Signal over Noise with Ulrike Hoffmann-Burchardi
The desk posits that the investment landscape is shifting from a capital expenditure focus to cash flow generation, particularly in the AI sector, as underscored by recent market reactions. Per the full note source, the significant drop in NVIDIA's share price following its earnings report, despite robust revenue growth, exemplifies this trend. With increasing scrutiny on how companies will monetize their AI ventures, the desk emphasizes the need for clear cash flow strategies that many firms are currently lacking. The market's concerns about mounting losses at firms like OpenAI and SoftBank suggest a broader caution among investors towards unresolved profitability in tech sectors.
What the desk is arguing
The desk argues that a pivotal shift in investor sentiment is emerging, whereby focus is transitioning from corporate capital expenditures to the revenue-generating capabilities of companies. This shift is reflected in the stark market responses to earnings announcements, notably NVIDIA's recent price drop despite a substantial year-over-year revenue increase of 62%. Per the full note source, the decline of more than 6% signals a crucial moment in tech where the sustainability of cash flows is paramount.
Moreover, this sentiment is echoed by Meta's guidance update, which, despite a positive revision, still led to a 21% decline in stock value. Such contrasting reactions illustrate a growing reluctance among investors to overlook profitability metrics in favor of growth narratives. This caution fundamentally reshapes investment strategies, particularly for AI-related companies operating under enormous operating losses.
Where it sits in our coverage
Our current consensus target for relevant currencies indicates a broader market view aligning with the cautious sentiment regarding AI profitability. Key targets among firms within this domain include: - jpmorgan: 1.10 (Mar 26) - bofa: 1.04 (Mar 26)
The desk's assessment aligns more closely with jpmorgan, suggesting that benchmarks reflecting sustained investor focus on cash flow generation will remain pivotal, albeit at a slightly elevated level compared to the lower bound from bofa.
How other firms see it
Firms such as jpmorgan and goldman share a perspective that prioritizes cash generation metrics moving forward, contrasting with bofa, which remains less optimistic in its assessments. This bifurcated view reflects the growing anxiety around AI-related capital deployment versus actual cash inflows. The trajectory of USD/JPY may act as a reflective gauge of these market sentiments, particularly as operational milestones in tech begin to unfold.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Market focus is shifting from capital expenditures to revenue generation, particularly in the AI sector.
- 02Investors are increasingly scrutinizing cash flow strategies, as noted by NVIDIA's stark share price reaction despite strong revenue growth.
- 03Corporate losses in tech, like those reported by OpenAI, indicate growing investor caution towards profitability.
- 04Recent earnings reports signal a broader reevaluation of tech investment strategies.
Market implications
Traders should pay close attention to AI company earnings and cash flow disclosures to gauge market sentiment. A pivotal level to watch is the reaction of USD/JPY to further earnings insights, which could signal shifts in risk appetite among investors as they reassess tech valuations.
Risks to this view
An unexpected surge in positive cash flow generation by major tech firms could pivot investor confidence and re-establish focus on growth narratives, challenging the current cautious stance. Additionally, any broader economic recovery that boosts overall market sentiment could mitigate current bearish views.
Hello and welcome to Signaled Over Noise. I'm Ulrike Hofmann-Borchati, CIO for the Americas and Head of Global Equities for UBS Wealth Management. The market sent a clear signal last week.
The AI story is moving from capex to cash flows, and that demands a new investment strategy. The market's reaction to NVIDIA's earnings last week marked a clear turning point, reinforced by several early warning signs that have emerged over the past weeks. First, Meta raising the lower end of its guidance by $4 billion was met with a 21% price decline since.
Two, the NASDAQ closing lower despite three constructive data points on increased capex from AMD, CoreWeave, and Anthropic. SoftBank's share price declined of over 25% over the last month. It is often used as an indirect market proxy for open AI, given that SoftBank owns an 11% stake, worth about 30% of SoftBank's market cap.
And of course, NVIDIA closing down almost 7% last week, despite booking a historic quarter with revenue up 62% year over year. These data points all suggest one signal. Capex is no longer what investors are focused on.
Instead, the focus has turned to cash flows. If and how will companies generate cash flows to pay for the trillions of compute infrastructure? The market seems particularly concerned about private companies, which have large amounts of compute on order while losing money.
For example, Microsoft earnings revealed that open AI lost 11.5 billion in the third quarter and other large frontier models likely are loss making as well. At this stage, these losses are financed by new fundraising rounds, while companies are trying to figure out how to monetize the AI offerings. There are many different ways to do so with subscriptions, API calls, advertising, lead gen, revenue sharing, and many more.
This will take time though, and not all AI companies will succeed given the intense competition. And another question is the price elasticity of demand. How likely will a user switch to a low cost open source model if prices are raised too much?
The uncertainty demands a pivot in the AI investment strategy. The AI7 the chip makers NVIDIA Broadcom, AMD, Micron, and the hyperscalers Google, Amazon, and Microsoft have appreciated by more than $10 trillion since the launch of JetJPT almost three years ago. That is double the size of the healthcare sector in the S&P 500.
Yet the users of AI have not seen comparable increases in valuation. This is where we see the next AI opportunity. Investing into companies that use AI to boost revenue and lower cost, increasing free cash flow.
And the logical place to start is where ROI is highest. Advertising, R&D, coding, and customer service. Our preferred way to express this view in sectors is via US healthcare.
US healthcare trades about 3% below its normal historical discount to the S&P 500. And we see three turning points in healthcare. First, policy headwinds turning into tailwinds with deals on most favored nation pricing and Medicare and Medicaid deals on obesity drugs.
The destocking cycle from COVID turning into clinical catalysts for new drugs. And lastly, rich and vast data from patient histories to payer data turning into insights with AI. Another sector also offers fertile picking grounds with customer history and rich market data.
And that is US financials. Also burgeoning capital market activity, deregulation, and a favorable rate environment could drive further upside from here. In short, both sectors, US healthcare and US financials embed a free call option on AI along other upside drivers.
AI is real and the ROI is tangible. But it's time to pivot towards those companies that have a clear path to generating cash flows with AI. Turning to the macro, Friday brought some relief from Williams, who signaled openness to a rate cut in December.
His remarks lifted the price dots of a cut to more than 70%. We agree with his assessment of a weaker labor market warranting a December rate cut. The release of non-farm payroll data from September last week belongs largely into the noise category.
It was expected to be strong based on seasonal factors. The more relevant signal was the slight uptick in the unemployment rate. The next number to watch will be the November non-farm payroll data that is slated to be released on December 16.
Too late for the December FOMC decision, but likely the deciding factor for the next meeting in January. With this, I wish everyone in the US a wonderful Thanksgiving break. I will be back with the next Signal over Noise on December 8, with some key takeaways from our tech conference in Arizona.
With this, stay well and stay ahead. UBS Chief Investment Office's investment views are prepared and published by the Global Wealth Management Business of UBS AG or its affiliate UBS. This material has no regard to the specific investment objectives, financial situation, or particular needs of any specific recipient and is published for informational purposes only.
As a firm providing wealth management services to clients globally, UBS AG and its subsidiaries offer both investment advisory services and brokerage services. Investment advisory services and brokerage services are separate and distinct, differ in material ways, and are governed by different laws and separate arrangements. In the USA, UBS Financial Services Inc. is a subsidiary of UBS AG and a member of FINRA SIPC.
For information, please visit our website at ubs.com forward slash working with us. For a full legal disclaimer applicable to the independent investment views produced by UBS, please visit our website at ubs.com forward slash CIO dash disclaimer.
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