August 2024 newsletter

International

August saw a spike in volatility across most markets. While the majority of global companies reported earnings, this was not the primary driver of the volatility. Weaker-than-expected unemployment data in the U.S. triggered a market sell-off, as investors feared that the Federal Reserve had delayed interest rate cuts for too long, potentially pushing the U.S. economy into a recession.

However, new macroeconomic data highlighted the limited risk of a U.S. recession, and U.S. inflation data came in lower than anticipated. The favourable inflation report reassured the Fed that it could now proceed with cutting interest rates, which led to a recovery in asset prices.

Volatility is generally something investors prefer to avoid, but it also presents opportunities. As shown in Graph 1, when the VIX, which measures the volatility of the S&P 500 index, rises above 35, the S&P 500 has historically gained an average of 14% over the subsequent six months. Investor panic often leads to increased selling, which in turn drives up the VIX.

August saw a spike in volatility across most markets. While the majority of global companies reported earnings, this was not the primary driver of the volatility. Weaker-than-expected unemployment data in the U.S. triggered a market sell-off, as investors feared that the Federal Reserve had delayed interest rate cuts for too long, potentially pushing the U.S. economy into a recession.

However, new macroeconomic data highlighted the limited risk of a U.S. recession, and U.S. inflation data came in lower than anticipated. The favourable inflation report reassured the Fed that it could now proceed with cutting interest rates, which led to a recovery in asset prices.

Volatility is generally something investors prefer to avoid, but it also presents opportunities. As shown in Graph 1, when the VIX, which measures the volatility of the S&P 500 index, rises above 35, the S&P 500 has historically gained an average of 14% over the subsequent six months. Investor panic often leads to increased selling, which in turn drives up the VIX.

Corporate earnings

Global earnings growth accelerated in Q2’24, reaching 10.5%, up from 6.5% in the previous quarter. This marks the fastest earnings growth since the fourth quarter of 2021, despite a slowing global economy.

The acceleration in global earnings growth was driven primarily by emerging markets and the U.S. European earnings turned positive for the first time in six quarters, while Japanese earnings, despite benefiting from a weak yen, slowed significantly from a high base. In the U.S. earnings growth continues to show gradual signs of broadening.

Investor expectations were arguably elevated going into the quarter, with many companies finding that merely meeting consensus expectations was insufficient to prevent share price declines. Companies remain focused on cost and productivity improvements, while capital investment growth is largely concentrated in selective industries or themes, such as AI and onshoring.

Trends that emerged from the second quarter earnings

Several companies experienced weakening demand as consumers across various income groups reacted to higher prices. This growing sensitivity to price increases has been evident for a few quarters.

However, there is now selective evidence suggesting that after a period of price stabilization, some companies are beginning to see nascent improvements in volume trends. As prices rise, pricing power—defined as a company’s ability to increase prices without losing demand—is becoming a key focus for investors. For many consumer companies it appears that further price increases are being met with resistance from consumers.

A significant divergence is emerging between the investment plans of technology companies and those in many other sectors. Generative AI continues to be a primary focus for tech companies, with the robust investment cycle in data centers being driven by strong end-user demand.

Both Amazon and Microsoft have indicated that demand for generative AI services currently exceeds supply, justifying an acceleration in capital expenditure. While AI enablers like Nvidia are the primary beneficiaries of this investment cycle, the monetization path further down the value chain remains somewhat unclear at this stage.

Earnings highlights

Nvidia

Nvidia continues to perform exceptionally well, as evidenced by its second-quarter results and third-quarter forecast, both of which exceeded our prior expectations and FactSet consensus estimates. Our confidence in Nvidia remains strong, driven by the company’s continued success in meeting the overwhelming demand for graphics processors (GPUs) and related products used in data centers to power artificial intelligence. Nvidia’s earnings beat, while impressive, was not as striking as in previous quarters, which may explain why the stock saw a decline in after-hours trading.

Revenue for the July quarter reached $30 billion, representing a 15% sequential increase and a remarkable 122% growth year over year, surpassing the guidance of $28 billion. Data center revenue was particularly strong, coming in at $26.3 billion, a 154% increase year over year. Despite the anticipated arrival of Nvidia’s next-generation Blackwell products later this year, the firm experienced no slowdown in demand for its existing Hopper family of products.

Nvidia projects Q3 revenue to reach $32.5 billion, representing an 8% sequential increase and a 79% rise year over year. The company’s key AI customers continue to plan significant investments in AI-related capital expenditures, and we anticipate that Nvidia will remain the primary beneficiary of this ongoing spending.

Nvidia’s valuation is currently looking much more attractive, with both its P/E ratio of 34x and PEG ratio of 1.2x below its long-term averages. The ongoing capital expenditure boom in AI is expected to drive exceptional growth in Nvidia’s revenue.

Eli Lilly

Cardiometabolic GLP-1 related sales, including Mounjaro, Trulicity, and Zepbound, nearly doubled in the quarter. While wholesaler stocking and reduced discounting significantly contributed to this growth, the drugs remain well-positioned in the market. We project combined peak annual sales of over $65 billion, up from $12 billion in 2023.

We anticipate additional indications for Mounjaro and Zepbound in areas such as sleep apnea and heart failure, following positive data reported in 2024. Furthermore, a head-to-head study of Zepbound versus Novo Nordisk’s Wegovy in obesity patients is expected to report later this year, with our expectation of slightly more favorable data for Zepbound based on cross-trial comparisons of previously reported studies.

Regarding the pipeline, we remain most optimistic about Lilly’s next-generation weight-loss drug, orforglipron. Expected to deliver pivotal data in 2025, orforglipron has the potential to offer the convenience of oral dosing, contrasting with the current injectable options.

Eli Lilly appears relatively expensive when compared to its long-term P/E ratio. However, the PEG ratio which provides a more comprehensive view by incorporating expected earnings growth, tells a different story.

Eli Lilly’s PEG ratio is currently around 1.2x, which is significantly lower than its historical average, indicating good value. We are bullish on Eli Lilly and consider it a buy.

Microsoft

For the June quarter, revenue grew 15% year over year to $64.73 billion, exceeding the midpoint of guidance, which was $64 billion. Compared to the same period last year, the productivity and business processes segment rose by 11%, the intelligent cloud segment increased by 19%, and the more personal computing segment expanded by 14%.

The results reinforce our long-term thesis, which focuses on the expansion of hybrid cloud environments and Azure. The firm continues to leverage its on-premises dominance to enable clients to transition to the cloud at their own pace. Our growth assumptions are centered around Azure, the migration to Microsoft 365 E5, and the increasing traction of the Power Platform for long-term value creation. Additionally, AI is rapidly contributing to growth, which we view as another significant secular driver.

The current valuation of a P/E ratio of 31x and a PEG ratio of 2.1x do not appear stretched and we believe Microsoft is well-positioned to sustain its strong earnings growth. We maintain our buy rating on Microsoft.

Summary

Although the probability of a U.S. recession has increased recently, we anticipate a soft landing for the U.S. economy. We expect economic growth to slow in the third quarter, to decelerate further in the fourth quarter, reach a bottom in the first quarter of 2025, and then begin to reaccelerate throughout the remainder of 2025 as the effects of Fed funds rate cuts impact the real economy. Companies exposed to negative trends in consumer discretionary spending are likely to benefit from the falling interest rates and stabilization of the softening job market.

The JSE All-Share Index concluded August at record highs, delivering a return of 4%. The rand appreciated against the dollar as economists slightly upgraded their growth forecasts for this year and the next. This adjustment is based on expectations that the two-pot retirement reforms will provide an initial consumer windfall estimated between R20 billion and R100 billion.

This, coupled with lower inflation — anticipated to decrease rapidly to 4.5% or less in the fourth quarter — is expected to pave the way for interest rate cuts of up to 75 basis points  between September and January. These developments are likely to stimulate household consumption and positively impact retail stocks.

As a result, South Africa’s growth rate is expected to improve, bolstering government tax revenues. This will also reduce the debt-to-GDP ratio, lower the country’s risk premium and further boost market sentiment.

The extent of these benefits will depend on consumer behavior, particularly how much consumers withdraw from their retirement assets when the new two-pot system takes effect on September 1 and whether consumers choose to spend the windfall or use it to pay down debt.

When Chile relaxed its pension fund rules during the pandemic, allowing three withdrawal episodes between the third quarter of 2020 and the first quarter of 2021, tax revenues initially surged by 40% as consumers engaged in increased spending. This supported an 11.7% rebound in GDP growth in 2021. However, the resulting decline in pension fund assets — amounting to 14% of GDP — led the government to halt the scheme.

Digital platform economy could be game-changer for SA

Naspers and the Mapungubwe Institute for Strategic Reflection (Mistra) have launched a research report that examines the “untapped potential of South Africa’s digital platform economy — a sector encompassing online platforms that facilitate economic transactions.”

The research indicates that the digital platform economy could significantly transform the country’s economic landscape. Projections suggest it could contribute R91 billion to the economy by 2035, increasing the sector’s share of GDP from 0.02% in 2022 to 1.38% by 2035.

Among various findings, the researchers highlighted a significant global shift between 2010 and 2022: the world’s top 20 companies transitioned from being predominantly resource-driven (36% to 7%) to being dominated mainly by digital platforms (16% to 56%).

Eskom

Between 2007 and 2022, Eskom tariffs approved by the energy regulator Nersa increased by 653%, compared to an inflation rise of 129% over the same period. Nersa is set to review Eskom’s latest proposal, which includes a 36% tariff increase for the next financial year, in addition to a 12.7% increase for the current year.

Eskom’s summer outlook briefing presented a base case scenario with a maximum load-shedding level of Stage 1. The utility indicated that load-shedding would not be implemented if unplanned losses remain below 13,000 MW. Notably, as of the end of August 2024, Eskom has achieved over 150 consecutive days without load-shedding.

Renergen

Mining is inherently challenging. It often yields only a few grams of commodity per ton of extracted rock and companies typically operate as price-takers. Despite concerted efforts to manage costs and processes, even the most efficient mining operations need help when commodity prices are favorable.

Junior miners must work diligently to maintain market support, a task made easier when positive news and market enthusiasm prevail. Renergen’s CEO, Stefano Marani, excelled by organizing investor site visits, generating favorable media coverage, and achieving critical operational milestones.

Even without helium extraction, the successful production and sale of LNG provided a compelling proof of concept. The vision of fueling trucks along the N1 with LNG and utilizing cryogenic transporters for the COVID-19 vaccine further highlighted the company’s potential. This resilience and adaptability have not gone unnoticed, as evidenced by the near tripling of the share value within just over a year, peaking in early 2023.

A proposed Nasdaq listing in early 2023 has yet to materialize. Helium production was delayed due to a leak in the cold box, which has only recently been repaired. With the helium project successfully underway, Renergen has positioned South Africa as one of only eight countries worldwide capable of producing liquid helium.

Nvidia boasts a wide economic moat, primarily due to its market leadership in graphics processing units (GPUs) and the essential hardware and software tools required to support the exponentially growing artificial intelligence market.

Nvidia’s GPUs excel at handling parallel processing workloads, utilizing many cores to efficiently process data simultaneously. In contrast, central processing units (CPUs), such as Intel’s processors for PCs and servers or Apple’s processors for its Macs and iPhones, process data in a serial fashion, handling “0’s and 1’s” one step at a time. GPUs have traditionally dominated the gaming market, and Nvidia’s GPU graphics cards have long been regarded as the best in class.

Recently, parallel processing has become almost essential for accelerating AI workloads. Nvidia not only took an early lead in AI GPU hardware but also developed a proprietary software platform, CUDA, which plays a crucial role in enabling AI developers to build their models with Nvidia’s technology. We believe that Nvidia’s advantage extends beyond hardware; the high customer switching costs associated with CUDA create a significant barrier, making it unlikely for another GPU vendor to emerge as a leader in AI training.
Nvidia’s chips are revolutionizing the industry.

For instance, an application that would traditionally require 960 CPU-only servers can now be handled by just two of Nvidia’s GPU servers. This shift not only reduces costs by a factor of 25 but also makes the application 84 times more energy-efficient compared to using CPU-only servers.

A TeraFLOPS represents one trillion floating-point operations per second, and it measures a computer’s capability to perform complex mathematical calculations with high precision. The graph illustrates a remarkable increase in Nvidia’s GPU performance, which has skyrocketed from 19 TFLOPS in 2016 to 20,000 TFLOPS in 2024. This represents a staggering 10,000-fold increase in just eight years.

In “Nobody Cares About Your Stuff,” Morgan Housel delves into the often overlooked reality that the material possessions we acquire—whether it’s a luxury car, an expensive watch, or a large house—rarely hold the significance we imagine they do in the eyes of others.

This chapter challenges the common belief that accumulating and showcasing wealth will earn admiration and validation from others. Instead, Housel argues that most people are too preoccupied with their own lives to notice or care about what someone else owns.

Housel’s message is a reminder that the pursuit of material goods as a means of impressing others is ultimately unfulfilling. He explains that while it’s natural to want to be recognized and appreciated, trying to achieve this through material possessions is misguided.

People may notice flashy items briefly, but they are far more interested in their own concerns, goals, and challenges than in someone else’s wealth. This realization can be liberating, as it shifts the focus away from external validation and towards personal fulfillment and meaningful financial goals.

The chapter also addresses the psychological and financial pitfalls of chasing material status. Housel highlights that the desire to impress others can lead to overspending, debt, and financial stress, all of which can undermine long-term financial security and happiness.

By constantly striving to keep up with others, people can find themselves trapped in a cycle of consumerism that leaves them financially vulnerable and emotionally unsatisfied.

Recognizing that “nobody cares about your stuff” allows individuals to break free from this cycle and make financial decisions based on their own values and needs rather than the perceived expectations of others.

Housel encourages readers to reconsider what truly brings them happiness and fulfillment. Instead of focusing on accumulating possessions, he suggests investing in experiences, relationships, and personal growth—areas that tend to offer deeper and more lasting satisfaction. By understanding that true wealth is not measured by what we own but by the freedom, security, and opportunities we create for ourselves, individuals can align their financial choices with what genuinely matters to them.

In conclusion, “Nobody Cares About Your Stuff” is a powerful reminder to prioritize authenticity over appearance in financial and personal decisions. Housel’s insights challenge the conventional notion that material possessions are a source of status and happiness, urging readers to focus on what truly enriches their lives. By letting go of the need to impress others and embracing a more intentional approach to money, individuals can achieve greater financial security, personal fulfillment, and peace of mind.

Sources: Alpine Macro, Anchor, Bloomberg, BNY Mellon, Charlie Bilello, Credit Suisse, Compound Advisors, Edmond De Rothschild, ETFMG, FactSet, Haver Analytics,  JP Morgan, Julius Baer, Morgan Stanley, Refinitive, RMB, Statista, Sygnia, Strategas, UBS