Nvidia Delivers; Japan finally hits a new high

Market Overview:

Nvidia results seemed to take on the significance of some major macro-economic data release and the resultant move in global markets only confirmed their importance. The AI standard bearer did not disappoint, posting year on year revenue growth of 265%. That was enough to catapult the stock to yet another all time high, with a staggering gain of 16% that increased the market cap of the company by $273 billion in one day getting on for 2/3 value of the whole of the FTSE 100 ! This was enough to drag the S&P 500 to a new all time high, with the Nasdaq now in touching distance of its November 2021 peak. Probably not coincidentally, both the Euro Stoxx and Nikkei followed through the following day with new all time highs. Amid all the drama, yields were broadly flat, Asian markets up a bit with Gold, but Oil finished a little lower.

Japan

Before taking a closer look at the Nvidia move, I thought I would give some air space to the Japanese Stock Market. Forgive me the indulgence, but it is not an overstatement to say that I have waited pretty much my entire investment career to see Japan achieve a new all time high.

When I first started work it was for MIM Britannia Asset Management, the forerunner of Invesco and to say we were Japanese influenced would be to underplay it. We had had the best two performing funds of all unit trusts in the 1980s, both Japanese. Our Chief Executive, Nicholas Johnson had been head of our Japanese desk and our MD also hailed from the Japanese fund management team. My first investment was a Japanese Warrant fund that had made me spectacular paper gains of more than 250% in a year 1989, before losing more than 98% in value in the following two years (lesson learned , less greed and remember to take a profit!). Nippon Telegraph and Telephone, Japan’s domestic telecom giant, was worth more than the top eight U.S. entries – IBM, Exxon, General Electric, AT&T, Ford Motor, General Motors, Merck, and Bellsouth – combined – sound familiar to current mega tech comparisons?

So, I have always had a nostalgic love hate relationship with this market. Having nearly hit 40,000 in 1989, the Nikkei was still below 10,000 not much more than 10 years ago, before turning the corner in 2013 and not looking back before finally on Thursday, hitting a new high. To put this into context, the Dow Jones Composite has risen more than 1,000 per cent over the period. My first cursory examination of the Japanese market had led me to question my boss as to why Japan was trading on a P/E of more than 60 x earnings, only to be told this was justified by ‘Japanese exceptionalism’. Now that does set off a few alarm bells as I hear talk abound on CNBC of ‘US exceptionalism’. Imagine if in another 35 years time, an AI Fund Manager writes a similar report to this , only in reverse talking about the strange environment in the 2020s when the US commanded a premium valuation just because it was the US !

Anyway, it would have been a bad mistake to have had most of your eggs in the Japanese basket and few in the US, so I do get a little concerned when I see so many model providers building their asset allocation based on MSCI Weightings which skew the weightings so highly toward the US. That said, the higher valuation commanded by the US market at roughly 20 x forward earnings, is nowhere near that of Japan and arguably completely justified by the ability of US corporations to consistently grow earnings. So what have been the reasons behind the Japanese recovery and can it continue?  When you can find seven good reasons, that’s always a good sign ….

  1.  Corporate Fundamentals: Unlike global trends where 2024 and 2025 earnings projections have dropped, Japan stands out with increasing optimism in earnings per share, indicating potential for growth. This optimism is supported by the fact that profits are still not at pre-pandemic levels, and the market capitalization to GDP ratio is decreasing.
  2. Corporate Governance Improvements: The implementation of the “third arrow” of Shinzo Abe’s Abenomics, focusing on corporate governance, is starting to bear fruit. This is evidenced by record corporate buybacks, indicating that companies are taking shareholder interests more seriously, which is a positive sign for potential growth.
  3. Value Stocks Rally: Japanese value stocks have seen significant rallies, contrasting with trends in the US market. This surge is partly attributed to the dominance of passive over active management in Japan, creating opportunities for value investors.
  4. Healthy Companies: Japan’s corporate sector is robust, with fewer “zombie” companies compared to other economies. This financial health provides a safer margin for investors.
  5. Economic Confidence: Corporate Japan is displaying a level of optimism not seen since 1989, as shown by the Tankan survey of executive sentiment. This confidence is particularly strong in the services sector and is improving in manufacturing.
  6. Labor Market and Wages: The unique “shunto” wage negotiation process in Japan suggests that wages, which have a significant bonus component, are expected to see their most generous increase in over three decades. This could lead inflation and contribute to economic optimism.
  7. Yen Could Strengthen :It is likely that at some point soon the BOJ will need to reverse its ultra loose monetary policy now that inflation finally seems to be picking up and that should feed in to a stronger currency

Despite the obvious past disappointments, the current indicators suggest that the Japanese market is in good health and despite the rebound still undervalued, with as highlighted several solid reasons to anticipate further growth. Much of the bounce in the Japanese market hasn’t translated into sterling gains for us in the UK (unless you were smart enough to buy a hedged vehicle), but that may be about to change. Maybe most of 2024 gains might actually come from Yen appreciation as that would probably dampen index returns.

Has Nvidia created a Dot Com Like Bubble ???

I think this is the best chart I have seen that explains that what we have witnessed in recent gains from the Nasdaq maybe a bull run, but falls well short of taking us in to bubble territory for the whole index. That is not to say that we won’t enter bubble territory and that there are not bubble candidates, chief amongst those is arguably Nvidia, but we haven’t yet seen the explosive, crazy characteristics of a bubble. I know a lot of hedge fund managers were shorting Nvidia and perhaps if they need to cover these shorts by buying back in, we might get the irrational surge higher. There are also anecdotal signs of crazy country, not quite taxi drivers telling you what stocks to buy, but I did read with interest that teenagers are now getting involved in buying stocks like Nvidia, at least they are not meme stocks ! Contrary to typical bubble scenarios, this situation has not yet displayed the usual indicators of increasing leverage. In fact, margin debt has been on a decline recently. Similarly, the proportion of margin debt relative to the overall stock market size has also been decreasing.

To my mind, rather than getting drawn in to a debate on whether this is the start of the bubble or if there is too much concentration in the Magnificent 7, I am much more interested in whether the ingredients are right for the US equity markets as a whole to keep going and here I find myself optimistic. Let’s consider the main macro drivers. Inflation although stickier short term than the authorities would like, it is still on a downward trend and this should allow central banks to cut interest rates later in the year. Economic growth particularly in the US is robust and likely to strengthen further as we go through the year, aided by interest rate cuts. The consumer appears to be in good health, confidence is high, they are seeing real wage growth and with unemployment still low they have the necessary job security to keep spending. Corporate earnings are trending upward with margins just about holding and this is a Biggy – productivity gains are increasing. Productivity is the go-go juice for bull markets as not only does it increase GDP output, it does so without fuelling inflation and feeds through nicely on to the bottom line with enhanced revenue and earnings.

What could possibly go wrong ?

I think the biggest danger here for US markets is that we don’t actually get the rate cuts that everyone is expecting. I think the markets could eventually digest this news, but not without some increased turbulence and perhaps as much as a 5 – 10% correction. How likely is this, well, regarding the current stance of the FOMC, there appears to be a readiness on Jerome Powell’s part to aim for a soft landing, even if the economy shows signs of picking up speed. Indeed, during his recent press conference, the Chairman of the Federal Reserve made it clear that a quicker pace in GDP growth does not directly impact the FOMC’s core mission. This openness to stronger economic growth is likely to persist unless the labour market starts tightening again. A significant increase in labour demand, through either a surge in employment or a rise in job vacancies, would probably pose the greatest challenge to lowering interest rates. At the moment, there’s no strong indication that such a shift is underway but I think  the Non-Farm Pay Rolls Data has become more critical than even the inflation numbers.

UK

I am not a political beast and do my very best to stay out of debating the pros and cons of policy decisions and like most people would welcome a tax cut if it comes in the Spring budget. I think that is likely and the economy would probably benefit from a bit of fiscal priming from the Tories as they attempt to win a few more election votes. However, I was alarmed to hear that the Government is actually considering offering a 1% mortgage option for new time buyers. I wholeheartedly agree with the premise that we need to create a society where hard working people can afford to own their own homes if they want to, but the latest scheme would be madness.

Now If I got out my A level textbook, it would highlight that if the price of a commodity was going up, to reduce the price you would need to either increase the supply or reduce the demand. So just what is Jeremy Hunt thinking as if you could buy a £200k house with as little as £2k saved, demand would explode. There is such a culture of ‘you have to own your own home in the UK’, that everyone would pour in and starter home prices would soar, sending ripple effects up the housing ladder. A subsidy designed to help a limited number of individuals get a head start on home ownership ultimately ends up disadvantaging those who follow, by making it harder for them to access the housing market. In addition, negative equity presents a significant risk for participants of the scheme. With only a 1% deposit required, a minor fluctuation in property prices could lead to homeowners owing more on their mortgage than their property’s value.

It’s important to note that while the scheme may ensure many more people can raise the deposit, it doesn’t alleviate the burden of mortgage repayments. Those on the scheme might incur a higher interest rate than others, as the guarantee typically only covers up to 80% of the property’s purchase value. Lenders bear the risk for the remainder, and this will no doubt be factored in to the price of the mortgages. Lets hope this scheme will not see the light of day.

Finishing on some good news as I like to, UK energy bills are set to fall to the lowest level in two years as wholesale prices continue to decline rapidly. The price cap will drop 12% to £1,690 from April 1, according to figures published by regulator Ofgem on Friday. The pricing mechanism, set on a quarterly basis, limits how much suppliers can charge per unit of energy. Analysts expect bills to slide further in July, helping to ease inflation and providing relief to consumers. This is possible as wholesale gas and power prices have dropped rapidly in recent months as mild weather and low demand ease pressure on global supplies.

Now that is great news on two fronts as a fall in bills in April could help to drive inflation below 2%, compared with 4% in January, and provide the catalyst for the BOE to start cutting rates. The cost saving will also directly feed into the coffers of households, probably boosting confidence and spending power. Add in the expected tax cut and the ingredients are right for a pick up in economic activity later in the year.