The move higher in Nvidia (NASDAQ:NVDA) stock – up nearly 270% in the past 12 months – has been absolutely stunning. It is also very disconnected from reality.
It’s not even a valuation question (which is obscene at this point). It’s a question of a narrative disconnect around AI. I’ve mentioned this before, but if AI is the next industrial revolution, it should benefit bonds, small-cap companies, and utility companies. None of those are showing any conviction in the story as Nvidia marches toward a $3 trillion market capitalization.
So, what’s the problem? I’ve called this a concentration bubble repeatedly, in that passive, market-cap weighted indices are largely being driven by just a select number of large-cap tech names. Of course, investors don’t care what’s driving the performance. They look only to the right of the equal sign, rather than the dangers lurking to the left.
This brings us to a weird scenario here.
Why the Fed May Need to Save Nvidia Stock
The “wealth effect” refers to the phenomenon where individuals feel more financially secure and confident about their wealth when the value of their stock portfolios increases, which can lead to increased consumer spending. As stock prices rise, investors see an appreciation in their investments, which boosts their perceived net worth. This heightened sense of wealth often encourages them to spend more, under the assumption that they have more disposable income or are better off financially. This surge in spending can, in turn, stimulate economic growth.
Conversely, when stock prices fall, the wealth effect can work in the opposite direction. This leads to reduced spending and potentially a slowdown in economic activity.
If Nvidia keeps going at this pace and becomes a larger and larger portion of the S&P 500 and other market-cap weighted indices, would that not imply that whenever a major downturn occurs that forces the Federal Reserve to step in, that the Fed wouldn’t be saving “the market” but rather Nvidia? Microsoft (NASDAQ:MSFT)?
To me, this is an interesting thought experiment, and scary one. It’s clear that the Fed should be worried mostly about the totality of the economy and the market. But because so many investors have exposure to the idiosyncratic risks of a select number of stocks, how can the Fed really do that?
The broader point is simple. Nvidia alone driving the market could, in the extreme, have implications on monetary policy reaction functions. This in turn could mean that the Fed bails out huge companies because their downward performance would result in a negative wealth effect for the economy at the extreme.
We live in Bizarro World. Seems appropriate given the dystopian future AI likely gives us.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
