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Double Feature: The Spy Who Loved Me & To China With Love
I. Jensen Versus The AI Trade Charlie Munger famously warned that there are three ways smart men can go broke: "Liquor, ladies, and leverage." NVIDIA co-founder and now former CEO Jensen Huang has run into trouble with the second of Munger's three L's. He won't go broke, but he is out of a good job. On Thursday, NVIDIA announced that Huang had resigned as CEO after 33 years at the helm of the company he co-founded in 1993. His departure followed revelations of extramarital affairs, including a reported relationship with a Chinese businesswoman suspected by US intelligence officials of spying for Beijing. Her Singapore-based company, Megaspeed, allegedly purchased NVIDIA's high-powered GPU chips and re-exported them to China, violating US export restrictions. The longtime CFO Colette Kress was appointed interim CEO while the board searches for a successor. Huang's departure rattled the AI trade, with NVIDIA shares plunging 4.3%, sending its forward P/E to 11.7 (charts). We promised you buying opportunities after the midterm elections. There were a bunch last Thursday and a few more today. Competitors AMD and Broadcom advanced 5.9% and 5.5%, respectively, on expectations of market-share gains (chart) As a result, the Nasdaq Composite held up relatively well, falling just 0.4% today (chart). Neoclouds also tumbled, with CoreWeave down 6.7% and Nebius down 16.8%, amid concerns about NVIDIA-backed financing (chart). Nebius was additionally pressured by disappointing revenue guidance and rising capital spending. Despite the latest AI jitters, the two-year Treasury yield rose 15bps to 4.87% this evening, remaining well above the federal funds rate and signaling that further Fed tightening is warranted (chart). The 10-year Treasury yield is back above 5.00% at 5.13% this evening. Yields rose on higher oil prices, with Brent crude up 3.1% to $95.66 this evening, after President Donald Trump dismissed the need for an Iran deal, and on hawkish Fed commentary following October's hot CPI report (chart). Markets now price a 100% probability of a December Fed rate hike: 84.7% for 25bps and 15.3% for 50bps. Futures imply more than 3 rate hikes over the next 12 months (chart). The combination of higher Treasury yields, driven by rising oil prices and hawkish Fed commentary, and renewed AI jitters weighed on the broader stock market. The S&P 500 fell 0.4%, its equal-weighted counterpart declined 0.9%, and the Russell 2000 lost 1.7% (charts). II. Nvidia: The Bear Case We can assess the risks Jensen Huang's departure poses to the broader AI trade with our familiar framework of three constraints on the AI investment boom. (1) Financial constraints. NVIDIA has been described by many as the central bank of the AI trade, conducting its own version of quantitative easing by helping finance the expansion of AI computing capacity. The company spent $42.2 billion purchasing equity securities during the first half of its current fiscal year, compared with just $1.2 billion a year earlier. The fear is that Huang's departure could slow or even end these financing activities, tightening financial conditions for an industry already facing questions about the returns on its enormous capital expenditures. (2) Political constraints. Huang has also been the AI trade's biggest cheerleader, tirelessly promoting its economic benefits and defending key players. During October's AI jitters, for example, he publicly defended CoreWeave's financial health amid a selloff in its shares and bonds, helping restore confidence. His departure could deprive the industry of its most influential advocate and cheerleader. Additionally, NVIDIA reportedly intervened in the Commerce Department's investigation into Megaspeed, while Commerce Secretary Howard Lutnick reportedly resisted efforts to blacklist the company, which remains off the Entity List. Reports also suggest the Trump administration knew about Huang's relationship with a suspected Chinese spy. These allegations could invite tougher congressional oversight and undermine Trump's national security argument for building more data centers in the US, making the AI buildout harder to sell to the public. (3) Physical constraints. Washington could respond by tightening chip export controls and closing loopholes that allow Chinese companies to access NVIDIA-powered computing capacity remotely. If so, China might retaliate by restricting exports of rare earth minerals, some of which are crucial for building data centers. China has already warned Washington against using the controversy as a pretext for imposing tougher technology restrictions. III. Nvidia: Our Base Case Our base case is that NVIDIA's financing strategy remains intact. Colette Kress, NVIDIA's longtime CFO and newly appointed interim CEO, has worked closely with Huang since 2013 and helped oversee the company's strategic investments and financing arrangements. During NVIDIA's August 26 earnings call, she defended these investments against accusations of circular financing, stating, "We recognize the scale of this support, and we know some will call it circular financing. We see it differently." She argued that these investments would generate attractive returns while strengthening NVIDIA's AI ecosystem, suggesting continuity under her leadership. We don't expect political constraints to meaningfully increase as a result of the controversy. Nor do we expect another trade conflict with China to erupt. Even if some of the constraints intensify, they would likely turn existing speed bumps into bigger speed bumps rather than roadblocks to the AI investment boom. AI remains the latest evolution in the Digital Revolution that began with IBM's mainframes, and we expect the investment boom to continue without Huang (chart). We therefore view any resulting selloff as another buying opportunity for the AI trade.
On Semi Prices, Utilities & Better Knee Repair
It’s well known that demand for semiconductors is booming, supply is tight, and prices are soaring. The managements of two neoclouds, CoreWeave and IREN, confirmed that on recent earnings calls. But might the tide reverse? Jackie explores three headwinds gathering force that could cause semi demand and prices to sink. It’s a contrarian view, but one that IREN’s CEO finds feasible. … Also: Constellation Energy’s Q3 results suggest a bright market environment for electric utilities providers. … And in our Disruptive Technologies segment, a look at the less invasive alternatives to knee surgery under development in corporate and university labs.
Time To Sound The All Clear Signal?
I. From Caution to Buying Opportunities On September 15, we advised our readers to "Proceed With Caution." In that note, we pushed our year-end S&P 500 target of 8,400 to mid-2027 and lowered our 2026 target to 7,900. Our concern wasn't earnings. We maintained our 2027 S&P 500 EPS forecast of $425 but lowered our year-end forward P/E forecast from 19.8 to 18.6. Why? Our worry list was getting longer: geopolitical conflicts, rising bond yields, domestic political uncertainty, and concerns about the AI trade. We reckoned that these risks were increasing and would depress valuations (FOMO) despite the ongoing strength of the economy and fabulous earnings momentum (FEMO). We reiterated our caution on October 14. On October 24, we observed that buying opportunities were starting to emerge, but better ones were likely after the midterms. On November 2, we warned that a Democratic sweep could deliver a cold shower for Wall Street. The Nasdaq plunged on November 5. That evening's QT was titled, "We Promised You Buying Opportunities After The Midterms." We concluded that Thursday's selloff was the buying opportunity we had anticipated. Our post-election cold shower warning proved timely. After initially rallying on Wednesday following Tuesday's midterm elections on November 3, the S&P 500 sold off sharply on Thursday. It found support at its 200-day moving average and has rebounded since then (chart). It is only 2.6% below its October 5 record high. The S&P 500 equal weight index is back at its record high. The Nasdaq rose to a record high on October 6 (chart). It then plunged 11.9% into correction territory through November 5. It is up 4.7% since then. FEMO has offset FOMO. Soaring S&P 500 forward earnings has offset the drop in the forward P/E (charts). We think that the latter probably bottomed on November 5, while the former should continue rising, albeit at a slower pace. Our worry list is getting shorter: (1) Geopolitics. The feared post-midterm re-escalation of the Middle East war did not materialize. Instead, President Donald Trump adopted a more conciliatory tone after Republican election losses, which some Republicans partly blamed on the unpopular war. Correspondingly, oil prices have retreated recently (chart). The White House now seems determined to maintain the status quo by continuing to blockade Iran, while seeking a diplomatic solution. (2) Bond yield. The 10-year Treasury yield is back in our old normal range of 4.00%-5.00% (charts). We view this range as consistent with solid economic growth. It rebounded to the top of the range yesterday after October's hotter-than-expected CPI, which increased the odds of a 25bps Fed rate hike early next month. We've expected a 50bps hike ever since the last FOMC meeting, which voted against another hike. (3) Domestic policies. The midterms are done, removing one key source of uncertainty. The market's recent rebound suggests investors are adjusting to the new political landscape, though fiscal standoffs over the federal budget and debt ceiling remain a risk. In our opinion, the Blue Wave in Congress and state governorships might slow data center construction, but it won't stop the AI buildout (chart). (4) AI investment boom. Investors seem to be coming around to our view that financial, political, and physical constraints should be speed bumps, not roadblocks, to the AI buildout. That's principally because demand for computing power remains exceptionally strong. CoreWeave's earnings report yesterday provides further evidence, with Q3 revenue surging 168% y/y to $3.7 billion and backlog reaching $132.5 billion. Such robust demand not only justifies continued investment in computing capacity but also helps ease financing concerns. Indeed, the company expects roughly $9 billion in customer prepayments and deposits, reducing its reliance on expensive borrowing. But is this exceptionally strong demand for computing power sustainable? The latest results from OpenAI and Anthropic suggest that it is. OpenAI's Q3 revenue surged 160% y/y to $10 billion, while Anthropic's soared 1,127% to almost $17 billion. This exponential revenue growth provides compelling evidence of rapidly expanding demand for AI services, which will continue to fuel compute demand. Meanwhile, reports that Anthropic's IPO is already multiple times oversubscribed suggest that investors remain eager to finance the boom. II. Bearish Sentiment Is Bullish We are pleased to see that the Investors Intelligence Bull/Bear Ratio plunged to 1.54 last week (chart). We expected that to happen in response to last Thursday's panic attack. From a contrarian perspective, this is a strong buy signal. For the remainder of the year, we expect analysts to moderate their earnings forecasts as they account for the speed bumps ahead, while investors become more comfortable paying a higher multiple as earnings estimates become more credible and sentiment improves.
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