Destined to Become a Long-Term Loser

Revisiting the latest speculative excess... A $184 billion jump in a single day... Yes, this is really Dan Ferris and not a cyborg... Owning the best businesses won't save you... This business is actually shrinking... Destined to become a long-term loser... Two things that could cause a return to reality... No one knows the future...

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Here we go again...

If you're thinking about whether the stock market has bottomed... you have it backward.

Instead, you should be wondering when the top will be all the way in.

I (Dan Ferris) have said that before. But even I continue to be astounded as it plays out before our eyes – and new pockets of speculative excess keep emerging.

I mentioned the latest example of speculative excess in the market in last Friday's Digest...

And the reason folks are buying all the Big Tech names again is as dumb as all the reasons they bought the crap out of every tech stock on the planet in 2020 and 2021...

It's because all the Big Tech companies are now seen as ways to play the latest technology craze that will soon magically transform life as we know it, make everyone rich, and turn everything around us into a wonderful utopia...

Artificial intelligence ("AI").

If you haven't used the online AI bot called ChatGPT yet, try it out. You'll want to see for yourself how dumb it is. It's essentially a prettier way of searching the Internet.

Then, I gave examples of how Big Tech companies Microsoft (MSFT) and Alphabet (GOOGL) are getting into AI.

This latest tech craze is likely why the Nasdaq Composite Index shot up 1.7% yesterday.

The tech-heavy index can thank one of its largest components for the big one-day jump...

I'm talking about chipmaker Nvidia (NVDA), which surprised the markets this week...

On Wednesday, Nvidia reported a 19% increase in first-quarter revenue. It also projected second-quarter revenue of $11 billion – which would be a 64% year-over-year increase.

The market loved Nvidia's announcement. As a result, the stock rose 24% yesterday.

At nearly $390 per share today, it's comfortably at a new all-time high. In fact, it's trading about 18% above its most frenzied 2021 peak closing price of roughly $330 per share.

The company's market cap rose from $755 billion to $939 billion yesterday. That's a $184 billion surge in a single day.

For perspective, $184 billion is roughly equal to the market value of some companies you'll recognize. It's like creating a new Accenture (ACN), Adobe (ADBE), or Abbott Laboratories (ABT) out of thin air.

Those three companies currently rank among the world's top 60 most valuable businesses. And yet, Nvidia's value increased by their entire market caps (or more) in one day.

Nvidia's stock now trades at about 145 times its past four quarters of net income.

Want to guess why Nvidia expects business to be so good?

Yup, that's right... AI.

The term "AI" appeared 15 times in the company's press release. And company co-founder and CEO Jensen Huang struck a breathless tone that felt very 2021 to me...

The computer industry is going through two simultaneous transitions – accelerated computing and generative AI.

A trillion dollars of installed global data center infrastructure will transition from general purpose to accelerated computing as companies race to apply generative AI into every product, service, and business process.

Our entire data center family of products – H100, Grace CPU, Grace Hopper Superchip, NVLink, Quantum 400 InfiniBand and BlueField-3 DPU – is in production. We are significantly increasing our supply to meet surging demand for them.

Now, Huang knows his business better than anyone else. And it has grown into a huge company under his guidance over the past several years.

(Stansberry Venture Technology editor Dave Lashmet and his subscribers know what I'm talking about. With a 1,466% gain, one of the legs of Dave's recommendation is currently the No. 1 position in our Stansberry Research Hall of Fame at the bottom of every Digest.)

With all that in mind, I have no reason to doubt Huang's claim that companies really are racing to "apply generative AI into every product, service, and business process."

I know that I made fun of the popular AI platform ChatGPT last Friday. But I'm not naïve...

AI is serious business. It's already very powerful. And it will only get more powerful. It can probably help humans like us do all kinds of things we haven't even thought of yet.

In the coming years, AI could spark a revolution on par with the dawn of the Internet.

Yes, this is really Dan Ferris and not a cyborg...

And yes, I really think AI is in the early days of a technological revolution. It's destined to change how we live and work in the weeks, months, and years ahead.

I'm not kidding. No bearish punch line is coming... about the technology.

But investing isn't always as simple as just backing the right new technology trend...

AI continues to evolve and thrive – and it will keep evolving and thriving. However, at this very moment, it isn't just as easy as buying Nvidia and waiting as it keeps soaring higher.

Some people try to make investing easy with advice like, "You can't go wrong if you buy the best companies." But as I've said before, starting at our annual conference in 2017...

Owning the best businesses won't save you...

During my 2017 presentation, I talked about the no-brainer companies that folks bought during the dot-com boom. People just "knew" they couldn't lose money with these stocks...

For example, Cisco Systems (CSCO) was the No. 1 darling of the dot-com era. The company sells the routers and switches that make up the "plumbing" of the Internet. So everybody thought it was a surefire way to profit from the exponential growth of Internet users.

Cisco went public as a penny stock in 1990. It peaked at around $80 per share in March 2000. Then, it crashed to roughly $8 per share in 2002. And it still hasn't returned to its peak.

Cisco earned $2.7 billion in net income in the fiscal year that ended in July 2000. At $80 per share, it was valued at around $560 billion – a little more than 200 times earnings.

At that moment, Cisco had 200 years' worth of earnings baked into its stock price. It could never live up to that kind of wildly irrational expectation.

No business has ever truly been worth that much. Even an amazing, growing technology business serving a new, rapidly expanding market isn't worth that much.

Everybody who bought Cisco's stock anywhere near that level lost money. And more than two decades later, they're still waiting for the investment to pay off...

When you factor in the dividends that Cisco has paid over the past 23 years, the cumulative total return for investors who paid $80 per share in 2000 is a loss of about 25%. Put simply, investors paid too much – and after 23 years, they're still 25% shy of breaking even.

A business that sells for 200 times earnings isn't signaling a new era of tech hypervaluations...

It's signaling that absolutely everybody in the market thinks it's a can't-lose investment.

It reminds me of what late investor Sir John Templeton warned us about. As he famously said...

Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.

The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

When investors are too optimistic, they're setting themselves up for terrible returns. That's true even if they're right about the underlying industry or technology trend.

The folks who put money into Cisco at the height of the dot-com boom were right about the Internet. It has revolutionized our lives. How did we ever get things done before it existed?

But from an investing standpoint, Cisco was way too expensive in March 2000. It was doomed to lose money for more than two decades (and counting).

Now, a little more than two decades later, investors are doomed to lose money on Nvidia as well. And not just because the business is deteriorating – although that doesn't help...

That's right. Nvidia isn't growing. It's shrinking...

Nvidia's operating margins have gotten crushed over the past five years. They peaked in July 2018 at 37%. And as of this past January, they were at about 16%.

The company's 12-month operating income was down nearly 60% year over year through January – from $10 billion to $4.2 billion. And its trailing 12-month revenue has declined 9% over the past two quarters.

I don't know why anybody thinks that kind of performance is worth 145 times earnings. Or why they think its stock was worth 24% more yesterday than Wednesday.

But that's the kind of market we're still in. And we're still living through this kind of market despite the big decline in 2022 and the fastest interest-rate-hiking cycle since 1980.

To make money at that kind of valuation, the business has to stop shrinking and grow at higher rates and higher margins for a long time. That's probably not going to happen.

So in the end, Nvidia investors are destined to become long-term losers for the same reason Cisco investors were destined to lose when they paid $80 per share in 2000. It's highly unlikely that the business will ever be worth what they're paying for it in the market today.

What does all this mean?

Like I said at the start of today's Digest, it means that people are looking for a stock market bottom when they should probably be looking for signs that the top is all the way in.

In other words, as long as new tech fads can make mega-cap stocks with declining margins trade for 145 times earnings... the speculative juices are still flowing and many popular stocks are still overvalued.

Two things might whack investors on the side of the head and help them return to reality...

We discussed the first one last Friday – the debt ceiling.

Like I said, I seriously doubt the U.S. government will default on its debt. But it might have to stop paying some of its bills. And that means Congress could do some real economic damage to the U.S. without even realizing it.

I recently spoke with macro investor Alf Peccatiello about the debt-ceiling debate for the next episode of the Stansberry Investor Hour podcast...

Peccatiello agrees that a default is highly unlikely. But he doesn't rule out the possibility that the government will begin to run out of money and need to prioritize debt payments over others...

He estimates that as much as 30% of discretionary government spending might get cut for long enough to hurt U.S. gross domestic product ("GDP") in the second and third quarters.

As a result, Peccatiello believes it could push us officially into a recession.

U.S. discretionary spending totaled $1.7 trillion in 2022. A 30% cut would take that down to about $1.2 trillion – removing roughly $500 billion in spending from the U.S. economy.

Maybe $500 billion doesn't seem like a big chunk of a $26 trillion economy. It's less than 2% after all. So let me put it this way...

In the first quarter, U.S. GDP grew roughly $328 billion. A $500 billion hit to the economy would erase all that growth and more.

In other words, it would turn last quarter's positive GDP growth into negative GDP growth. And if that happens for two quarters in a row, the National Bureau of Economic Research would officially declare a recession.

That brings me to the other possible head-whacking thing for investors...

Interest rates.

Simply put, the high valuations in the stock and bond markets suggest investors are complacent about the likelihood that rates will stay higher for longer.

We've mentioned the CME Group's FedWatch Tool in the Digest before. It uses federal funds futures market pricing to come up with the probability of whether the Federal Reserve will hike, pause, or cut the benchmark rate at future Federal Open Market Committee meetings.

Recently, the FedWatch Tool indicated that the central bank would likely pause its rate hikes in June. As we go to press, it lists a 65% chance that the Fed will hike rates another 25 basis points at that meeting.

Looking even further out, the FedWatch Tool previously projected that the Fed would keep rates unchanged through its July meeting and start cutting rates in September. Now, it overwhelmingly favors another rate hike by July at the latest. And after that, the current data shows that the Fed could leave rates unchanged through at least November.

That doesn't sound like the end of the current rate-hiking cycle.

Keep in mind that this is how the inflation saga played out, too...

First, the Fed's narrative was "transitory" inflation. After it stuck around longer than expected, the tune changed. And now, more than a year later, it has supposedly peaked.

The Fed recently decided that instead of talking about a possible "pause" in rate hikes, it will use the term "skip." That way, it's clear that just because the Fed keeps rates unchanged at any given meeting doesn't mean it won't then go back to increasing them at the next one.

It sure sounds like the Fed is trying to condition us to forget about pauses and rate cuts.

We'll see how it all plays out.

But so far, inflation and the higher rates intended to combat this problem have outlasted most folks' expectations. So calling for the end of this cycle right now feels a lot like the folks who always want to call the bottom of the bear market.

I don't know the future...

No one does – not even ChatGPT.

When it comes to the debt-ceiling debate, we don't know how the standoff in Congress will play out in the days ahead. We don't know how far these politicians are willing to go.

I've assumed that Congress can't possibly go too long without a debt-ceiling deal. Throughout history, it has always worked something out in the nick of time.

But maybe I'm wrong. Maybe the politicians will push it further than we would ever believe.

And a lot of folks assumed the Fed would start cutting rates later this year.

But maybe they've gotten it all wrong. Maybe the Fed thinks that fighting inflation is far more important than an influx of bank failures, a deep recession, or all sorts of other economic maladies.

Nvidia's surge yesterday, the hunger for all things AI, and the general complacency in the market right now suggest that nobody is really worried about any looming disasters.

But that's a mistake...

Nvidia might look like one of the best companies in the world today. However, there's a good chance it will turn into the next Cisco in the near future. And it won't be the only one...

The investing crowd won't chase the speculative excess forever. When it stops, watch out.

New 52-week highs (as of 5/25/23): Applied Materials (AMAT), ASML (ASML), Broadcom (AVGO), Commvault Systems (CVLT), Meta Platforms (META), Microsoft (MSFT), and Palo Alto Networks (PANW).

Our mailbag is quiet ahead of the long holiday weekend. Speaking of that, one quick housekeeping note before we wrap up...

Our offices and the U.S. markets are closed on Monday in observance of Memorial Day. So after this weekend's Masters Series, we'll pick up with our regular Digest fare on Tuesday.

Until then, you can send your thoughts, comments, and observations on the markets to feedback@stansberryresearch.com. We always look forward to hearing from you.

Good investing,

Dan Ferris
Eagle Point, Oregon
May 26, 2023