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Executive Summary

Today’s missive compares the historical price movements in Cisco Systems to the price movements in Nvidia today. While there are some differences, the outcome is likely to be the same.  

I encourage you to read The Details below for more information.

“Whenever you find yourself on the side of the majority, it is time to reform (or pause and reflect.)”
–Mark Twain

The Details

The S&P 500 Index is being led by a handful of companies. The leader among them is Nvidia. Appollo Academy recently reported on this concentration in an article entitled, “The S&P 500 Looking More Vulnerable,” found here. The following is an excerpt.

“The top 10 companies in the S&P 500 make up 35% of the market cap but only 23% of earnings. This divergence has never been bigger, suggesting that the market is record bullish on future earnings for the top 10 companies in the index.”

This is not the first time in history where a bubble was led by technology related stocks. The following was excerpted from Crescat Capital’s article “Connecting the Critical Nodes,” and compares Nvidia today to Cisco Systems during the Technology Bubble. (emphasis mine)

“Cisco Systems was the most valuable company in the world at the peak of the dot-com bubble in March 2000. Its stock price had reached a high of $80.06 per share giving the company an enterprise value (EV) of $548 billion or 5.5% of US GDP and 37 times sales. Investor exuberance over tech stocks was high. The future economic promise of the Internet for the world economy was strong, but the forward earnings growth rates implicit in tech stock valuations were not achievable. Stocks had overshot. Tech earnings were getting ready to inflect sharply downward in the course of the normal business cycle. Cisco’s stock price would fall 89% over the next two-and-a-half years. The stock price has yet to return to its prior high in the 24 years since. Advancements in AI technologies today portend enormous productivity benefits for the long-term growth of the economy, just like the Internet did in 2000. But valuations among the leading technology companies are even more stretched today than they were then implying future earnings growth rates that once again should prove impossible to achieve. For instance, Nvidia recently earned the most valuable company in the world status with an EV of $3.3 trillion, a record 11.7% of total US GDP at its recent peak on June 18, more than twice as high as Cisco’s achievement in 2000. It also has an even richer multiple of 41 times revenues. We think it has impossible future growth expectations to live up to.

 

Valuations Shockingly Stretched vs. the Economy at Large

But it is not just Nvidia. When we look at all of the largest ten tech stocks’ combined EV relative to GDP in 2000 vs. today, the valuation is also about twice as big, over 60% compared to about 30%. The basic law of economics that we postulate works like this: Valuation comparisons relative to GDP matter because the economy at large can only grow so much and there is only so much total economic spending to go around to drive the earnings and stock price multiples of competing free market enterprises, and a lot more than just 10 companies are gunning for this market share.

Furthermore, just like the Internet proved to be, we believe that AI is a highly disruptive technological innovation, that will allow new companies to rise by attacking the monopolistic business models of the entrenched tech giants. Joseph Schumpeter, the Austrian Economist called this process ‘creative destruction’… 

Indeed, competition is critical to expanding the real GDP growth pool necessary to make AI a truly positive-sum game for overall economic progress. We are highly confident that advancements in AI are at a critical mass phase for long-term economic progress. But for us, this means that we must first prepare for creative destruction in the short term which means a significant bear market ahead for the leading large-cap tech stocks and the S&P 500 including potentially a substantial stock market crash.”

The historical stock price movements in Cisco Systems are presaging what is likely to happen to Nvidia in the not too distant future. As we know the future doesn’t repeat itself; however, it does often “rhyme.” 

The S&P 500 Index closed at 5,615, up 0.9% for the week. The yield on the 10-year Treasury 

Note fell to 4.19 %. Oil prices decreased to $82 per barrel, and the national average price of gasoline according to AAA rose to $3.52 per gallon.


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© 2023. This material was prepared by Bob Cremerius, CPA/PFS, of Prudent Financial, and does not necessarily represent the views of other presenting parties, nor their affiliates. This information should not be construed as investment, tax or legal advice. Past performance is not indicative of future performance. An index is unmanaged and one cannot invest directly in an index. Actual results, performance or achievements may differ materially from those expressed or implied. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy.

Securities offered through First Heartland Capital, Inc., Member FINRA & SIPC. | Advisory Services offered through First Heartland Consultants, Inc. Prudent Financial is not affiliated with First Heartland Capital, Inc.