Nvidia's turnaround pulled all our chip stocks higher as Wall Street bought the reset

Published Thu, Aug 25 20223:06 PM EDTUpdated Thu, Sep 1 202212:07 PM EDT

Semiconductors stocks rallied Thursday as Nvidia (NVDA) saw its shares turn their premarket losses into gains shortly after Wall Street's open. As noted Wednesday evening , we thought Nvidia's weaker forward guidance, after a quarter that basically matched its preannouncement, would be viewed as a reset of expectations. Following a sharp decline after-hours, Wall Street apparently came to see it our way. Shares of Club holding Nvidia were up nearly 3% in Thursday's session, taking our other chip holdings along for the ride. Advanced Micro Devices (AMD), Qualcomm (QCOM) and Marvell Technology (MRVL) were all up between roughly 3% and 5% in the regular session. (Marvell reported its quarter after the closing bell Thursday, basically in-line with forecasts on earnings-per-share and revenue but a little light on guidance.) The price action in Nvidia's stock was a bit counterintuitive. In general, our rule of thumb is that when a stock rallies on bad news — and the quarter certainly can't be characterized as good news — it's a bullish sign. The reason: It's a sign that most of the sellers have already sold and the buyers are coming because they sense a bottom forming and want to get in before it's too late. Taking a look at analyst reactions to Nvidia's quarter and guidance, just about every analyst on the Street cut numbers and lowered their price targets. The analyst at Citi did as well, cutting their target from $248 per share from $285. However, what separates Citi's call from the pack is that despite the PT cut, they opened a so-called positive catalyst watch call on the stock heading into Nvidia's developers GTC conference, starting Sept. 19, highlighting expectations for new gaming product announcements. In Citi's view, gaming should rebound into 2023 as the inventory correction comes to an end and new products launch. They called out management's commentary that the data center road map remains on track and acknowledged that the Automotive segment is inflecting. They also thought that longer-term, this is a data center play and that shares will continue to benefit from secular growth in artificial intelligence and the protection provided by the company's competitive moat. We tend to agree with pretty much everything Citi said here, with one caveat. Their "positive catalyst watch" call is ultimately, a trading call. The analysts think there could be a trade setup into GTC. Our issue is that we aren't as certain on the timing of the inventory correction in gaming, and while we do expect new products to be unveiled at the event, the lag between those announcements and products hitting shelves and benefiting sales is unclear. It will be heavily impacted by how effectively Nvidia and its channel partners can flush out existing inventory. So, our thinking given Thursday's stock action — which again, we take to be a bullish sign that the bulk of the sellers have already had their way — is that if you aren't in the stock, these levels would be acceptable to take a starting position. We do have Nvidia as a 1 rating, meaning we see the stock as a buy at these levels. However, if you already have a position, as we do, then there's simply no rush to take on more exposure. We've owned Nvidia for a long time and have cost basis at just over $73 per share. We last added to our position back in May at $173.12 per share. The stock on Thursday was trading around $177. After Wednesday's after-the-bell release, we highlighted late 2018 and early 2019 as the appropriate parallel when it comes to trading in Nvidia stock. Keeping with that, there are two dates we want to highlight and use as anchor points to get a better sense of the potential moves we could see in coming months. On Nov. 15, 2018, Nvidia reported a slight revenue miss but beat on earnings per share expectations for its then-fiscal third quarter. Shares fell a little over 26% over the following two days. On Jan. 28, 2019 the company preannounced results, cutting its revenue outlook again and adjusted its gross margin forecast. Over the following two days, shares fell nearly 18%. The big takeaway for us is that the drawdown on the second shoe dropping wasn't as large as the first drawdown. Moreover, we have arguably already seen two shoes drop, the preannouncement on Aug. 8 of this year and the poor third-quarter guidance we just got with the fiscal second quarter earnings release. Following that Jan. 28, 2019 announcement, shares bottomed at just under $33 (Nvidia split it shares 4 for 1 in July 2021) the next day and proceeded to rally to a high of around $48 by mid-April 2019, a roughly 45% gain. However, shares quickly did an about-face and traded to a closing low of $33.45 in early June, 2019 – essentially giving the entire move back. That was the bottom you wanted to buy as Nvidia never saw that level again and proceeded to more than double between then and pre-Covid pandemic peak of just over $73 per share. By the way, despite this recent brutal drawdown in we have seen in 2022, we are still about 140% above those levels. So, big picture: While there was a heck of a trade in that period between Jan. 28, 2019 and mid-April of that year, from the perspective of a long-term investor who isn't able or willing to try and play the swings, it was ultimately dead money between later that January and early June 2019, and that is what we think we could be looking at here, a stock that has fits and starts over the next few months but that ultimately will not be able to truly reverse and grind its way to new highs until we get this inventory behind, new products launched and production ramped and at a higher level, get a grip on inflation which remains an anchor on valuations. Of course, there's no way to know the exact path shares have ahead of them but in our view, there are three ways to take this analysis and make it actionable: Tell yourself you want play the hedge fund game, follow Citi's "catalyst call" and maybe catch some upside into next month's event (and have an exit strategy in case the reversal we saw in 2019 plays out again this time around). Or, come from the perspective of a long-term investor that currently doesn't have any exposure to Nvidia, acknowledge that while there may still be some downside, the future growth thesis remains intact — and you are ready, willing and able to stomach volatility and build your position over time into any further weakness from here. (Jim Cramer's Charitable Trust is long NDVA, AMD, QCOM and MRVL. See here for a full list of the stocks.) Update: This story was modified on Sept. 1 to fix some typos. 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A sign is posted at the Nvidia headquarters in Santa Clara, California, May 25, 2022.

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