be the catalyst for some kind of sell-off or some kind of pullback. That's right. And I think we're also, we are late cycle. Now, late cycle doesn't mean it can't go on for another two years. But when you think about where the unemployment rate is, it's at the bottom of the historic range. This is the second longest period of time that we've been... Longest period of time, we've been under 4 % for this long. And the output gap in the economy is we're basically at a full economy.