• Nvidia earnings skyrocket on soaring demand for AI chips

• Boost could fuel next leg of Wall Street’s rally

• But Fed’s ‘higher for longer’ stance is a growing headwind

The AI effect

The Q1 earnings season is almost coming to an end and one of the last big names to report is Nvidia. The chip maker just announced a staggering 461% year-on-year jump in earnings per share for the first fiscal quarter of 2024. Revenue is up an equally impressive 262% as the company struggles to keep up with demand for its artificial intelligence (AI) graphics processors.

The strong figures beat the already high expectations, but more importantly for investors and the stock’s 90% year-to-date gains, Nvidia issued revenue guidance for Q2 that was above analysts' consensus.

Sky-high valuations?

The stock price rose more than 6% in after-hours trading, surpassing $1,000 for the very first time and increasing its lead over the other Magnificent 7 stocks. Yet, from a valuation perspective, Nvidia is far from being the most overvalued among the mega caps and is comparable to Amazon and Microsoft when looking at their forward 12-month price/earnings ratios.

This underlines the ongoing attractiveness of the Big Tech despite the stratospheric rise in their share price, as most of them have been able to deliver on the earnings front. The few such as Tesla that haven’t, have been brutally punished by the markets.

A solid quarter for earnings

So where does this leave Wall Street? All three of the major indices managed to more than recover from the April pullback to notch up fresh record highs on the back of the stellar earnings season. From the 93% of S&P 500 companies that had reported as of May 17, 60% posted better-than-expected revenue, while earnings on average grew by 5.7% y/y in Q1, making it the best quarter since Q2 2022 according to FactSet.

But is this enough to sustain the latest rally? Outside of the Magnificent 7, S&P 500 profits are on track to have shrunk in Q1. However, Bloomberg Intelligence is forecasting that over the course of the next year, net-income growth for the S&P 500 excluding the Magnificent 7 will catch up with that for the big seven.

Can AI drive the broader market?

Moreover, if non-technology companies that are investing in AI start to reap some of the rewards in the next few quarters, the earnings potential could be even greater than what investors have currently priced in. What’s stood out in this earnings season is the number of companies other than the Big Tech that mentioned AI in their earnings call, particularly in the energy sector.

Even commodities are attracting attention on the expectation that the surge in the use of AI chips will generate demand for metals such as copper, as well as precious metals, including silver, gold and platinum. This could bode well for mining stocks.

Foggy times for Fed policy

As long as nothing spoils the soft-landing narrative, Wall Street could end 2024 on a positive note, scaling new all-time highs simply on the AI momentum. However, aside from the looming presidential election in November, there’s a cloud of uncertainty hanging over the US economy amid some conflicting data that is making the Fed’s job of managing inflation quite challenging.

The Fed has been very careful not to overtighten, but in doing so, it’s run the risk of setting policy too loose and there’s growing talk of the possibility of further rate hikes. But it’s far from a clear picture as some other indicators suggest that the economy is in the midst of a sharp slowdown.

For investors, what is increasingly certain is that interest rates will stay at high levels for a considerable period of time, and this is putting a lid on Wall Street gains. What the past year has shown is that the stock market can live with fewer and a delay in rate cuts if this achieves a soft landing. It can even live with a recession if it means the Fed will slash rates. But what it might struggle with the most in the coming months is the uncertainty of not even the Fed knowing where rates are headed.