It all started with such a bang, but the last few weeks show how tough it is to engineer substantial changes, even for Donald Trump.
The two major global conflicts continue, there is huge uncertainty over US trade tariffs, and Musk’s reign at the DOGE is over with questionable results achieved. The US budget deficit and US Government debt continue to expand. US debt is rapidly approaching $37 trillion, or $323,000 per US taxpayer and 123% of US GDP (up from 58% in 2000) all according to US Debt Clock.org. We will come back to what is going on in Government debt and its possible impact in a future update.
What the US President has shown he can do is move equity markets. Trump’s ‘Liberation Day’ tariff announcement knocked 13% off the S&P 500 index in just a few days, and 7% had already been wiped off in the run up to it. His staying of the reciprocal tariff announcements and subsequent softening on individual country deals (although there have not been that many) has seen a 19% rally in the S&P 500 in the last month and a half.
Throughout this, Trump has shone a light on ‘US Exceptionalism’ from an equity investor perspective – a phenomenon at its peak last year, as everything US went up and everything rest of the world failed to keep up with the ‘magnificent seven’ (Mag 7).
My thoughts on this are:
- Several of these Mag 7 companies are at the heart of what Trump is trying to do with his MAGA mission: Apple should be making iPhones in the US, not China or India; Nvidia should not be selling US tech to China (although it appears China’s tech business might be doing very well without copying its US counterparts!).
- The US dollar is weakening versus other currencies, making US exports more competitive, which Trump wants, but which hurts foreign investors in US equities.
- Are levels of US debt an issue, how can it be reversed and what will be the impact?
- No one wants to see their investments going up and down at the whim of one man!
I can read dozens of postulations from market experts on every one of these issues daily on LinkedIn. At times it feels like these are the only topics being talked about and they are clearly worrying investors, who last year could only see upside from the US stock market index. Some commentators are dismissive, saying it is just another ‘buy the dip’ opportunity, whereas others (including some serious heavyweights) are more cautious.
Trump has highlighted the cracks in the US Exceptionalism thesis and our table below shows these are feeding into returns.
Other areas of the stock market are doing substantially better than the shares in big cap US tech companies as investors take profits from Mag 7 exposure and invest elsewhere. And with Mag 7 companies making up such a big proportion of global equity indices, these are doing less well than other investment markets such as fixed income.
The table shows all our funds and how much of Tideway’s clients’ money is invested in each fund, the fund returns this year so far, and over one year. The table is ranked by performance this year so far and shows our big winners are equity funds investing away from US tech in areas like defence and infrastructure, in defensive strategies like Ruffer and in fixed income.
Our allocation of capital is currently nicely skewed towards the better performing investments.
Nvidia Earnings
A key piece in the puzzle is Nvidia, the poster child for artificial intelligence (AI), who posted its Q1 results on Wednesday, well behind the rest of the Mag 7 who posted earlier in April.
Nvidia’s big customers are 4 of the other Mag 7 companies: Microsoft (by far the largest), Amazon, Meta and Tesla. Nvidia sells the ‘picks and shovels’ for AI across a range of industries, mostly using Taiwan Semiconductor Manufacturing’s chips as its building blocks. According to an article on Yahoo Finance, Nvidia’s 4 biggest customers are reportedly spending some $330bn on AI this year and have historically spent between 10% and 50% of this on Nvidia’s products. Microsoft makes up almost 20% of Nvidia’s revenue. This is spending that has only really been going on in earnest for the last year and a half.
In addition to the huge spending ramp in Nvidia’s space, Nvidia’s market dominance and lack of chip manufacturing costs means it is immensely profitable, with c50% profit margins.
This week’s earnings showed Nvidia to have a 70% year on year increase in revenue and a roughly 30% year on year increase in profit (depending on which accounting methodology taken) for the first quarter of 2025. Given the size of its operation, these results are incredible and no wonder Nvidia has come from a value of $300bn in August 2020 to vying to be the most valuable company in the world at $3.4trillion today. This is more than a tenfold increase in under 5 years and a return that has powered the Nasdaq and S&P 500 indices to their levels today. Nvidia’s value is now around 7% of the entire top 500 US companies combined.
The earnings report beat most analyst expectations. How did the share price react? Well, as I write, Nvidia share price is c2% higher than Wednesday’s closing price before the announcement and roughly the same as it was in mid-June 2024. The stock pays a tiny dividend, less than 0.1% p.a., and despite a volatile ride and staggering financials, US investors are flat over almost 12 months and UK investors will be down 5% after converting dollar values back to pounds.
How can this be? The answer is in the way stock markets and equity investors value businesses – they are looking forwards, not backwards.
Most of the value of Nvidia was already baked into the price last summer.
As can be seen from the chart above, the price to earnings ratio rose in June last year as the spending on AI and the amount of that spending flowing to Nvidia became clearer.
Whilst not entirely clear from the chart, the price for the company relative to its earnings will have peaked around June 2024, probably in the high 60s, and has been falling ever since. Peak values for business rarely correlate with peak profits – they correlate with the likely increase in those profits in coming years.
Any sign that AI spending is tailing off from one of its big clients, being diverted to competitors of Nvidia, or of profit margins falling, could mean profit increases in the future will be lower and Nvidia’s price to earnings ratio will fall as investor appetite falls. In the last 12 months that drop in investor appetite for Nvidia stock has pretty much wiped out the stellar increase in revenues and profits when looking at the quoted value of the business.
This is why we like investing in companies at lower price to earnings ratios. For these companies, just maintaining steady profit growth can bring big upward moves in their share prices, of which there are quite a few examples in those top performing equity funds this year.
By contrast, the very highly valued companies on an ‘earnings treadmill’ quarter after quarter and will be punished if they ever get off. Unless of course you are Elon Musk and Tesla, who are selling future earnings that don’t even exist yet and which no one can quantify. Then the price is simply what speculators are prepared to pay without the ability to do any credible analysis!
