(Bloomberg) — US semiconductor stocks have come roaring back over the past month, and the largest of them — Nvidia Corp. — has led the charge. Even some bulls on the company say the rally may not have much further to run.
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Nvidia’s third-quarter results late Wednesday are likely to show that demand for electronics is still drying up, with analysts predicting an 18% drop in sales. Yet the stock, at 39 times estimated earnings, is still priced for a much better environment, at a time when the global economy appears to be heading for recession.
“It’s the worst of all worlds, because the rate of revenue growth is declining, macro fundamentals are deteriorating, and the valuation is still exceptionally high,” said James Abate, chief investment officer at Center Asset Management. “If we do go into a recession, which I think we will, the next stage will be a deterioration in earnings, and it would not be abnormal to see further weakness in Nvidia.”
Abate owns Nvidia but has been trimming his position in the stock, which has risen nearly 50% from its mid-October low. It’s still down by 43% for the year. The stock rose 2.9% on Tuesday, supported by the latest data on producer prices, as well as signs of improving China-US relations.
Plenty of investors are betting that this year’s bear market in tech stocks has run its course: Regulatory filings this week showed that Warren Buffett’s Berkshire Hathaway Inc. took a stake of about $5 billion in Taiwan Semiconductor Manufacturing Co., which makes chips for Nvidia among others.
The bull case is that the Federal Reserve will slow the pace of interest rate increases as inflation gradually cools off, allowing the economy to dodge a recession. In that scenario, investors can look ahead to an imminent rebound in tech demand.
Nvidia is a bellwether in all this because it’s the largest component of the Philadelphia Stock Exchange Semiconductor Index by market value, and a leader in the key market for data-center chips. It’s long been a favorite of institutional investors because of its record: In the decade leading to their peak a year ago, Nvidia shares returned 58% annually, far outpacing Apple Inc., Microsoft Corp. or Amazon.com Inc.
Yet there’s still no evidence the worst has passed. Delivery times for semiconductors shrank by six days in October, the biggest drop since 2016, while Morgan Stanley wrote that the latest industry data showed weakness across product categories. Texas Instruments Inc., Qualcomm Inc., and Intel Corp. all issued cautious forecasts in their results this earnings season, as Nvidia did last quarter.
Geopolitical concerns have also weighed on the stock, given US restrictions on China’s access to semiconductor technology, although Nvidia is producing a processor that conforms to the regulations.
Analysts have been slashing their estimates on the sector, and Nvidia has not been spared. The average estimate for the company’s 2023 earnings has dropped 16% over the past three months while the consensus for revenue is down 11%. Revenue growth is expected to be barely positive in 2023.
Yet the stock, at 39 times earnings, is a third more expensive than its average for the past decade, and sells for more than double the multiple of the semiconductor index.
Analysts do forecast that Nvidia will return to double-digit growth in 2024. That expected rebound is a reason why they remain largely positive on Nvidia’s long-term prospects. Citigroup Inc. says the stock is “close to a bottom,” with data-center sales likely to trough in the first quarter, while Morgan Stanley also sees the business bottoming.
Some longtime bulls on the stock are, like Abate, hedging their bets. Funds run by Cathie Wood’s ARK Investment Management LLC — which have held the stock since the firm began operating in 2014 — have been paring their stakes in recent weeks.
Tech Chart of the Day
The Nasdaq 100 Index last week posted its biggest weekly gain since November 2020, and the advance has it looking much stronger on a technical level. On Friday almost half the index’s components were above their 200-day moving average price, the highest percentage since March, and up from about 8% in late September. Over the past year, an average of 32% of components have been above this closely watched technical level.
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–With assistance from Subrat Patnaik.
(Updates to market open.)
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