The Breakdown - Markets Shrug Off Predictable Powell at Jackson Hole

Episode Date: August 26, 2023

Today on The Breakdown, NLW examines Nvidia's massive earnings report as well as Powell's Jackson Hole speech, which, far from last year's shock, was almost exactly as expected. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Friday, August 25th, and today we are doing a macro roundup. Before we get into that, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Well, friends, today the big thing, of course, is Jackson Hole and Powell's speech therein. And so I thought it would be good to put that in a wrapper of the stories that have been going on around and outside of the industry, things that have been impacting traditional markets, to put that news of what Powell said in its proper context.

And for that, I want to start with a story that those of you who have been listening to the AI breakdown will be quite familiar with. That is, of course, Invidia. Nvidia absolutely blew earnings out of the water after the market closed on Wednesday. Their Q2 net income came in at a staggering $6.7 billion, which was a 422% increase from the same quarter last year. Sales growth shot up by 171% on an annualized basis to reach $13.51 billion. Profit came in at $2.70 per share. Now, compared to analyst estimates, those figures represented a 30% beat on profits per share and a 22% beat on sales.

That is massive, especially considering how much hype and anticipation Nvidia had going into this. Now, overnight on Wednesday, shares rocketed up over 6% and hit a high point of $517 per share. That pushed the stock up more than 220% on the year. The company also announced the approval of a ridiculously large $25 billion in buybacks, representing a little over 2% of the total market cap at current prices. Now, this is the second quarter in a row with blowout earnings for Nvidia.

Q1 sales came in at $10.3 billion, outperforming analyst estimates by almost 30% again. During their Q1 report, NVIDIA had guided $11 billion in revenue for Q2, which was an estimate that exceeded analysts' forecasts by over 50%. And it turns out even that was far too conservative. Now, of course, Nvidia's success has been coupled to the rise of AI. The firm's H100 GPU is the top of the line in AI computing,

and it's not particularly close. Individual units range in price between $25,000 and $30,000 with a volume discount, but that isn't even really the highest end product being demanded by the world's largest tech firms. That distinction goes to the HGX box, which is essentially eight H-100s assembled into a single unit of raw AI computing power. Invidia's CEO, Jensen Huang, said of the product line, we call it H-100 as if it's a chip that comes off of a fab, but H-100s go out really as HGX to the world's hyperscalers, and they're really quite large system components.

In fact, the HGX units require a supply chain of 35,000 parts to put together and are sold at the lofty price tag of $299,99 per unit, and even at that price, Nvidia are struggling to keep up. Huang said, we're not shipping close to demand. Now, in a lot of ways, there really has not been anything like this phenomenon in recent memory. Invidia has built their firm around the transition away from GPUs as just being used for graphics processing and video games to focus on more generalized use cases for that style of chip architecture. That transition started many years ago. For example, in 2012, researchers used

NVIDIA chips to achieve previously unheard of image recognition. Since then, the firm began working alongside AI researchers to optimize their chips for the tasks demanded by high-end AI models. They took on an explicit AI focus starting around 2017. That process of iteration has led to Nvidia being the singular leader in AI chips, with a wide gap between them and their nearest competitor. During a recent interview, Huang said, this type of computing doesn't allow for you to just build a chip and customers use it. You've got to build the whole data center. And indeed, the customers seem perfectly willing to spend the high-end dollars for premium performance. One high-profile startup, for example, Inflection AI, recently raised $1.3 billion in funding to finance the purchase

of 22,000 H-100 chips. Mustafa Suleiman, the CEO at Inflection, and previous co-founder at Google DeepMind, said that none of NVIDIA's competitors could offer a comparable solution. Huang broke down the math of his company's product offering like this. He said, If you can reduce the time of training to half on a $5 billion data center, the savings is more than the cost of all the chips. We are the lowest cost solution in the world. This year, Meta has committed to spending $30 billion on data centers, with much of that capital likely to be spent with Nvidia as just one example. Now, Huang was not at all bashful on this week's earnings call, stating that, quote, a new computing era has begun. Many others agreed with him.

Dan Ives from Wedbush called it a 1995 internet moment and said it was the guidance heard around the world. Indeed, so far this year, the market has been responding as if a pair of shifting technology change is underway. Invida is by far the best performer in the S&P 500, and alongside Nvidia, six other big tech firms have been benefiting from the AI enthusiasm as well. This includes meta, Amazon, Apple, Alphabet, which is Google, Microsoft, and Tesla. Together, this group, which has now become known as the Magnificent Seven, have outperformed the S&P 500 index by more than 60% this year. It's not uncommon for a trading day to see more than 90% of returns come from these seven AI leaders. In fact, overall, less than 40% of stocks have outperformed

the broader S&P 500 over the past year. Historically speaking, this narrow range of market breadth is typically only seen in the wake of a massive market downturn, and even then only briefly. The only really comparable era of the last decade when market breadth had maintained such a lopsided slate for so long was in the second half of 2020. During that period, both Etsy and Tesla were added to the index and recorded 300 and 140% returns respectively. The rest of the top performers that year were rounded out by L brands, PayPal, and, of course, Invidia. As another, comparison point. So far this year, the median S&P 500 company is up only 2.34% compared to the 16% returns for the overall index. What's more 228 companies in the index have seen their share price

decline year to date. Now, the high-flying NASDAQ 100 index is a little bit more evenly spread. The index saw the best first half returns in its 52-year history this year, notching up a 30% gain. 32 firms are outperforming the index this year so far, while the bottom quarter declined in price. Now, these periods of narrow returns don't typically proceed a major market correction. However, this situation is somewhat unique. It's rare that multiple companies across a leading sector are so reliant on a single company to supply a critical component. But that's a situation we find ourselves in right now. Now, part of why this matters, of course, is that, as you just heard numbers around, AI has effectively been keeping markets afloat this year. One of the most dramatic moments of this

was during the battle around the U.S. debt ceiling. This is a time that the market should have been, by all accounts, incredibly nervous, significantly wobbly. I mean, hell, we had our debt downgraded when all was said and done. But it couldn't beat out NVIDIA and AI enthusiasm. Now, that wasn't exactly the case yesterday. A lot of the reporting on Thursday was about how concerns over what Jerome Powell would say at Jackson Hole on Friday

were tamping down any particular bump from that NVIDIA earnings beat. You'll remember that the annual Jackson Hole Symposium is a big central bankers event that focuses on the long term of monetary policy. It's a chance for the Fed to signal where things are going more than just in the next couple months. At least that's what it's historically been. Last year, it was notable because at the last minute, Powell decided to rip up his speech and give a terse eight-minute diatribe that basically said that markets were getting way out

ahead of themselves, effectively ending a late summer rally. Powell said at the time in no uncertain terms that the inflation fight was not over and stated explicitly that, quote, there will be pain. Now, coming into this, Adam Posen, president of the Peterson Institute for International Economics, said, there's no way Powell's speech can be that tight and clear this time, because the economic outlook is genuinely more uncertain. Central bank decision-making in some sense is easier when you have policy wrong and you have a long way to go to where you should be. It's more difficult when you have to sort through being close to the right policy, but not sure you're there, and that's where the Fed is now. And so, a year later, the inflation fight is still underway, and it was anticipated that Powell would use his appearance to reinforce the Fed's commitment to finishing the job.

Up until now, the policy choices have frankly been somewhat obvious, continue raising interest rates until inflation cools or something breaks. And even when something breaks, try to fix it without changing interest rate policy and see if that works. However, with inflation now moderating to its lowest level in almost two years, there is a lot more potential for disagreement among FOMC members. Powell was expected to give his views on whether rates should continue to go high, into the end of the year, as well as to sketch out how the Fed would determine when the time would come for rate cuts. Forecasts from Fed members have generally called for rates to be held higher for longer,

but with pressure on the banking sector, it's unclear whether policymakers would be on board with sticking to that strategy. Now, as well as the rumors of dissent among FOMC members, the economic establishment is beginning to question whether the inflation fight is even worth taking all the way to its conclusion. Responding to a Wall Street Journal article published on Monday, Paul Krugman tweeted, I agree with Jason Furman's call for a 3% inflation target. The rationale for 2% has been overtaken by a couple decades of experience. So if you think 3% is the right target, shouldn't we be declaring victory? Or to put it a different way, if 2% was a mistake, how many people should lose their jobs for a mistake? Now, Yuga Kohler's senior staff engineer at Coinbase captured much of the sentiment in the crypto space when they wrote,

the difference between a 2% and a 3% inflation rate over the course of 75 years is literally 100%. Raising the target is a sleight of hand to inflate away national debt. Stephen Geiger, an economics commentator and Paul Volker fan said, And stick with me here. We keep it at 2%, and the Fed and federal government can just do their job. So what did we actually get? Well, in this case, it was much what we expected. Bloomberg's headline reads, Powell signals Fed will raise rates if needed, keep them high. The Wall Street Journal writes, Powell, Fed will proceed carefully on any rate rises. And as per Bloomberg, the key takeaways were that one,

Powell acknowledged that the economic backdrop is better than it was a year ago, but he said that the Fed stands ready and willing to raise interest rates further if they need to. Two, he continued to focus that everything going forward will be data-driven, but he did not put the possibility of cuts on the agenda, saying, based on this assessment, we will proceed carefully as we decide whether to tighten further or instead to hold the policy rate constant and await further data. Third, Bloomberg says the comments are consistent with expectations that the Fed will leave interest rates unchanged at the next meeting, with the possibility of another rate hike later in the year. Fourth, Powell acknowledged that interest rates are now high enough to be restrictive,

meaning that they are weighing down on growth and inflation. And finally, Powell said two percent is and will remain our inflation target, throwing some damp water on that part of the conversation. Nick Timrose from the Wall Street Journal, widely viewed as the Fed Whisperer, called it a risk management speech. He quoted Powell as saying, given how far we have come at upcoming meetings, we are in a position to proceed carefully. The Kobeesi letter pointed out some data from bond traders around what their predictions are. They write, odds of a 25 basis point rate hike in September more than doubled to 21.5% after Powell's speech. Odds of an additional rate hike this year just hit a two-month high of 52.1%. Rate cuts are now not expected to begin until June 2024. Doug Bonaparte hit it out

the park again with another great headline. Breaking, stocks fall as Fed Chair Powell signals he's willing to destroy the economy. But in point of fact, stocks are actually leveling out and even going up slightly, based, I think, on expectations being met. So all in all, a much less dramatic speech than last year, and frankly, just a real continuation of what we've gotten from Powell for the last two years. Lockworks Jack Farley wrote, Powell chooses to close his speech with Paul Volcker's phrase will keep at it for the second year in a row. And that is pretty much the story. Now, the last interesting thing that I wanted to point out for this week just by way of closing is that the three-day BRICS summit came to a close on Thursday in South Africa with news that

six new members would join the loose economic bloc. Argentina, Egypt, Ethiopia, Iran, Saudi Arabia, and the United Arab Emirates have committed to join in January. This adds to Brazil, Russia, India, China, and South Africa, there's BRICS, bringing the ranks of membership up to 11. President Xi Jinping called the expansion historic and said it would be a new starting point for BRICS cooperation. Still, while the addition of new nations to the economic cooperation group does add strength, the announcement falls far short of the hype that we had seen coming into it. There had been rampant speculation this year that the group would unveil a common trade currency backed by gold, which frankly, rumors of a BRIC's currency have been persistent for over a decade,

but have so far never materialized. So all in all, the world continues to be interesting, but doesn't look all that different than it did heading into the week. AI is up, inflation is down, interest rates are flat, but maybe up. And so, as so often has been the case for the last few months, the best thing to do is go touch grass. Until next time, be safe and take care of each other. Peace.