Opinions

The market’s faith in artificial intelligence was shaken, tested, and then reaffirmed this week exposing just how much global risk appetite still depends on a handful of megacaps and the promise of AI-driven growth. But when Nvidia’s results arrived, they delivered both vindication and a reminder of the fragility of sentiment. The chipmaker’s blowout forecast briefly pulled indexes higher, but enthusiasm turned to anxiety and back again in the span of a single session. We believe Nvidia might be the sole winner in the current AI capex megacycle. We look at the F3Q26 results and analyse what these numbers say what we believe might be the story of next 5 years. Key observations are as following: 1. Management provided solid evidence that addressed several key investor questions. 2. Management sees potential upside to its prior Data Center revenue outlook of $500 bn in 2025/26. 3) Rubin remains on track for introduction in mid-2026 and a strong revenue ramp in 2H26. 4) The company sees an extended useful life for its past generation GPUs, with most of its Ampere series GPUs (shipped up to six years ago) still running near full utilization. Nvidia reported revenue of $57.0 bn, well above street estimates at $55.4 bn. Gross margin came at 73.6% against street at 73.7%. In fact the company expects to be able to hold its gross margin at ~75% throughout FY27 as well. AI GPUs are likely to represent on average high 80% to 90% of total NVDA data center sales in FY2026-FY2027 which is a high margin business. There is huge demand for Blackwell & Rubin as can be seen in total inventory which is up 132% Q/Q at $19.8Bn. The company has positioned itself much ahead in time for the anticipated demand. The core of the company, the data center business delivered quarterly revenues of ~$43b versus market estimates of ~ $42b (with Blackwell at +46% q/q to ~$41b in revs and Hopper/all else down from ~$6b to $2b in the quarter). The management reiterated its prior expectation that it sees over $500 bn of customer demand for its Data Center products across both Compute and Networking products for its Blackwell and Rubin generations and the company sees the potential for upside to this figure based on incremental customer orders. Nvidia continues to see a path to $3 -4 TN in annual AI infrastructure spending by 2030, and it expects to capture significant share of this market. Just like the dot com era, many companies will go under but AI is here to stay just like the internet stayed. Growing hardware demands of AI infrastructure are driving a shift from asset-light to asset-heavy business models, marking a significant change in the technology sector. With robust CapEx spending expected to continue and significant investments needed to support an AI-enabled future, Nvidia is at the right place at the right time with the right mix of technology and capital. We might debate the likes of Oracle & Palantir’s place in AI’s future but Nvidia is different. They are the factory of building blocks of what will be required for AI applications in future.

US S&P 500 companies have delivered far better than expected results in Q2CY25. For Q2 2025 (with 90% of S&P 500 companies reporting actual results), 81% of S&P 500 companies have reported a positive EPS surprise and 81% of S&P 500 companies have reported a positive revenue surprise. For Q2 2025, the blended (year-over-year) earnings growth rate for the S&P 500 is 11% against consensus estimates of 4%. If 11% is the actual growth rate for the quarter, it will mark the third consecutive quarter of double-digit earnings growth for the index. From a valuation perspective, the forward 12-month P/E ratio for the S&P 500 is 22.1. This P/E ratio is above the 5-year average (19.9) and above the 10-year average (18.5). At a sector level, commodity sectors - Energy and Materials - were a drag on overall earnings growth. Ex-Energy EPS growth stands at +14% yoy. Interestingly, the spread between Mag-7 and S&P500 ex Mag-7 has narrowed, with ex Mag-7 seeing the best EPS growth in years, at +9% yoy. A weaker dollar helped drive an acceleration in S&P 500 sales growth during 2Q 2025. We expect DXY to remain weak in medium term too and hence act as a tailwind for S&P 500 sales growth. In earnings call transcripts of all the S&P500 companies from June 15 through August 7, the term “recession” was cited on 16 earnings calls conducted by S&P 500 companies during this period. This number is well below the 5-year average of 74 and the 10-year average of 61. In fact, this number reflects a quarter-over-quarter decline of 87% compared to Q1 2025, when the term “recession” was cited on 124 earnings calls. Summary: Corporate margins are still not affected by tariffs incomplete pass through or because of weak US consumer demand. Hence, we believe there is sufficient scope for US corporates to imbibe tariff impact in their margins if consumer demand proves elastic to higher prices. From a valuation point of view, there is still some scope for upward move in broader markets as well as select pockets. Fed rate cuts are still not priced in fully in earnings and we expect a moderately reduced +ve earnings surprise to continue for one more quarter. It is only after Q3CY25 results that we expect some consolidation in US equities.

The second quarter earnings season for the S&P 500 is off to a strong start compared to expectations. Both the percentage of S&P 500 companies reporting positive earnings surprises and the magnitude of earnings surprises are above their 10-year averages. 12% of the companies in the S&P 500 have reported actual results for Q2 2025 to date. Of these companies, 83% have reported actual EPS above estimates, which is above the 5-year average of 78% and above the 10-year average of 75%. In aggregate, companies are reporting earnings that are 7.9% above estimates, which is below the 5-year average of 9.1% but above the 10-year average of 6.9%. In terms of revenues, 83% of S&P 500 companies have reported actual revenues above estimates, which is above the 5- year average of 70% and above the 10-year average of 64%. Of the 60 companies that have annoucned results till now for Q2CY25, 83% have reported actual EPS above the mean EPS estimate, 5% have reported actual EPS equal to the mean EPS estimate, and 12% have reported actual EPS below the mean EPS estimate. Companies are reporting earnings that are 7.9% above expectations. This surprise percentage is above the 1-year average (+6.3%), below the 5-year average (+9.1%), and above the 10-year average (+6.9%). What does not break finally gets stronger. Investors seem to be looking through tariff hikes and focusing on the outlook for healthy economic and earnings growth in 2026. Consensus earnings revision breadth has recently jumped to the highest level since 2022, and the outperformance of cyclical industries suggests the equity market is pricing an outlook for solid GDP growth despite consensus expectations for sluggish growth in coming quarters. Recent dollar weakness should provide a small tailwind to S&P 500 earnings. The trade-weighted US dollar has depreciated by 7% YTD and we expect a further 4% weakening through year-end. Company 10-K filings indicate that international sales account for 28% of S&P 500 revenues. A 10% decline in the dollar is associated with a boost of roughly 2-3% to S&P 500 EPS, all else equal. We now expect a range bound performance of S&P500 for H2CY25 between 5600-6500 with risks evenly balanced. We expect that bouts of policy, macro, monetary and economic uncertainty/volatility will persist. Still, fundamental trajectories remain our guiding force. Investors have already contended with the uncertainty posed by Deepseek concerns on AI, a Liberation Day wake up on tariff risks, the Middle East flare up, and the recent budget process. The implication now is for shock effects to be lesser and/or more localized. Generally, our expectation is for policy-related impacts to become more company/sector specific and less-broader index.

We believe the current uptick in US equities are temporary. US equities are pricing in only less than 50% of a US recession. In the past 5 downturns, S&P500 on average fell 37% peak to trough. Last 3 times, starting forward P/E was 19x, and trough P/E 12x. So far, from the February market peak to last Friday close, S&P500 is down 13%, and currently trades on 19x P/E. These valuations look suitable for the start of a downturn, not the end. The frequent flipflops in policy had led to irreparable damage to US consumer confidence & corporate decision making. Average tariffs in US now stand at 27% in a scenario where there is no import substitution & rerouting from other cheaper destinations. Average tariff stands at 18% if there is import substiution & reshoring of Chinese imports in US to other countries. Also the fact the US bond markets are effectively broken seeing the daily volatility does not augur well for US equities health too. Term premiums have a lot of scope to go up higher from here. Flow wise, US equities again saw 6.3 BN USD outflow last week against MSCI Europe which saw inflows of 6 BN USD. We are yet to see the worse in economic hard data and hence the downside on US equities is still not over. There might be buyers emerging in H2CY25 but we might see a lower low in H1 first. In summary it might get worse for US equities before it gets better.

US equity markets have fallen sharply in the past few weeks, reflecting a surge in policy uncertainty and growing fears of a sharp economic slowdown. On the other hand, due to German new chancellor Merz's recent announcement of a large fiscal stimulus package consisting of almost 1 TN new spending on defense & infra has led to European equities sharply outperforming US equities. From an earnings point of view, US earnings outlook is beginning to crack. The recent draw down in stocks is signalling to sell-side analysts that they need to bring down their annual profit outlooks even further from here. For Q1 2025, the estimated (year-over-year) earnings growth rate for the S&P 500 is 7.1% against 11.6% as on 31st Dec'24. At this point in time, 104 companies in the S&P index have issued EPS guidance for Q1 2025. Of these companies, 65 have issued negative EPS guidance and 39 have issued positive EPS guidance. The number of S&P 500 companies issuing negative EPS guidance for Q1 2025 is above the 5-year average of 56 and above the 10-year average of 62. US equity funds (-$2.8bn) saw outflows last week, especially notable because the second week of March typically sees large inflows; Europe ($5bn) continued its recent strong run with the strongest inflows in 8 years. CTAs have also been a major driver of European outperformance recently as they sharply increased exposure to the region since the start of the year. We do see L/S hedge funds yet to fully close their short positions that they opened up post the US elections. So not everyone has reduced their bearishness on Europe yet and so there might be more to go in terms of positioning catch-up for Europe.Also, positioning-wise, despite the recent inflows, the long-term gap between Europe and US remains wide. So, the region is far from crowded. Consequently, Europe may potentially attract more inflows as long as growth and activity fundamentals remain supportive. We believe that this developing theme of rotation of flows from US equities to European equities specially Germany is likely to be the theme of CY25. Not only because of German recent fiscal expansion announcements but also because of investor positioning. This will be compounded further by earnings downgrades in US compared to earnings upgrades in Europe. With current US administration policy focus on tariffs, US equities are in a tough spot & will discount corporate tax cuts as well as deregulation efforts.

US equities are entering Q3 earnings season on the back of a 50-bps rate cut by Fed, strong US labor market data & hopes of Chinese stimulus. But then there are headwinds of middle east tension as well as continued storm season in US amid a looming US election in Nov. Currently US equities are in a goldilocks scenario due to expected no landing of US economy. Slightly hot CPI and claims data this week reminded us that soft landing is a fragile concept, yet equities don't seem too bothered. In fact, the steady grind higher in market seems to confirm our recent view that post the sharp summer selling by systematic funds, the asymmetry had shifted to the upside again from a positioning standpoint. We look for S&P 500 earnings growth to decelerate modestly from 11.8% in Q2 to 9% in Q3. The slowing is driven by a narrow group of sectors and in our reading is well understood and temporary. Over half the slowing (2.8pp) comes from Energy (1.5pp) on the back of lower oil prices; another significant chunk from the widely anticipated continued slowing for MCG (Mega Cap Growth) & Tech (1pp). Growth for the rest should hold steady in the mid-single digits. Looking ahead, we see S&P 500 earnings growth reaccelerating in Q4 (16%) and through 2025 (11%) as the broader cyclical recovery continues to widen. The playbook for close US elections has historically been for the market to pull back (4-5%) starting a month before and then rally into year-end on a clear resolution. But this time it looks different considering the goldilocks environment & market positioning of systematic funds. We continue to expect S&P 500 make new highs towards 6000 by the end of CY24.

Nvidia's Q2 earnings did beat the analysts estimates & even the Q3 guidance was higher than average analyst estimates but the beat was the smallest in last 2 years. Combine that with the lack of clarity on the timing & amount of shipment of it's forthcoming Blackwell Chips, we get a sense that the stock might correct towards 100 levels than making new highs above 141 levels. Large investors such as CALPERs too have started exiting the stock in Q2.

Introduction: Globally the trend of disconnect between equity markets & real economy is at it’s maximus. While economic indicators in US are flashing amber, S&P 500 continues to make record highs. The trend is common across UK, Eurozone as well as certain Asian markets.

Q1CY24 earnings results from US equities have significantly surprised on the upside, led by the super strong earnings results from the tech giants. S&P 500 is on track to post 7.1% earnings growth for the January-March period, topping analysts’ preseason estimates of 3.8%.