Markets Rally & TSMC Bets Big on AI

WEEKLY UPDATE

Good week for stocks

The major market fluctuations continued this week with interest rates slightly declining and the stock market rising, driven by lower-than-expected inflation and strong earnings reports from several banks. Europe, in particular, had a stellar week, seeing its best performance since September, with the Eurostoxx600 increasing by about 2.5%.

Lower than expected inflation

On Wednesday, the market reacted positively to lower-than-expected core inflation in the US for December. Although the overall CPI rose by 0.4%, bringing the annual increase to 2.9% from the previous 2.7%, the markets welcomed the news. Much of the inflation rise was due to higher energy prices, and core inflation (excluding energy and food) only increased by 0.2% month-on-month, the lowest rate in five months and below the expected 0.3%.

Falling interest rates led by the US

Despite December's slightly lower-than-expected inflation, the news caused a significant reaction in the bond markets. This reflects a fear of high inflation, partly driven by the US's expansionary fiscal policy, causing quick market fluctuations on small positive or negative news. This time, investors drove interest rates down, with the 10-year US Treasury yield dropping by about 12 basis points to around 4.65%. In Denmark, the 10-year swap rate fell by around 8 basis points. Small steps perhaps, but the core inflation surprise was also minor.

Europe follows suit

Following expectations of US Federal Reserve rate cuts, Europe mirrored the movement with the US inflation figures on Wednesday. The next day, the ECB released minutes from December's policy meeting, indicating increased confidence in achieving stable inflation. They are prepared to continue normalizing monetary policy, which has already reduced the euro area's policy rate by 1% from its peak last spring.

Banks performing well

As usual, several major US banks reported fourth-quarter results this week, showing strong earnings that generally exceeded Wall Street estimates and lifted the overall market. Despite mixed reactions among different financial stocks, the Dow Jones U.S. Banks Index rose by 7.7% last week, with Morgan Stanley and Goldman Sachs seeing significant gains of around 12% each.

Apple's Challenges

Apple has experienced its largest monthly decline since September 2023, despite a 20% increase over the past 12 months. The stock is under pressure due to a 17% decline in sales to China last year and a 25% drop in the fourth quarter of 2024, causing Vivo and Huawei to surpass Apple in the Chinese smartphone market. Apple also faces tough competition from other popular domestic AI-compatible and foldable smartphones.

NDI-FUTURETECH

NDI-FutureTech is up 4.85% this year after a 37% run last year and is still among the top performers among eToros partner portfolios.

Are stocks expensive?

There is much debate about whether the US stock market is expensive. Some experts point out that the US stock market is pricey based on the P/E ratio, which indicates the price-to-earnings relationship right now. Investment, however, is about future earnings of companies, and we believe AI and the new US administration are the two most important factors to watch.

TSMC reported good earnings this week, and most importantly for NDI-FutureTech, they were very bullish on future accelerator chip production. More on that later.

Returning to the P/E debate and its significance for long-term returns for an index investor, the S&P500 graph (see below - logarithmic scale) since 1950 identifies periods where investing in the S&P500 would yield good 10-year returns (marked in green) and poor 10-year returns (marked in red).

The figure shows two red-marked periods where the S&P500 entered a secular bear market. Investing during these periods leads to poor 10-year returns. Investing during the green-marked periods, characterized by subsequent secular bull markets, results in good 10-year returns. Unfortunately, it is impossible to determine what drives secular bull markets, so predicting the next ten years is uncertain.

Our take is that we doubt the P/E value of the market can predict its overall direction over the next ten years. We am convinced that technological development drives secular bull markets. Technological advancement only happens rapidly under the right circumstances, as discussed in Week 52:

Many of today’s technological advancements originated in the United States, tracing back to monumental efforts like the Manhattan and Apollo projects. Both were extraordinary political, economic, and technological achievements made possible by technological optimism, a clear vision of a futuristic society, FOMO, abundant liquidity, and the involvement of the best minds in atomic and rocket technology. Since Neil Armstrong landed on the moon in 1969, however, there has been stagnation. It seems the Western world’s agenda has been dominated by complacency, a lack of technological ambition, and, perhaps most significantly, a reduced appetite for risk. The most groundbreaking advancements of the past 50 years have come from individuals like Jensen Huang and Elon Musk, who have demonstrated a clear vision for the future, a commitment to technological optimism, the ability to raise funds, and the talent to assemble the best engineers for their projects.

All this talk, however, is about index investing, and as previously discussed, NDI-FutureTech is essentially a diversification away from BigTech and index investing and towards the next generation of tech companies (with the exception of the chip sector, often made up of mature companies). Therefore, an investor in NDI-FutureTech should consider whether they believe the chip sector, SaaS, AI, cloud, etc., will be good investments over the next ten years. In the short term, our companies will follow the market trend, but over ten years, NDI-FutureTech's performance will be determined by the development of companies in the portfolio and management.

Strong development in TSMC

An indication of the strength of current technological development came from Taiwan Semiconductor, which reported earnings this week. Revenue increased by 37% compared to last year, and the profit margin is rising, resulting in a 56% increase in earnings per share. AI revenue grew by 200%, and high-performance computing (chips for data centers) now accounts for 53% of revenue and is expected to double by 2025. In fact, high-performance computing capacity is currently maxed out at TSMC, which is working hard to increase CoWoS (Chip on Wafer on Substrate) capacity to meet demand.

TSMC expects the growth rate for accelerator chips (commonly referred to as AI chips) to grow by 40% annually over the next five years. One should always be cautious about taking company leaders' future projections at face value. It is part of their job to be optimistic about their company and products. Therefore, we tech investors keep a close eye on TSMC's investments in future production capacity. TSMC's CapEx (investment in production equipment) is increasing from $29.8 billion in 2024 to $38-42 billion in 2025, corresponding to a 34% growth.

TSMC is thus backing up its growth expectations for high-performance computing with substantial investments. Interestingly, TSMC has started upgrading older facilities to produce leading-edge chips, meaning production of leading-edge chips can increase at an even higher rate than CapEx growth suggests. Regardless, TSMC's significant increase in investments shows its belief in the 40% growth estimate for leading-edge chips. For us as investors, this means that TSMC clearly does not think the AI boom is cooling down, quite the opposite.

THE WEEK AHEAD

Trump, Trump, and more Trump

We can't ignore it. The biggest and most anticipated event of the coming week is President Donald Trump's inauguration this Monday. There are high expectations for his inaugural address, with the entire world watching and wondering if there will be any new significant announcements. The markets are likely to be quite sensitive to the potential impact of these, particularly on Tuesday until things settle down again.

Europe restarting the engine?

On the macro front, the week's most important economic data comes at the end of the week on Friday when we get PMI figures from France, Germany, and the Eurozone. It will be exciting to see if the positive stock market development in the euro area this week was a precursor to signs of a turnaround in the struggling European economies.

Earnings

Next week, we will see fourth-quarter earnings reports from some major American legacy companies such as Procter & Gamble, Johnson & Johnson, Abbott Labs, Union Pacific, and American Express. Here at NDI, we are more focused on tech-related companies such as Texas Instruments, Intuitive Surgical, and SK Hynix. We are particularly eager to hear about the growth in high bandwidth memory from SK Hynix, the world's largest memory chip producer, as discussed in our Week 35 newsletter.