Inflation Confidence

OPINION

The Government — particularly Josh Frydenberg — is breathing a sigh of relief as the most recent positive economic data demonstrates a strong Australian economy.

Inflation is now both locally and internationally the hottest and most controversial economic topic for the year. Put simply, it’s because the entire global economic recovery hinges on the ability of central banks to keep interest rates low for an extended period in order to give the global economy the push it needs towards a full recovery.

The most recent Australian inflation figures have come in lower than anticipated at 1.1% per annum. This re-affirms the RBA’s carefully articulated argument about maintaining low interest rates until the economy reaches a level of full employment. Unemployment is now down to 5.6%, consumer spending is racing back to pre-Covid-19 levels, and trade figures are strong due to high iron ore prices — all of which contributed to a $30b windfall in the current budget figures.

It seems the ‘Achilles’ heel’ to all this good news is inflation uncertainty.

The topic of inflation has not been part of our vocabulary since the era when Paul Keating was treasurer in the 1980s and Australia experienced “the recession we had to have”.

An analogy that best describes the importance of inflation is that like watering a plant, both too little or too much water may kill it. And so it is the right balance of low constant inflation increases business profits over the long term — increasing business productivity. Such strategy helps to reduce unemployment, increases tax revenue and naturally erodes the real value of debt.

Too much inflation can have the opposite impact. The most powerful tool left to control high levels of inflation is the RBA’s use of contractionary monetary policy (increasing interest rates). However, this is not without risk — done prematurely, it will have a negative price impact on assets such as shares and property, further stunting economic growth and possibly spiralling the economy into a recession.

Governments and central banks will need to put on a brave face and maintain confidence in their ability to steer the global economies through these tricky times. A loss of confidence from consumers and businesses is enough of a catalyst for a self-fulfilling prophecy for inflation issues to emerge unfavourably.

This is, in itself, a very thought-provoking concept as inflation is not purely driven by economic data and activity. It is also driven by the future expectation of businesses and workers, which drive businesses to make decisions such as increasing prices on goods and services and employees hitting up bosses for a pay rise.

Covid-19 has completely skewed economic data

Worth contemplating when attempting to interpret economic data is the “base effect”. Covid-19 forced the economy to a complete standstill, with all the major economic indicators falling off a cliff. Once the economy has been rebooted from a virtual standstill, the economic indicators are all being overly exacerbated during the economic recovery. As an example, we have had two quarters of GDP growth at 3%, however, our economy is still nowhere near the same levels as it was pre-Covid-19 despite the data implying otherwise.

Be prepared that the next inflation figure will be an absolute whopper, as it will reflect people returning to work and spending money on normal items such as childcare, entertainment and transport.

—

Paul Miron has more than 20 years experience in banking and commercial finance. After rising to senior positions for various Big Four banks, he started his own financial services business in 2004.

msqcapital.com

Chip makers are fighting to assure investors that the artificial-intelligence boom is racing forward. Wall Street might not believe it until Nvidia’s NVDA -0.98%decrease; down pointing triangle Jensen Huang says so.

When Huang steps up to the mic for his company’s earnings call Wednesday, he will have the world’s attention. What he says about Nvidia’s present will preview the future of AI, dictate the path forward for a tech-crazed stock market and influence an American economy increasingly tethered to hopes that the boom won’t go bust.

The $5 trillion chip maker has provided the key building blocks for AI since the launch of ChatGPT in 2022 set off a race for dominance among OpenAI, Anthropic and established Silicon Valley giants. Now, as Nvidia backstops sprawling data-center projects and an exotic money pipeline to boost chip demand, the company’s influence is arguably bigger than ever.

But there are signs of trouble ahead. Political pushback to AI is growing. A bond selloff propelled borrowing costs to their highest levels in years. The hyperscalers that include some of Nvidia’s key customers—once cash-printing machines—are relying more on debt. OpenAI recently told investors its revenue rose by a tepid 18% in the second quarter while its losses deepened.

Nvidia is increasingly stepping in to shore up potential weak points across the market. Earlier this month, the company teamed up with six of Wall Street’s biggest firms on a $500 billion AI-financing plan, pledging to backstop lending to customers that can’t afford its chips otherwise. The chip maker last week also took a stake in Cloverleaf Infrastructure, which arranges power for data centers, and struck a $6 billion deal with startup Poolside aimed at developing a powerful open-weight AI model.

After watching shares in other chip makers and the so-called Magnificent Seven tech companies swing wildly in recent months, Wall Street is hoping Nvidia can beat expectations—again. The countdown is on.

“It’s kind of becoming more and more like the World Cup final than the Super Bowl at this point,” said Brian Mulberry, chief market strategist at Zacks Investment Management. “It’s just gotten to be that big.”

The company has smashed analysts’ earnings estimates for each of the 14 quarters since the AI boom kicked into high gear. Nvidia posted 210% annual growth in net income in its last three-month period, according to FactSet, making Wall Street’s 126% projection look pedestrian.

Expectations for a blowout second quarter have risen rapidly over the course of this year. All Nvidia will have to do to beat this target: outrun 95% annual earnings growth to more than $51.5 billion. Analysts project the chip maker will report record sales of $92 billion for the period, up from a forecast of $78 billion at the start of this year.

In July, big-tech earnings sparked volatility. Concerns about runaway capital spending spread across the sector after Alphabet’s and Tesla’s results, driving a $890 billion wipeout that contributed to the unwind of hedge fund Situational Awareness. Microsoft posted the largest one-day gain in market capitalization by any company, ever, after a quarter proving that it could still show investors the money. SpaceX rocketed higher after a record-breaking initial public offering, only to see $1 trillion in value evaporate.

Surging memory prices and borrowing costs have fueled fears that those and other companies will be unable to keep plowing more money into supplies including Nvidia chips. Shaia Hosseinzadeh, founder of OnyxPoint Global Management, has recently bought dips in AI-infrastructure stocks when Wall Street has strained to absorb massive debt issued by Silicon Valley.

“The macro data is really quite robust,” he said. “Of course, there’s a level at which everything breaks.”

Investors have kept pumping money into the AI trade despite concerns around chip consumers—and to the benefit of chip producers. That is why Nvidia’s outlook for semiconductor demand could send ripples through counterparts such as Micron Technology and Sandisk, developers of the data centers in which their chips reside, and a supply chain of power producers, contractors and other specialists that underpin the globe-spanning AI build-out.

“We joke internally that we’re all Nvidia analysts now,” said David Lefkowitz, head of U.S. equities at UBS Global Wealth Management.

The irony is that investors have tended to sell Nvidia stock immediately after blockbuster earnings, with shares falling each trading session after its four past quarterly reports. Some are betting that will be the case this time around, too.

The options market is pricing in a 5.3% swing, higher or lower, in Nvidia shares during the session following earnings, according to Option Research & Technology Services. That is higher than the 4.8% average move in Nvidia’s stock over the last 12 months after the company reports quarterly results.

In recent days, some of the most actively traded Nvidia options have been put contracts tied to the stock falling from its Friday value of $214.75 to $205 and $210 apiece, according to Cboe Global Markets data. Put options give the right to sell a stock by a set price and typically represent a bearish wager.

Many analysts remain optimistic. Frank Lee, global head of tech hardware and semiconductor research at HSBC Global Investment Research, recently raised his price target for Nvidia shares to $360 from $325, citing, among other things, Nvidia’s strategic partnerships with suppliers and its role as a top contributor to open-source AI.

Inflation Confidence

MSQ Capital’s Managing Director Paul Miron explores the world’s hottest and most controversial topic.

OPINION

Nvidia’s earnings will test Wall Street’s confidence in the AI boom.