Even with stocks only a couple of percentage points below record highs, global financial markets wobbled in August. Last week’s big focus was the continued rise in bond yields, thanks to ballooning government deficits, the monster wave of artificial intelligence debt, and inflation worries.
The calendar looks light this week, save one very big item: Nvidia’s NVDA second-quarter earnings, which come out after the closing bell on Wednesday. This week’s Market Brief presents highlights of what to watch for from Nvidia, along with a look at the stock’s historical post-earnings track record.
First, though, is a look at what the huge rally in Nvidia and other big semiconductor stocks has meant for investor portfolios. Many investors may not realize just how big a bet they are making on this volatile sector. Finally, a research note from the San Francisco Federal Reserve offers thoughts about another important consideration: the correlation between stocks and bonds.
What do semiconductors have in common with railroads? They’ve seen two of the biggest industry concentrations in stock market history, according to the CRSP Stock Database. And semiconductors are well ahead of the telephone boom of the early 1930s.
What does this mean for investor portfolios? By now, it’s become almost an accepted fact for many investors that Big Tech stocks heavily dominate their portfolios. But they may not realize they are making an even narrower big bet on semiconductor stocks, especially in index-tracking mutual funds and ETFs.
“The growth of the semiconductor industry has been truly astounding,” says Morningstar Indexes strategist Dan Lefkovitz. “Nvidia has been one of the biggest stocks in the market for years now, but I think many investors will be surprised to hear that Broadcom is now pushing $2 trillion in market cap and Micron Technology exceeds $1 trillion.” He says three of the top 10 stocks in the US market are now from a single industry: semis.
Semiconductor stocks aren’t only making up a large percentage of portfolios in the United States. As Leslie Norton noted Friday, emerging market funds are now heavily tilted toward such names, thanks to huge gains in Taiwan Semiconductor Manufacturing TSM, Samsung Electronics 005930, and SK Hynix 000660.
Back in the US, the semiconductor and semiconductor equipment and materials industries together far outstrip the next-largest industries in size. The software application and infrastructure industries combined make up just over 11% of the Morningstar US Large Cap Market Index, which tracks the top 70% of the market capitalization of the US stock market. Internet content and communication (home to Alphabet GOOGL and Meta Platforms META) is now less than half the size of the semis category.
This means investors should buckle up for a bumpy ride. Most portfolios—especially those with index funds—now have their largest exposure to a group of stocks prone to significant ups and downs in both the short and long terms.
“Semis have a history of cyclicality and volatility,” Lefkovitz explains. “Over the past three years, their returns have been among the most volatile of any industry in equity markets.”
In years past, most of Wall Street would tune out for the last two weeks of August. But these days, Nvidia releases a must-watch earnings report around this time. While the stock is up some 360% from May 2023, when an AI-driven surge blew away expectations and kicked off the AI stock boom, post-earnings performance has been muted.
As Nvidia is perhaps the most dominant player in the AI infrastructure boom, investors will be paying close attention not just to its numbers, but also to color from the company on the broad outlook for the AI buildout.
Morningstar senior equity analyst Brian Colello has this to say about Nvidia earnings:
We’re looking for another beat-and-raise quarter, given the strong capex trends among hyperscalers and enterprises. Nvidia should generate well over $300 billion of data center revenue in calendar 2026, which is effectively fiscal 2027, and perhaps over $500 billion in fiscal 2028.
Perhaps the most polarizing issue has been Nvidia’s financing and backstopping of certain partners, including its recently announced $500 billion mobilization of large financial asset managers to invest in artificial intelligence. We trust that Nvidia will lay out its case for why it is arranging such partnerships and/or financing certain firms.
Brian Colello
For more of what Colello will be watching, check out our preview of Nvidia’s earnings.
Investors primarily manage stock market volatility by counterbalancing it with a bond portfolio. That works fine when stocks and bonds move in opposite directions. But as investors found out the hard way in 2022, it’s painful when a bear market in stocks coincides with a big selloff in bonds. The relationship between stocks and bonds is a key factor in the benefits of basic portfolio diversification, like 60/40 portfolios, which hold a blend of the two investment types.
The good news for portfolio construction is that over the last few years, bonds and stocks have gone back to a strong inverse relationship. But why? A recent article by Thomas Mertens, associate director of research at the Federal Reserve Bank of San Francisco, dug into stock and bond market correlations, whether the economy is driven more by demand-side trends or supply-side dynamics, and what that means for the outlook.
Here’s how Mertens explains the concept:
Intuitively, higher demand leads to more economic activity and higher prices, resulting in inflation. Higher economic activity tends to raise stock valuations, while higher inflation tends to boost bond yields, leading to a positive stock-bond correlation. A negative shock to supply, on the other hand, makes goods scarcer, leading to lower economic activity but higher prices. While stock valuations decline due to lower activity, inflation raises bond yields, such that the comovement of stocks and bonds is negative.
In line with the negative stock/bond correlation, the 1990s marked a transformative era in information technology, leading to significant investment. After the dot-com boom ended, these supply-driven developments gave way to more pronounced demand-side risks.
Thomas Mertens, associate director of research at the Federal Reserve Bank of San Francisco
Fast forward to the pandemic, which caused an especially extreme global supply shock, and more recently to the Iran war, which led to an energy supply shock. In this environment, stock/bond correlations would be expected to be negative.
Mertens also dives into the correlation between stocks and oil prices, which has turned similarly negative: “When oil supply is squeezed, the price of oil rises. And because oil is an important input into the supply chain and the production and transportation of many goods, low oil supply tends to weaken economic activity. This can create a simultaneous decline in stock prices and an increase in oil prices. In other words, oil supply shocks can lead to a negative stock/oil correlation.”
Mertens says the backdrop suggests the negative correlation between stocks and bonds will continue. “The forward-looking nature of asset prices and the persistence of the stock-bond correlation suggest that a supply-driven economy may be the new normal for some time.”
The author or authors do not own shares in any securities mentioned in this article.
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