What Happened This Week? Kashkari on 10-yr TIPS, ARM Earnings, VanEck's Meme Coin Index, DeepMind's AlphaFold 3, Utilities Outperformance
This is my second episode of weekly updates on major market events. I appreciate the support received after the first article. As an avid market follower, I'm always excited to share some of the most notable events from the past week that deserve investor attention, along with my own views.
This past week featured comments from Fed officials after blackout periods, earnings reports from chip designer Arm Holdings, the launch of VanEck's Meme Coin Index, the debut of Google DeepMind’s new AlphaFold, and outperformance of the utilities sector. I will provide more detailed information on each of these topics in the following article.
Kashkari on 10-yr TIPS
Since the Federal Reserve's last rate hike in July 2023, inflation has fallen from above 3% to closer to 2%, leading many economists to argue that the real federal funds rate has significantly tightened in recent months. Minneapolis Fed President Neel Kashkari, however, indicated that the current monetary policy might not be as restrictive as many have assumed, based on the 10-year Treasury Inflation-Protected Securities (TIPS) yield.
In an article published earlier this week, Kashkari indicated that inflation has decreased by 285 basis points from the end of January 2023 to the end of January 2024. Considering the Fed raised rates by 75 basis points during this period, this translates into a significant 360 basis-point increase in the real fed funds rate. However, despite this substantial rise in real rates, the 10-year TIPS yield has only increased by about 60 basis points. Kashkari interprets this as an indication that market expectations for the future path of interest rates have adjusted downwards, which means the market does not anticipate a prolonged period of high rates, and therefore the overall stance of the monetary policy may not be as tight as one would conclude from just observing the nominal federal funds rate and the recent rapid disinflation.
In a Friday interview, Kashkari again highlighted the importance of the 10-year TIPS yield as a key indicator of the Fed's policy restrictiveness. He noted that the 10-year TIPS yield reflects not only the current and expected paths of the federal funds rate and the Fed’s balance sheet but also inflation expectations. This measure helps to project the future trajectory of policy actions rather than merely the immediate or short-term adjustments.
ARM Earnings
Chip designer Arm Holdings on Wednesday reported its third earnings since its Nasdaq debut. The company's last earnings, which exceeded expectation, drove its shares up by 48% following the announcement. Investors are particularly interested in how the ongoing AI revolution affects Arm, as it provides chip architecture to major tech firms like Apple, Amazon, Nvidia, and Qualcomm.
Here is what ARM reported for the quarter ended March 31, compared with the street consensus based on FactSet:
For fiscal 2025, Arm said it expects revenue to come in between $3.8 billion and $4.1 billion, compared with $3.99 billion expected from analysts polled by FactSet.
During the earnings call, analysts were interested in Arm's strategy to expand its presence in the data center market for AI applications. In response, CEO Rene Haas highlighted a partnership with Nvidia. He pointed out that Nvidia's recent launch of its Blackwell GPU platform is set to boost the adoption of ARM technology in data centers tailored for AI applications.
Specifically, the GB200, Blackwell's first chip, integrates two Nvidia GPUs with one Arm CPU. Haas suggested that this increased incorporation of ARM architecture in such environments is expected to accelerate adoption rates in data center more than initially anticipated. Furthermore, Haas emphasized ARM's cost-effectiveness in performance and its strategic positioning in various layers of data center technology, including custom chips that enhance connectivity and memory access, pointing to strong growth prospects in this sector.
To summarize, Arm once again exceeded earnings expectations with a 47% revenue growth. However, over half of Arm's royalty revenue in fiscal 2024 came from smartphones and consumer electronics, and given Arm's dominant 99% market share in the smartphone sector, substantial revenue growth from these areas may be challenging without raising prices.
Reflecting this, Arm is revising its royalty model, shifting from charging chipmakers based on chip value to charging device makers based on the value of the entire device, as reported by the Financial Times in March 2023.
I personally believe there are two major challenges with this strategy: first, dominant smartphone makers like Apple and Samsung have special agreements with Arm, with Apple reportedly paying less than 30 cents per chip regardless of the device, according to The Information. This includes technology used in iPhones, iPads, Macs, Apple TVs, Apple Watches, and HomePods. Second, if Arm significantly increases its royalty rates, smartphone makers might switch to using RISC-V, an open-source infrastructure that requires no loyalty or license fees.
Given these dynamics, it is crucial for Arm to quickly expand into the cloud or data center business to reduce its reliance on the smartphone and consumer electronics sectors. This is also why analysts concentrated on Arm's data center expansion during the earnings call.
VanEck's Meme Coin Index
- Big thanks to Mr. Christian Hollar for providing this headline!
This week, the crypto space witnessed new developments with asset management firm VanEck launching the Marketvector meme coin index, "MEMECOIN." This new index specifically targets six prominent meme coins, including Dogecoin (DOGE), Shiba Inu (SHIB), and Pepe (PEPE). Each coin within the index is capped at a maximum weighting of 30%, ensuring a balanced representation across these popular digital assets.
According to its description page, the index defines a meme coin as a type of cryptocurrency named after characters, individuals, animals, artworks, or other memetic elements, supported by passionate online traders and communities, and is primarily created for entertainment.
Investors are increasingly focusing on meme coins for several reasons. First, platforms like Solana have significantly reduced transaction costs, fueling sustained interest in meme coins, according to Tushar Jain, Cofounder and Managing Partner at Multicoin Capital.
Adding to the context, Solana's transaction fees, typically between $0.003 and $0.005, are substantially lower compared to Ethereum's average transaction fee of about $2.47, as reported by bitinfocharts.com.
Second, hedge funds are showing a growing interest in meme coins, as highlighted by Bloomberg. For example, Stratos, a hedge fund based in Newport Beach, California, garnered a 137% return in the first quarter by investing in a meme coin named Dogwifhat, which at one point surged more than 300 times in value. Although there was a subsequent decline, this case exemplifies the high-risk, high-reward potential of investing in meme coins.
According to the Bloomberg article, the overall market value of memecoins has reached approximately $54.7 billion. Prominent investment funds like Brevan Howard and Pantera Capital have recognized the staying power and significant trading opportunities presented by memecoins. Hedge funds are increasingly drawn to this sector due to the potential for substantial profits, even though memecoins are often considered controversial and seen as speculative or akin to gambling.
Nevertheless, some industry participants view memecoins as "culture coins," representing membership within a particular community or belief system. This cultural aspect can drive interest and value independently of traditional economic fundamentals.
To summarize, the increasing involvement of hedge funds in the memecoin space highlights a broader trend of institutional interest in high-risk, high-return crypto assets, despite their speculative nature and inherent risks. The launch of the Marketvector meme coin index, I believe, is a good example of this rising interest.
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DeepMind's AlphaFold 3
On Wednesday, significant advancements were made in the intersection of AI and biology. Google DeepMind and Isomorphic Labs announced AlphaFold 3 on Wednesday, claiming it can predict "the structure of proteins, DNA, RNA, ligands and more, and how they interact."
This AI model, built on its predecessor AlphaFold 2, can "predict the structure and interactions of all life’s molecules with unprecedented accuracy" and notably enhanced the prediction of how proteins interact with various molecules, achieving "at least a 50% improvement compared with existing prediction methods," according to the announcement.
For reference, every protein is made up of a sequence of amino acids, and interactions between those amino acids and the external environment determine how the protein “folds” — which dictates its ultimate shape.
Investors should take note of developments like AlphaFold 3 for several compelling reasons:
To summarize, investors should note AlphaFold 3's potential to revolutionize drug design, agriculture, and materials by cutting costs and speeding innovation. Nvidia's focus on digital biology highlights significant growth potential, despite the biotech underperformance.
Utilities Outperformance
Lastly, I want to move on to utilities sector. Utility sector is the second best performing sector year-to-date, up 12.54% as of Friday May 10th, just little shy of the communication sector but nearly doubling the performance of the tech sector. This is a significant reversal from last year, when high interest rates and costly projects lowered investor interest in utilities.
The anticipation of rate cuts later this year, coupled with a growing long-term demand for electricity driven by advancements in artificial intelligence, has made this traditionally defensive market segment attractive. The International Energy Agency (IEA) forecasts that global electricity usage by data centers will double by 2026, rising from an estimated 460 terawatt-hours (TWh) in 2022 to over 1,000 TWh, an amount roughly equivalent to Japan's total electricity consumption.
At the beginning of May, we saw Microsoft entered into a significant five-year renewable energy agreement with Brookfield Asset Management. This partnership aims to develop new renewable energy capacity to support the increasing demand for Microsoft Azure cloud services and aligns with the tech giant's goal to match 100% of its electricity consumption with zero-carbon energy purchases by 2030.
This deal represents the largest corporate clean energy purchase ever, nearly eight times larger than any previous single corporate power purchase agreement (PPA), according to ESG today.
As AI applications in data centers require increasing amounts of electricity, tech companies like Microsoft are turning to zero-carbon energy sources to meet both their electricity demands and sustainability goals.
In April, Goldman Sachs forecasted a base case scenario where data center power demand will grow at a compound annual growth rate (CAGR) of 15% from 2023 to 2030. This growth is expected to increase data centers' share of total US power demand to 8% by 2030, up from about 3% currently.
Further, Goldman highlighted that US power demand is "likely to experience growth not seen in a generation." This is noteworthy because US electricity demand hasn't grown by 2.4% over any eight-year period since the start of the century. Historically, US annual power generation growth over the last 20 years has averaged less than 0.5%, according to Goldman.
Turning to markets, what are the top 5 best performing stocks in S&P 500 this year and their common theme? No surprise, they are Super Micro Computer (SMCI), Vistra Corp (VST), Constellation Energy (CEG), Nvidia (NVDA), and NRG Energy (NRG). The common theme among these companies is their integral role in providing infrastructure for AI.
Vistra Corp, Constellation Energy, and NRG Energy, while not as widely known as Super Micro and Nvidia, are major competitive power generators in the U.S. These companies, which have exposure to clean energy sources, are set to benefit from the increasing demand for electricity and the push towards sustainable energy goals.
For instance, a major catalyst for Vistra Corp's recent outperformance was highlighted by Daniel Loeb in his 2024 investor letter, where he noted Vistra's acquisition of nuclear generation assets from Energy Harbor in March 2023. This move is seen as a smart capital allocation by Loeb that positions Vistra well for the future, particularly as the market begins to value the "increased penetration of intermittent generation (renewables), and an inflection in power demand from AI/data centers and electric vehicles."
Similarly, Constellation Energy is in discussions with major companies to provide nuclear power for artificial intelligence (AI) data centers, according to CEO Joe Dominguez. The company has already secured a deal last June with Microsoft to supply nuclear-generated electricity to its Virginia data centers, and the deal aligns with Microsoft's goal to operate these data centers on 100% carbon-free electricity continuously.
NRG Energy, although no longer owning nuclear facilities, operates primarily in competitive energy markets such as Texas and parts of the Northeast. According to CEO Lawrence Coben, these regions have regulations and market structures that support rapid project development and cost efficiency. This environment is particularly advantageous for managing the substantial load growth from data centers. Further, as an independent power producer (IPP), similar to Vistra Corp, NRG Energy is well-positioned to capitalize on increasing electricity demand, potentially translating this into significant earnings gains more effectively than regulated utilities could, according to many wall street analysts.
To summarize, utility stocks are generally considered defensive because they provide essential services like electricity, natural gas, and water, which have consistent demand. This demand ensures stable revenue streams for utility companies, making these stocks a hedge against market volatility and economic uncertainty, although they may be perceived as somewhat unexciting. Nevertheless, the rise of AI is driving increased demand for data centers, which in turn boosts the utility sector. The current investment climate, characterized by expectations of rate cuts and opportunities to monetize from AI, has made electric utility stocks increasingly attractive to investors. Particularly, utilities that utilize sustainable energy sources are seeing the most benefit, aligning with a broader corporate focus on sustainability goals.
Behind the Scenes
This article was intended to be published earlier, but I took some time off to enjoy downtown Durham. Special thanks to Bill for providing this open mic opportunity.
This concludes the article. If you have any ideas, suggestions, or comments, please feel free to share!