Nvidia Earnings: The Key to Sustaining the Market Rally?

The Nvidia (NVDA.O) second-quarter earnings report, scheduled for release after the US market close on Wednesday, appears to hold the key to sustaining the rally in the US stock market. Its significance may even surpass the signals sent by Federal Reserve Chairman Jerome Powell regarding future interest rate cuts. The US markets saw a significant rise last Friday, with the Dow Jones Industrial Average (DJIA) reaching its highest level since December. This rise was fueled by Powell's hints at the Jackson Hole symposium about a possible rate cut in September. Small-cap stocks also had their best daily performance since May, while the S&P 500 (SPX) recorded a third consecutive week of gains. However, the markets retreated on Monday, as investors began to reflect more deeply on the reasons behind Powell's dovish tone.

Why Do Rate Cuts Matter?

Lower interest rates typically have a direct positive impact on the stock market, as a decrease in the yield on risk-free Treasury bonds increases the present value of future cash flows. However, if rate cuts are driven by an economic slowdown, corporate earnings may also deteriorate. And if rate cuts lead to inflationary pressures, the real value of future cash flows will erode. In his speech, Powell warned that the labor market is cooling down and that inflationary risks from tariffs are apparent, suggesting that both scenarios may be unfolding.

Bond Market Concerns

The bond market echoed these concerns. On Monday, the spread between the yields on 2-year and 10-year US Treasury bonds rose to its highest level since 2021, with short-term yields falling faster than long-term yields. This means that the bond market expects the Federal Reserve to cut interest rates but remains concerned about persistent inflation and stalled economic growth.

Growth Challenges for Tech Giants

Lori Calvasina, head of US equity strategy at RBC Capital Markets, pointed out that weak growth could test the performance of the technology giants that have driven the rise in the US stock market this year. She added that Wall Street needs to see a "significant upward revision in market consensus GDP expectations" before analysts raise their earnings forecasts for these companies. "This will pose a challenge to further upside in the US stock market overall, and especially the large-cap growth and technology stocks," she said.

The Significance of the Nvidia Earnings Report

In this context, Nvidia's second-quarter results, scheduled for release on Wednesday, take on particular importance. This leading artificial intelligence chip company is at the heart of the rise in tech stocks, with about 40% of its revenue coming from companies like Microsoft (MSFT.O), Amazon (AMZN.O), Meta Platforms (META.O), and Alphabet (GOOGL.O). Nvidia holds an 80% share of the AI chip market and has a market capitalization of about $4.3 trillion, representing about 8% of the total market capitalization of the S&P 500. According to estimates by Dan Morgan, an analyst at Synovus, about 60% of the capital spending of these major technology companies will flow into AI, so Nvidia's sales outlook will directly confirm or challenge the most important narratives in the market.

Nvidia's Impact Surpasses Rate Cut Expectations

The largest six technology companies by market capitalization account for about 34% of the total market capitalization of the S&P 500, meaning that Nvidia's performance may have a greater impact than rate cut expectations. Although the Federal Reserve will receive employment and inflation data before the mid-September meeting, Nvidia's outlook may be more decisive.

Caution Advised

While AI trading is certainly a positive factor for the US stock market, Calvasina of RBC pointed out that investors sold off technology stocks last week because "the AI theme that is driving the rise in the stocks of major companies has once again been strongly questioned." Nvidia's stock has added more than $1 trillion of market value over the past 12 months and is up nearly 30% so far this year, meaning that the stock's valuation has become very expensive. Jacob Falkenscone, head of global investment strategy at Saxo Bank, warned that Nvidia's stock "has little room for error" before Wednesday's earnings report. "Despite Nvidia's dominance, its 'Achilles heel' is that competitors or regulators could quickly change the rules of the game. If growth slows or profit margins are lower than expected, there could be a significant downside risk," he said.

Conclusion

The Nvidia earnings report serves as a litmus test for the sustainability of the AI boom and its impact on the stock market. Investors should closely monitor this report and assess potential risks and rewards before making any investment decisions.