AI Spending Soars

In this issue of the peel:

• Finally, yesterday, the BEA dropped their highly anticipated second estimate of real GDP growth in Q2. Spoiler alert—it’s almost too good. Find out what the numbers have to say below.
• Best Buy shares lived up to the company’s name on Thursday, while CrowdStrike had a desperately needed good quarter despite… “the incident.” Meanwhile, Dollar General plunged thanks to kindergarten-level inventory management skills, and Nvidia got punished for stellar earnings.
• Nvidia shares fell as if we just discovered that AI is about as useful as NFTs. Nothing could be more false—just take a look at the planned AI spending by some of the world’s biggest companies. Competition is coming, but the ocean’s big enough for everyone.?

Market Snapshot

Banana Bits

• The new market for trade is dropping—private companies.?
• Consumers love AI chatbots as ChatGPT usage doubled from its already insane usage levels last year.?
• Even your dad’s tech companies are getting in on the AI parade. Just take a look at Dell’s latest earnings report.
• Lulu went full lemon in its latest quarter, missing on sales and lowering guidance.?
• France issues preliminary charges against detained Telegram CEO Pavel Durov.

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Macro Monkey Says

Round 2

It’s truly poetic.

Curving grades (needless to say) saved my college career. And now, curving GDP growth is saving my portfolio and the economy.

The difference is—the economy actually has a valid reason for its curve, as I’m not sure that crying during office hours counts as valid. But increased consumer spending sure does.

The Bureau of Economic Analysis (BEA) just released its second estimate of U.S. GDP growth in Q2. Let’s get into it.

What Happened?

Get the kegs ready. Professor BEA just announced that real Q2 GDP growth is getting curved as economic expansion came in hotter than previously thought.

Originally, the estimate pegged (ayo?) second-quarter growth at 2.8%. With the benefit of more complete data, we learned that real Q2 growth was actually closer to 3.0%.

Source

Just one quarter away from getting that annoying *ss bar from Q3’20 off this damn chart…

Anyway, shoutout to you apes because you clearly did your job. Most of the 0.2% increase was primarily driven by higher consumer spending than previously thought.

Meanwhile, weaker fixed investment, exports, private inventory investment, federal government spending, state & local government spending, and higher imports slightly offset the good work we all put in.

Real consumer spending growth of 2.9% helped save the broader market amid the turmoil of Nvidia’s earnings report, getting revised up 0.6% from the 2.3% prior estimate.

Consumer spending makes up anywhere between 66-70% of U.S. GDP in any given period, so when we’re discussing recession probabilities, this isn’t just the most important factor—it’s the factor.

However, that increased spending came with a downward revision to personal savings. Previously, the BEA reported a Q2 personal savings rate of 3.5%, but yesterday, we learned that it was actually close to 3.3%.

Real disposable personal incomes were unrevised, chilling at their prior estimate of 1% growth for the quarter.

Given that incomes grew slower than spending while personal savings fell, this indicates that consumers are relying on those savings to fund their expenses. Paired with other recently released data, much of the increased spending was likely on credit cards.

On the inflation side, both the headlining PCE price index and the core PCE price index (excluding food and energy) were revised lower by 0.1%.

Headline PCE grew 2.6% in the second quarter while core PCE grew 2.8%, both continuing to trend lower.

There were some less-than-ideal aspects of the report, like the downward revision in durable goods orders to a 2.6% decline.?

But the biggest risk seems to be 1) how the strength of this report impacts the rate outlook and 2) how drastic the divergence between wealthy and/or higher-income consumers is vs non-wealthy and/or lower-income consumers.

The Takeaway?

Well, we can address that first risk pretty easily.

Yesterday’s upward revision to a healthy 3% annualized GDP growth rate in Q2 essentially eviscerated all hopes and dreams for a 50bp cut in September.

Source

Markets are still pricing for a 1/3rd shot at 50bps, but I’ll be damned.

The second risk mentioned above is much harder to quantify.

With credit seeming to rise as fast as the market, it’s clear consumers are strapped for cash even with their savings. The ownership class is fine as always, but the lower of the U.S. economy may be reaching a breaking point.

Just look below at how sh*tty Dollar General did last quarter.

What's Ripe

Best Buy (BBY) 14.11%

• It’s not often that share price performance truly lives up to the company’s name. But that was clearly the case yesterday with Best Buy, thanks to earnings.
• They weren’t exactly “good” earnings, but the tech retailer did beat expectations despite a 3% sales decline. Profits grew 6% thanks to effective cost controls.
• The good news is that sales fell less than in 2023, and guidance was raised. Best Buy is also getting creative with marketing and in-store strategy, launching an ad campaign via YouTube videos and creating its own “Apple Genius” bars.

CrowdStrike (CRWD) 2.83%

• As a thank you for giving employees an excuse to get off the desk by f*cking the global technology complex a few weeks ago, traders are bidding up CrowdStike.
• The cybersecurity firm beat across the board on 32% sales growth and $3.86bn in subscription revenue, which is above estimates for $3.85bn. Net income grew 451%.
• However, it’s not all fine and dandy. Crowdstike is facing more lawsuits than Donald Trump, particularly Delta Airline’s $550mn in costs and lost revenue.
• CEO George Kurtz said the impacts of “the incident” include longer sales cycles and negative $30mn in subscription revenue per quarter as part of a customer commitment package, bringing guidance lower. However, few deals were lost.?

What's Rotten

Dollar General (DG) 32.15%

• Shoutout to anybody whose sole purpose in life is to act as a cautionary tale to everyone else. Dollar General is the corporate version of that, especially in Q2.
• Earnings missed with operating profits down 21% annually. Sales grew 4.2%, but weakness in the firm’s core lower-income consumer base is terrorizing shares.
• Inventory looks like it was managed by Michael Scott, with heavy writedowns denting profits. The WSO Alpha portfolio was not happy with this holding (who should I fire?).

Nvidia (NVDA) 6.38%

• To beat or not to beat—that is not the question with Nvidia’s latest earnings. As we discussed yesterday, the firm’s stellar numbers weren’t nearly enough.
• This is nothing new. With the growth markets already priced in, given Nvidia’s enormous run-up, they had to blow expectations out of the water for a green print.
• So, although Nvidia kept hogging all the AI dollars like it was on Hoarders, it was their lowest beat in years. Competition is coming—and the market smells it.

Thought Banana

Stop Tweaking

Nvidia shares yesterday looked like the guy I saw on the street corner shirtless and showing off his moves at 7:30am—clearly tweaking, but no one’s really sure why.

I mean, I suppose we can all take a guess. Nvidia shares fell as earnings-induced euphoria dissipated… meanwhile, bro’s something-else-induce euphoria was just getting started.

What’s Happening?

Nvidia’s phenomenal earnings didn’t send shares flying because growth came in below what the market had already priced in.

But, if you think this is the start of a severe downfall, think again. Outside of potential market-wide risks, all systems appear to be go for the King of Capital markets.

Based on what megacap tech stocks have indicated, supply may very well still be the company’s constraint. Take a look at the implied next 12-months capital expenditure plans for the 2nd, 4th, 5th, and 7th largest companies in the world:

For Meta and Alphabet, these implied capex estimates are derived from management's explicit guidance. Microsoft’s and Amazon’s come from assuming extensions of their latest quarterly capex spending to the next four quarters.

So, we conservatively estimate that four companies alone will spend $227.50bn on capex over the next year.

Comments from Microsoft indicate that 50% of their total capex will go to AI training and inference. Meta explicitly guided for closer to 40%.?

Meanwhile, Alphabet said their capex plans are “driven overwhelmingly by investment in our technical infrastructure, with the largest component for servers followed by data centers,” which I interpret as meaning that over 50% is going towards AI.

Lastly, Amazon said, “The majority of the spend will be to support the growing need for AWS infrastructure as we continue to see strong demand in both generative AI and our non-generative AI workloads,” meaning, again, 50% to AI.

Who Cares?

Basically, this is all to say that Nvidia’s money vacuum is still working just fine.

If anyone still thinks AI is a bubble, just know that bubbles don’t generally come with hundreds of billions of dollars in spending from just four companies in a single year.

Now, obviously, not all of this is going to Nvidia. Google’s TPUs, Amazon’s Trainium, Inferentia, Graviton, and others are examples of self-made chips, like Apple’s M series.

Meta is also reportedly working on its own chips, Sam Altman essentially works for Microsoft, and Tesla is building its own chips and clusters too.

So, Nvidia is facing serious competition from its largest customers. However, with more AI startups than grains of sand on Earth, the runway of demand for chipmakers is still enormous.

Source

Plus, there’s potential for non-tech companies to lean into investment here just like they were all eventually forced to build out websites and e-commerce outlets.

Calling this a “gold rush” dramatically understates how horny these firms are for chips.?

I feel the same way about Ruffles cheddar & sour cream when I come home from the bar, but I think Alphabet CEO Sundar Pichai said it best in stating, “...the risk of underinvesting is dramatically greater than the risk of overinvesting for us here.”

The Big Question: Will AI startups and non-tech companies spend enough on AI to replace lost demand from big tech companies? What’s the timeline for when this will play out?

Banana Brain Teaser

Previous

If the volume of a ball is 32,490 cubic millimeters, what is the volume of the ball in cubic centimeters? (1 millimeter = 0.1 centimeter)

Answer: 32.49

Today

An open box in the shape of a cube measuring 50 centimeters on each side is constructed from plywood. If the plywood weighs 1.5 grams per square centimeter, which of the following is closest to the total weight, in kilograms, of the plywood used for the box? (1 kilogram = 1,000 grams)

Send your guesses to [email protected]

?

AI is the new electricity. Just as electricity transformed many industries starting about 100 years ago, AI is now poised to do the same.

Andrew Ng

How Would You Rate Today's Peel?

?? All the bananas

?? Meh

?? Rotten AF

Happy Investing,

David, Vyom, Ankit & Patrick