The Stock Market Needs to Think About the Unthinkable: A Disappointment From Nvidia

Wall Street will be laser-focused on Nvidia CEO Jensen’s Huang’s assessment of AI demand this week. (AFP via Getty Images)

Nvidia’s second-quarter earnings could prove to be even more important to sustaining the U.S. stock rally than Federal Reserve Chairman Jerome Powell’s pivot toward lowering interest rates last week.

Stocks powered firmly higher on Friday, with the Dow Jones Industrial Average closing at its first record since December, after Powell’s Jackson Hole speech opened the door to a September rate cut. Small-caps had their best day since May and the S&P 500 index extended its weekly winning streak to three.

Stocks gave back a good portion of those gains on Monday, however, as investors appeared to look more deeply into the reasons behind Powell’s dovish signaling.

Lower interest rates tend to be immediately supportive for stocks as a lower risk-free yield on Treasury debt increases the discounted present value of future cash flows. But if interest rates are falling because the economy is slowing, corporate earnings could also deteriorate. If the cuts stoke inflation pressures, the value of future cash flows is also eroded.

Powell’s speech, in which he warned of a cooling job market and “clear” risks that tariffs will bring inflation, hinted at both.

Bond markets echoed his concerns. Early on Monday, the spread between yields on two-year and 10-year Treasury notes rose to the highest levels since 2021 as short-term yields fell faster than those at the longer end. That means bond investors see lower Fed rates ahead but remain worried that inflation will continue to accelerate while growth stalls.

Weaker growth could test the megacap tech rally that has powered the lion’s share of this year’s stock market advance, according to Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets. Wall Street will need to see “substantial upward revisions to consensus GDP forecasts” in order for analysts to raise their forecasts of earnings for the biggest tech stocks, the strategist argued.

“We believe this poses a challenge to further gains in the broader U.S. market and the big cap growth / tech trades in particular,” she said.

With the outlook for earnings and share-price gains in big tech under question, Nvidia’s fiscal second-quarter earnings, due after the close of trading on Wednesday, are even more squarely in the frame than they would have been otherwise. The leading maker of chips for artificial intelligence is at the epicenter of the megacap tech trade, generating around 40% of its revenue from Microsoft , Amazon.com , Meta Platforms, and Alphabet.

Nvidia commands an 80% share of the AI chip market. With an overall market capitalization of around $4.3 trillion, it represents around 8% of the entire S&P 500.

Nvidia’s direct link to the capital-spending plans of those enormous companies—around 60% of that money will go to AI, according to Synovus analyst Dan Morgan—means its sales outlook will either confirm or challenge the market’s most important narrative.

The sheer heft of the market’s six biggest tech stocks, which now comprise around 34% of the S&P 500’s overall market value, also means that what Nvidia has to say likely will carry more weight than expectations for a Fed rate cut.

And while economic data—numbers on jobs and inflation are due before Fed policymakers next meet in mid September—may well affect the odds for easier monetary policy, Nvidia’s outlook may be more definitive.

While the AI trade has been unambiguously positive for U.S. stocks, investors dumped tech holdings last week as “skepticism about the AI theme, which has powered the mega caps, returned in force,” according to RBC’s Calvasina.

And Nvidia is an expensive stock that has added more than $1 trillion in market value over the past 12 months. It is up nearly 30% for the year.

That leaves Nvidia stock with “little margin for error” heading into Wednesday’s update, argues Saxo Bank’s global head of investment strategy Jacob Falkenscone.

“For all its dominance, Nvidia’s Achilles’ heel is the speed at which competitors—or regulators—can change the game,” he said. “If growth slows or margins disappoint, the downside could be sharp.”

Write to Martin Baccardax at martin.baccardax@barrons.com