A New Lead Dog?

It was a tumultuous week and although the S&P 500 was only down about 1% for the week and 3% from the all time closing high last week, it sure felt a lot worse. The S&P500 had broken key technical levels on Thursday and Friday was uneventful until the end of the day, when the market finally bounced from short term oversold levels, right back to key technical levels all over again. The index is at a decision point where this will either mark the completion of a mild correction, or a bounce before the next leg down. Mild pullbacks are common, but the speed of this pullback was impressive, faster than March of 2020, and the market leaders of the last 10+ years were relative underperformers, which has us leaning toward another leg down.

Fourth quarter earnings are winding down. The ‘big one’ (NVIDIA-NVDA) was reported on Wednesday and did not disappoint as the rollout of the new Blackwell chip was smooth and exceeded expectations.  While growth was very solid at NVIDIA, the hyper growth stage now appears to be behind us. Goldman Sachs projects capital spending by the four main hyperscalers, which is a huge chunk of NVDA revenue, to rise 27% in 2025. While that is very impressive growth, it is down from roughly 70% growth in 2024. Goldman’s early projection for 2026 is 13% growth. If NVDA is to grow faster, it will need to diversify its customer base and become less reliant on the hyper scalers (Microsoft – MSFT, Amazon – AMZN, Meta (META) and Alphabet (GOOGL) to buy their chips.

The big initial push into AI is ending/over. From here, the emphasis is shifting to AI generating returns for AI users as well as the hyperscalers. The implication is that from here forward, most every company is effectively an AI play. Companies that can make AI work for them should have opportunities to be more profitable and gain share. Those that can’t make AI work, could have a very rough ride.

For those playing the trading game, the questions are: where will the earnings growth be? Will it enable the old leaders continue to lead? Or will the list AI beneficiaries broaden, allowing the ‘other 493 companies’ to accelerate earnings growth too? And will stock market  leadership therefore begin to shift?

It’s not an academic question. If AI is to reach its lofty promises, by definition, AI users have to begin to benefit and those benefits will be built on a smaller base, thus enabling some potentially rapid earnings growth.

Despite the late Friday rally, the old leaders are looking tired. The earnings news from NVIDIA on Wednesday was about as good as could have been expected, but that wasn’t enough to jump start the tech train again. NVIDIA has been an unbelievably great stock over the past few years, but it has effectively gone sideways since June of last year (see chart below), despite a great earnings performance.

The market leaders of the last decade will not cede their position easily, but things are starting to point in that direction. According to David Kostin, Chief U.S. Equity Strategist at Goldman Sachs, “The outperformance of the Magnificent 7 has historically reflected its earnings superiority. 2025 bottom-up estimates imply the excess earnings growth of the Magnificent 7 will narrow from 32 pp [percentage points] in 2024 to 6 pp in 2025 and 4 pp in 2026,” If accurate, that should provide plenty of room for the ‘other 493’ in the S&P 500 to pick up the pace.

As AI matures, the earnings divide between the AI hyperscalers and everybody else begins to narrow. We remain in the early innings of a long term game, however, we suggest that well diversified equity portfolios are likely to perform well if AI can come close to reaching its promise.

 

What We’re Reading

  

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The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

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All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

Past performance is no guarantee of future returns.

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By: Adam