Why Digital Infrastructure Stocks Like Nvidia And AMD Have Seen A Selloff

Our theme of Internet Infrastructure Stocks which includes companies that sell hardware and software for server processors, graphics units, memory, and networking equipment, has seen a correction recently. This has reduced the theme’s year-to-date returns to around 8%, causing it to underperform the S&P 500, which has gained over 10% in the same period. This follows a solid 2023, which saw the theme return over 60%. While the excitement surrounding generative artificial intelligence technologies has benefited the theme, there are a couple of factors that have weighed on returns of late. Below we take a look at some of the trends that are currently driving the theme.

Artificial intelligence workloads are computationally intensive and are driving demand for accelerated computing chips and GPUs sold by the likes of Nvidia (NASDAQ:NVDA) and AMD (NASDAQ:AMD). For perspective, for the current fiscal year, Nvidia – which is the biggest beneficiary of the AI trend – is expected to see sales roughly double to $110 billion per consensus estimates, with net profits expected to grow at an even faster pace. This trend is also helping other players within the computing ecosystem, including memory manufacturers such as Micron (NASDAQ:MU) who could witness rising demand for faster, higher-density chips, such as  DDR5 and high-bandwidth memory (HBM) products. Micron is expected to see sales grow by over 45% this year, driven by higher AI-related demand and a recovery in the memory markets.  The trend could hold up, as companies look to shift their sizable installed base of traditional data centers to accelerated computing using GPUs to perform more artificial intelligence tasks.   Moreover, while the initial AI models deployed were largely text-based,  models are increasingly multimodal, working with speech, images, video, and 3D and this could call for higher amounts of computing power.

That being said, there have been some concerns of late. Weak U.S. jobs numbers and concerns of a recession have resulted in considerable market volatility. If there is indeed an economic slowdown, large businesses could pare back on capital spending. Moreover, the economics of the AI business have also yet to be sorted out given the high costs of training and running large models. Most customers will need to figure out how they can earn meaningful returns on the sizable amounts they are spending on AI data centers. There have also been media reports that Nvidia’s latest Blackwell GPUs could face delays of three months or more on account of design flaws and this has also hurt the broader theme. Things have been a bit more mixed for networking players within our theme, such as Cisco, who have seen lower demand from cloud service providers and telecommunication players amid economic uncertainty.

Now the Internet Infrastructure theme has performed well over a longer period as well, returning about 66% since early 2021. However, its performance has been inconsistent, with the theme declining by close to 40% in 2022, considerably underperforming the broader S&P 500.  In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could the theme face a similar situation as it did in 2022 and underperform the S&P over the next 12 months – or will it see a strong jump?

While the structural shift toward greater digitization will drive the theme in the long run, valuations are also a bit high, making the risk-to-reward tradeoff a bit less attractive for the near term. Within our theme, Nvidia stock has been the strongest performer of late, rising by 2.2x over the past 12 months, as demand for graphics processing units surged, driven by demand from the AI space.  On the other side, Cisco (NASDAQ:CSCO) stock has fared worse than the other stocks in our theme, declining by about 15% over the last 12 months.

[1] Returns as of 8/7/2024
[2] Cumulative total returns since the end of 2016

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