Investor Focus Diverts from Debt Ceiling to Artificial Intelligence: May 25, 2023

Semiconductor developer Nvidia Corp.’s strong earnings guidance has sparked a market rally today with the company’s forecasted demand for artificial intelligence (AI) products bucking a trend of technology companies generating disappointing results due to a glut of computer chips. The stronger-than-expected Nvidia guidance is also shifting investors’ focus from the June 1 deadline for Washington, D.C., negotiators to avoid a catastrophic failure to raise the nation’s debt ceiling. Shares of Nvidia were up more than 30% after the company said yesterday that it expects sales in the current quarter to hit $11 billion. Analysts anticipated sales guidance of only $7.2 billion.

Rather than focus on the minimal progress made by elected officials on increasing the debt ceiling, investors have turned bullish with the Nvidia guidance causing shares of other semiconductor companies with exposure to artificial intelligence to surge upward. Taiwan Semiconductor Manufacturer Co., which makes chips for Nvidia, and other Nvidia suppliers experienced strong share price gains. Shares of other companies with a strong presence in personal technology devices that previously provided disappointing guidance are lagging, with Intel Corp. shares down more than 5% while Samsung shares are virtually flat.

During an earnings call yesterday, Nvidia co-founder and CEO Jensen Huang said the company is experiencing surging demand for AI computer chips, which resulted in first-quarter revenue of $7.19 billion compared to $6.52 billion expected by analysts. Revenue climbed quarter-over-quarter (q/q) from $6.05 billion but declined year-over-year (y/y) from $8.29 billion. The company’s diluted earnings per share (EPS) of $1.09 exceeded the analysts’ expectation of $0.97 but fell y/y from $1.36. While revenues climbed significantly for the company’s automotive and data center segments, other categories such as gaming and professional visualization declined.

As negotiators make minimal, or even no, progress, Fitch Ratings and Morningstar have placed the United States on negative watch, implicitly threatening to cut the nation’s credit rating if a debt ceiling resolution isn’t made in the next few days. Yields are higher across the board as a result.

Nvidia’s guidance has reversed a three-day long market decline, even as debt-ceiling woes continue. After proposing a budget with spending increases, Democratic President Joe Biden has proposed a spending freeze and limits on future fiscal-year budget increases, while Republican House Speaker Kevin McCarthy has emphasized that his party insists on significant spending cuts. Democrats are also proposing to implement new revenue sources, which is something Republicans are opposing. As negotiators make minimal, or even no, progress, Fitch Ratings and Morningstar have placed the United States on negative watch, implicitly threatening to cut the nation’s credit rating if a debt ceiling resolution isn’t made in the next few days. Yields are higher across the board as a result. 

Fitch Ratings’ and Morningstar’s actions aren’t a new development, as credit rating agencies have previously become alarmed by political brinkmanship and high debt-GDP ratios. Similar events have occurred following the 2008 global financial crisis that led to credit downgrades and/or negative outlooks on U.S. Treasuries in 2011, 2012, 2013 and 2020. Further negative outlooks and credit downgrades in the event of continued political gridlock would impose significant cost burdens on U.S. taxpayers and borrowers of all kinds. U.S. Treasuries act as risk-free instruments in financial markets. A deterioration in their quality would drive up interest rates for all other products including mortgages, corporate bonds and credit cards.

On the economic data front, this morning featured moderating unemployment claims and upward revisions in first-quarter Gross Domestic Product (GDP) and in the Core Personal Consumption Expenditures (PCE) Price Index. Initial unemployment claims came in at 229,000 for the week ended May 20, much lower than expectations calling for 245,000 and similar to the previous week’s level of 225,000. First-quarter GDP growth was revised higher from 1.1% to 1.3%, still only half the fourth quarter’s 2.6%. Core PCE inflation, which is the Fed’s preferred metric that the central bank uses for its 2% target, was revised higher as well, from 4.9% to 5% for the first quarter. On balance, a strong labor market and upward revisions to GDP and PCE inflation is exactly what the Fed doesn’t want to see at this juncture, supporting wagers of another 25-basis point (bp) hike at next month’s meeting with odds up to 42%.

Tech stocks are supporting equities this morning with cyclical Indexes lower while bond yields march higher on upwardly revised economic data, strong labor conditions and the continued debt-ceiling impasse in Washington. The Nasdaq and S&P 500 Indexes are up 1.3% and 0.6% while the cyclically tilted Dow Jones Industrial Average and Russell 2000 Indexes are down 0.2% and 0.9%. Bond yields and the dollar continue to gain upward momentum, without having recently taken a meaningful break, the 2 and 10-year Treasury yields are up 9 and 5 bps each to 4.43% and 3.77% while the Dollar Index is up 22 bps to 104.11. Oil is sharply lower this morning as investors assess the dichotomy between leaders within the OPEC + cartel. Comments from Russian Deputy Prime Minister Alexander Novak drove prices sharply lower, to $72.42 per barrel for WTI crude oil, a 2.6% decline. While Tuesday comments from Saudi Arabia’s oil minister indicated a potential cut in production at next week’s meeting, Novak dismissed the idea by calling for an unchanged position.

While equity investors cheer fascinating AI developments, significant risks are front and center within the macroeconomy. With Fed tightening expectations rising and no end in sight in Washington, continued increases in bond yields supported by both factors can significantly impair the valuation landscape for equities, which are already stretched. The ability for companies to downsize, manage interest expenses, and keep revenue at elevated levels has been very impressive, however, with earnings falling a lot less than feared.

While investors brush debt-ceiling fears aside and focus on the rise of AI technology, many retailers are struggling with consumers curtailing their spending on discretionary items as illustrated by Dollar Tree Inc.

The company, which operates Family Dollar and Dollar Tree discount retail stores, reported quarterly net income of $299.0 million, or $1.35 a share, down from $536.4 million, or $2.37 a share y/y. After adjusting for nonrecurring items, its earnings per share of $1.47 fell below the consensus expectation of $1.52 and declined y/y from $2.37. For the most recent quarter, the company’s $7.32 billion in revenue exceeded the consensus expectation of $7.28 billion and increased from $6.99 billion y/y. Additionally, the company’s same-store sales rose 4.8% and beat the 3.6% consensus expectation. The metric exceeded the consensus expectations for both Dollar Tree and Family Dollar brands. In discussing the quarter, Dollar Tree Chief Executive Officer Rick Dreiling said the company isn’t immune to shoppers shifting their spending toward consumables, such as snacks, that aren’t as profitable as other items. He also said theft of products is impacting profits. The company’s forecast for second-quarter EPS of $0.79 to $0.89 missed the consensus forecast of $1.18. It also lowered its full-year EPS guidance range to $5.73 to $6.13 from $6.30 to $6.80.

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