Week ended Aug 25th 2023: Nvidia, Jackson Hole and real interest rates
“Turning to the outlook, although further unwinding of pandemic-related distortions should continue to put some downward pressure on inflation, restrictive monetary policy will likely play an increasingly important role. Getting inflation sustainably back down to 2 percent is expected to require a period of below-trend economic growth as well as some softening in labor market conditions
. Fed Chairman Jerome Powell at Jackson Hole Symposium, Aug 25th 2023
Before getting into the modest news flow this week – including what flowed from the Jackson Hole Symposium – let’s kick off the end of this lazy August week with a quick market summary.
Global equities were generally better on the week except for China, whose economy remains under the microscope. Nonetheless, global indices remain negative for August and for the 2H2023.
US equity indices were mixed, with tech shares generally rallying, leading the NASDAQ Comp to the week’s biggest gains.
US Treasury yields were higher at the short end of the curve and slightly lower at the intermediate and long end, with the yield on the policy-influenced 2y UST closing above 5% for the first time since the mini-bank crisis in early March.
Corporate credit continues to be better bid, with spreads narrowing across the investment grade-high yield spectrum. The only exception was EUR high yield, which experienced slightly wider spreads WoW.
Gold was stronger and oil was marginally weaker WoW. The US Dollar continues to defy gravity and is slowly strengthening against the DXY index, with both Sterling and the Euro continuing (as expected) to back off of recent highs (vis-à-vis the US Dollar).
If you want to see the gory detail, for the week and more, go straight to "The Tables" section below.
WHAT HAPPENED THIS WEEK THAT MATTERED?
There wasn’t a lot of newsworthy market-moving news this week, although three things caught my ear.
Nvidia’s remarkable results, announced Wednesday after the close, inspired a short dose of euphoria and “feel good” in risk markets the morning following the release, which quickly faded as the day wore on. (Friday re-started the upward trajectory in tech shares but for other reasons apparently.)
Most eyes and ears were focused on the Jackson Hole Symposium which started Thursday evening, and more specifically on what Mr Powell would say.
There seems to be more and more discussion, especially on #Bloomberg, regarding real interest rates. I took quick look at whether or not the current level of real interest rates (around 2%) should be concerning given history.
Nvidia 2Q23 earnings
Nvidia (NVDA) announced their 2Q2023 earnings (quarter ended July 31, 2023) on Wednesday after the close (company press release here). The results far exceeded analysts’ consensus expectations on the top and bottom line, as well as representing significant “beats” vis-à-vis the prior quarter and the same quarter of the prior year, as you can see below:
NVDA is perfectly positioned to take advantage of the groundswell of interest in AI, probably more than any other company, and this is reflected in the company’s 2Q23 results, as well as the very optimistic guidance provided by CEO (and co-founder) Jensen Huang on the analysts’ call following the earnings release. The company also increased its share repurchase programme to $25 billion. For context, the company repurchased circa 7.5 million shares for $3.28 billion in the second quarter. Despite this remarkable quarter and favourable guidance – and without going on and on about NVDA – three things bother me:
Any way you slice it, the valuation using fundamental analysis looks ridiculous. I wrote about this last week so will not repeat what I said then. However, the pop in the shares post-earnings in fact proved to be short-lived, even as nearly every analyst on the Street rushed to bang up their price targets to $550-$600+ per share following the earnings release (which raises many other questions that I won’t drift into in this update). Great company, stupid price…..be patient because this is FOMO at its best.
Results in the 2Q23 might have been better-than-expected because sales were brought forward from China, which is facing a reduction (or elimination) of its ability to source the most sophisticated AI chips from US chip companies like NVDA courtesy of the Biden Administration. (See Reuter’s article regarding August 9th executive order here.)
A share buyback can cut both ways in that it suggests confidence in the company by the Board and top management, and provides support for the stock price. However, banging up the share repurchase programme at these valuation levels seems slightly ill-advised to me.
The stock ended higher on the week at $460.18/share (+6.3% WoW) but closed well off its post-earnings intraday high of $502.66/share on Thursday morning. Despite analysts rushing to revise their price estimates up to even more ridiculous levels, perhaps enough investors were smart enough to take money off the table at these lofty levels.
Jackson Hole Symposium
At the Jackson Hole Symposium sponsored by the Kansas City Fed (link to symposium here), Fed Chairman Powell’sspeech was along the lines of what the Fed talking heads had largely laid the groundwork for leading up to this event. Firstly, the Fed is fully committed to increase rates further if economic data suggests that the current trend in disinflation might be disrupted. Secondly, the Fed is committed to maintain tight monetary policy for as long as it takes to get inflation back to the 2% target, meaning rates are likely to remain elevated even when the Fed decides to pause its rate rises. I heard nothing new, and apparently the markets didn’t either. After gyrating on Friday, UST yields ended a few basis points higher and equities rallied, although whether or not Mr Powell’s comments had anything to do with either is impossible to say. Mr Powell’s written comments from the Federal Reserve website are here, and the video is also on the website, here. In the afternoon, ECB President Christine Lagarde addressed the conference, and you can find a transcript here. Whether you think the Fed has bungled its role or not, the reality is that the economic metrics of the US look far better than those of Europe at the moment since the Eurozone in particular is facing sluggish growth and persistently stubborn inflation, that old cocktail known as “stagflation”. Ms Lagarde certainly has her work cut out for her, and decisions to be made at next monetary meeting will certainly be interesting.
Real interest rates
Since the topic of real interest rates has been discussed a lot recently, I thought I’d take a look. The chart below from FRED shows the 10-year constant maturity spreads for TIPS (inflation-linked UST notes), as well as the 10-year outlook for real rates from the Federal Reserve Bank of Cleveland which has a longer data series.
Real interest rates are driven by long-term structural factors, including changes in productivity and demographics, and I have neither the expertise nor patience to drift into this in detail. However, what you should note in the graph above is that real interest rates were considerably higher in the pre-GFC period, especially prior to the early 1990s. Between the early 1990s and the advent of highly accommodative unconventional monetary policy during the GFC, real rates hovered in the 3% area (say 2% to 4%). The GFC ushered in a period of essentially “free money” with the Fed Funds rate anchored at 0% alongside several rounds of QE that kept long-term yields anchored at artificially low levels. I view this period (between the GFC and pandemic) more as the aberration than the time before and now, when real rates have been around around 2%.
The current 2% level – which is concerning some people – has so far had no real bearing on US economic growth or the jobs market. I think real rates need to push higher to create a drag and help address inflation – 2% doesn’t seem to do it. The actual rate is of course theoretical and often-discussed, and if you want to do more research, I suggest you dig up some research on r* (r-star), the long-term neutral rate of real interest rates.
Interest starts accruing again on US student loan debt on September 1st, with payments resuming in October 2023. You can find further information on the Federal Student Aid website. Student loan debt in the US is around $1.6 trillion
Upcoming central bank meetings are as follows:
Federal Reserve (FOMC): Sept 19-20 (with updated projections)
ECB: Sept 14
Bank of England: Sept 21
Bank of Japan: Sept 21-22
The tables below provide detail across various global and US equity indices, the US Treasury market, corporate bonds and various other asset classes.
Corporate bonds (credit)
Safe haven and other assets