The Nvidia Stock Run Will Soon End

I did myself the favour of watching a couple of videos of Jensen Huang, CEO of Nvidia, this weekend. Is Nvidia that different? Is the company really that ahead?

Many don't even know that Nvidia does not manufacture chips. They design chips. They rely on TSMC (Taiwan Semiconductors) for manufacturing.

Now here is the trick question - why is Nvidia surging on the stock exchange but TSMC is just barely hanging in there? This is a multi-billion-dollar question.

Why the Divergence Between Nvidia and TSMC?

The best argument I can find online is that Nvidia has better margins. Nvidia has pricing power and can charge a premium on its chip designs. But that argument has flaws.

The revenue of TSMC doubled that of Nvidia in 2023. Nvidia posted a revenue of about $30 billion while TSMC posted a revenue of about $70 billion.

It doesn't end there. The total assets of Nvidia is about $40 billion while the total assets of TSMC is about $173 billion. Now, this is not about merely comparing two companies in the same industry. This is comparing two companies in the same value chain.

Let's revert to some common sense here. Who do you think should have more market share? The company that manufactures or the company that designs?

I know you think that depends on a lot of factors. But from the numbers we have of the assets and revenue, you know what the answer should be. If the stock market was a fair reflection of the real economy, TSMC should have a larger market cap. But that is not the case today.

TSMC has a market cap of $690 billion. While Nvidia has more than double at $1.7 trillion. That is where the facts stand today in early February 2024.

Before going into any prediction of what will happen or what is supposed to happen, first, we have to understand why Nvidia has more market cap than TSMC.

Contrary to what you hear in stock analysis, business news, or interviews with the CEO. This is the truth you will rarely find anybody admit to openly.

The Real Reason Nvidia is Surging

First, you have to understand that not only is Nvidia surging, but we also have the magnificent seven stocks on the US stock exchange. So far in 2024, they have yielded more than 40% in gains while everything else barely moves an inch.

To understand what is happening, we go back to 2023 where this anomaly began. And for us to really understand what happened in 2023, we have to go back to 2020.

In 2020, the lockdowns were announced and the Federal Reserve started with stimulus. The central bank printed trillions of dollars during those periods. No one knows exactly how much. Some say it is north of $10 trillion. But we know it is trillions because the US national debt grew by trillions.

This stimulus sent the US stock market into overdrive. So, while businesses on the ground were finding it hard to operate, the stock market was surging like it was the best economy ever. Meanwhile, the supply chain had issues and most businesses couldn't operate.

The stimulus led to the crazy year called 2021. Everything was still surging. Stocks made new highs. The important note here was that barely anything new is getting produced. It was the stimulus from the central bank that flowed directly into the stock market.

Then, the effect started to show on the price of goods and services. Inflation began to roar its head. And the central bankers initially dismissed it as "transitory". But they couldn't ignore it anymore in 2022.

The Fed started raising rates aggressively in 2022. This caused the stock market to get a reality check and fall heavily during the year. On the heels of this, plus the central bank still maintaining its high-interest rate posture, analysts predicted a recession in 2023.

They expected a continuation of what happened in 2022. And then, almost all investors took a defensive posture to their strategy. Now, this is where it starts to get interesting...

How do you take a defensive posture in the modern-day economy? Stocks and bonds now rally together. Historically, investors ran to bonds when there was a threat of recession. This time they couldn't because there are some concerns.

The government debt had gotten to unsustainable levels such that the interest payment is now the biggest item on the US budget. Foreign buyers of US bonds are reducing their exposure. The central bank is publicly refusing to buy more bonds to tighten monetary policy and bring down inflation. And the current US administration doesn't exactly instil confidence.

To add to all of that, the US Treasury was now borrowing at an unprecedented rate. A combination of all of these raised bond yields to about 4%. Bond investors are scared, that bond prices might fall further. So no one wants to park a significant chunk of capital there.

Also, everybody saw what happened to SVB earlier in the year 2023. Their bond portfolio drove them into the ground. So, bonds became risky in the midst of a recession call.

So what did investors do? They hulled their way back to stocks. The idea is to find strong companies with strong cash reserves and bet heavily on them. Great businesses that they know won't go down whatever happens.

There was a fleeing into the dependable names. And gradually, there was a divergence. Seven stocks stood out. However, Nvidia being one of them wasn't something anyone predicted.

Now, you must understand that the money flowing into these stocks is mostly money that has found itself in the hands of investors through the easing cycle, especially of the last 4 years. Everyone wanted a return on their money. Bonds weren't trustworthy. So investors just gradually gravitated to big-name stocks with huge cash positions and dependable businesses (that a recession would hardly hurt).

It wasn't the companies or businesses that came up with a brilliant idea. It was trillions of dollars that was looking for a place to park itself.

Nvidia joined the fray with the AI trend. ChatGPT went mainstream and no tech company was ready for the AI boom like Nvidia. So, they naturally lead the conversation and growth narrative. Hence, the trillions of dollars looking for a home found Nvidia as a place to park.

Here is my guess of the end-of-the-year rally in 2023. Most investors had a defensive position. Many were keeping out cash expecting that the market would crash. But it didn't. So, many realized that they would post poor performance for the year if they stayed on the sidelines since the recession was not going to show up.

So, the rally at the end of the year was to save face for many investment firms. If you asked most Wall Street firms what their performance was in 2023 without November and December, you would realize this to be true. Those last two months saved the year for many who were positioned for a recession and none came.

And now, into 2024, many investors are betting on a repeat of 2023. As you can see lots of money is already piling up into those seven stocks again. But it won't work like last year.

The Inflection Point

Now you realize that Nvidia has its market cap, not because of its business, not because of its revenue, not because of its growth potential, not because of its margins, not because of its AI leadership. Instead, it is because trillions of dollars were looking for a home in the US markets.

This explains why TSMC isn't part of the wave. TSMC is not listed as a public company in the US. TSMC is not an American company. So, the market cap of TSMC is still within the reasonable range.

Nvidia is a great company. It has a great business. But the stock price is clearly in a bubble territory. And this is how the bubble will pop.

Why is money running away from the real economy and hiding in seven stocks on the US stock exchange? It is because the money came from the Fed, the US dollar is the global reserve, and real businesses are not expected to perform well financially when the cost of borrowing is high.

No one wants to borrow money or refinance at this high interest rate level. And so they will rather sacrifice growth than borrow at a high interest rate. This is why you see companies laying off staff.

Their growth narrative is doing the same thing with less overhead. But that will start to change when the cost of borrowing money starts to come down. This is what will send money out of the "stock market" economy into the real economy.

You know what I am talking about - rate cuts. The moment the Fed starts cutting rates, things are going to change drastically. The Magnificent Seven party will be over.

And this is because there will be better opportunities for money to grow in other places. Emerging markets will become appealing again. Bonds will feel less risky. But that is not all.

No one knows what the extent of the fallout will be. But there will be a fallout once the Fed starts cutting rates. Most analysts are saying that rate cuts would be a good thing for the markets. But they would be dead wrong, just as they were wrong on the recession call for 2023.

The Fed is not going to cut rates because inflation is coming down. That's a distraction. The real reason the Fed would cut rates is financial stability. There is a looming crisis in commercial real estate on the horizon.

There is arguably a $1.2 trillion hole in commercial real estate financials. But no one knows exactly where that hole is. And just like the 2008 crisis, by the time we all realize where the hole is, it will be too late. Banks are notorious for covering up stuff until it is so bad that it can't be covered up anymore. Whatever you are hearing about commercial real estate now is just the tip of the iceberg.

Here is my opinion - the market will crash when the Fed begins to cut. However, I may be wrong. And this is definitely not financial advice.

My opinion with Nvidia is that it will suffer a steep crash more than others. It has $40 billion in assets and a $1.7 trillion market cap. The bear market won't be kind to that sort of metric.

All the other magnificent seven members have hundreds of billions in assets (except Tesla which has about $93 billion in total assets, but its market cap is about $600 billion). Think about that.

However, pending the time the rate cuts begins, the Magnificent Seven party will keep going on. So, while you enjoy the party, keep your eyes on the exit.

Stay rich.

P.S. Read this next - Bitcoin: The bull run is not over yet