Weekly market update: The magnificent… data centres

Last week, in the Macro Memo podcast we ran with Gavin Hinks, Mark Kennedy, a member of our UK and global executive board, joked that I managed to reduce the global economy and the global financial markets to the share price of Nvidia.

The story of semiconductors is much more than their share price. It’s a story about data centres driving innovation. Data centres are providers of computing power to the hundreds, even thousands of smaller companies, looking for the next AI hit app, like Chat GPT. Often, those companies don’t have the processing power to achieve the leap themselves. Data centres are purveyors of the necessary tools for technological innovation.

Demographics in the Western world have been barely positive. In Europe, they’ve gone in reverse. Globalisation has stalled, and the additional benefits of global trade will be marginal at best. The only way for Western economies to grow is through improvements in productivity. And AI is their best hope to achieve that.

Data centres provided by semiconductor companies, such as Nvidia, AMD and Intel are quickly becoming what James Watt and Co. was for the first industrial revolution, Vanderbilt, Standard Oil and Ford for the second, and Microsoft, IBM and Apple for the third. The engine of growth towards a new era.

(So central are they thus to global economic growth, that I wonder whether there should be a central bank for chipmakers).

For lack of a better analogy, data centres have become more central to the global economy than the world’s banks. A bank’s money can be used to fund innovation. But there are plenty of banks, private investors and public markets to do that. Those companies are singular in that it they lend not money, but computing power, thanks to its powerful computer chips-originally designed for gaming.

In the past few weeks, Nvidia has been leading the stock market higher and higher.

 Does it sound an awful lot like the Internet Bubble?

Yes, but this time… looks different.

We are talking not about a social media company or a software company whose products are in peril by the AI revolution, like Meta, Google or Microsoft. Nor about intermediaries, like Amazon. We are talking about makers of things. And, unlike Apple and Tesla, makers of extremely rare things. The computing power, the fuel, is necessary for the growth of the rest of the market.

Those behemoths are the genuine leaders of the AI revolution. I will not opine on whether present valuations justify an investment in them or not. But what I will say is that the repricing in the semiconductor industry, the main driver of equity returns so far in the year, does not have the usual makings of a stock bubble.

Can this alone drive the market higher sustainably?

Not yet.

Data centres may well fuel Mark Zuckerberg’s dreams of a metaverse or Joe Biden’s dreams of technological superiority, but we are not there yet. We have but a tool to make an AI. Assuming that Quantum computing is a good decade away from commercial use, data centres will be key to the next step forward. The proverbial pick-and-shovel shops in the gold rush. But it’s good to remember, that while the shops made money, when the gold rush was over they died out too. Gold was necessary to keep them going.

A central depository of computing power is necessary for all aspiring AI developers to operate. One of them may well discover the next big thing. Something that will become what Microsoft Windows and Office was to the PC. Only then can we talk about the AI revolution.

But that thing has not arrived yet. And when it does, it may not just as well arrive from Google, Apple, Microsoft, Open AI or any other incumbent, as it may from a non-listed, VC-funded company operating out of a garage.

Data centres and their profitability give us a glimpse of a new age. It will still take patience and fundamental research to determine the winners -and losers- of that age. Powerful as semis are, gone are the days when the whole stock market boiled down to a few stocks. No matter how ‘magnificent’ they are.

George Lagarias – Chief Economist

Market update

Last week, global stocks gained +1.0%, with most regions posting positive returns. US stocks advanced +1.1%, outperforming UK stocks, which only edged up 0.1%. European stocks also rose +1.3%, leading the developed markets, while Japanese and Emerging Markets stocks both increased by +0.7%.

Meanwhile, in the bond market, slight declines in yields were seen across the board. The US 10 year Treasury yield dropped 3 basis points to 4.25%, the UK 10 year Gilt yield fell 7 basis points to 4.04% and the German 10 year Bund yield slid 4 basis points to 2.36%.

The commodity market was mixed, with gold and oil moving in opposite directions. Gold prices rose +0.5% to $2035/oz in spite of the hawkish narrative presented by several Federal Reserve members last week, while the relative volatility in oil markets persisted, as brent crude fell -2.1% to $76/barrel.

Macro news

China cut its benchmark five-year loan prime rate last week while keeping its one-year loan rate unchanged. The five year rate – which is the peg for most mortgages, was cut by 25 basis points to 3.95%, more than the 10 basis point cut expected by economists. The move comes as China continues to struggle with an ailing property sector, a stagnant economy and falling stock prices.

A measure of annual foreign direct investment in China fell to its lowest level since 1990 last year. Foreign direct investment (FDI), which measures the amount of foreign capital flowing into a country was reported to be $33bn in 2023 according to data released by the State Administration of Foreign Exchange. This value represents an 82% drop from 2022’s figure of $180bn, reflecting a loss of confidence from overseas investors.

A measure of UK consumer confidence fell by more than expected in February, dropping to -21 versus an expected figure of -18, showing that consumers remain reluctant to spend after the UK fell into a technical recession. The index shows that consumers are far more confident than they were a year ago, however, the index had fallen to -49 at its lowest at the end of 2022.  

The week ahead

Investors will be watching US economic data next week as Core PCE, durable goods orders and manufacturing PMI data are being released. Elsewhere, China PMI data will be released, as well as flash inflation data for the eurozone.