Will This Market Go Higher Than Anyone Expects?

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Cestrian Capital Research’s Alex King is worried he isn’t bullish enough. Markets from a technical analysis perspective, using Elliott Wave and Fibonacci (2:25). Taking advantage of AI, tech sector (6:00). This is an abridged conversation from a recent Investing Experts podcast.

Transcript

Alex King: My instinct is we’re going to see a continued run up in markets through 2024, certainly up until the presidential election. And we’ll see what happens after that.

And if that happens, then there is a possibility that actually the low that you should be measuring from is the COVID crisis low. And if you measure from that low, again, using many tech analysis methods, but certainly ours, then it says actually, the NASDAQ and the S&P could run up quite a long way from here, numbers that sound silly right now.

So, if I looked at the (NASDAQ:QQQ), and I took our bull case and it is our bullish case, you’d say it could run up to 650, but that sounds silly now and there’s not really much point saying that. But then the start of large bull markets, if you come up with any price targets, it always sounds silly at the time. So the best thing to do is see how it goes.

So the work for us is, again, in the NASDAQ, look at what happens when it gets into the low 400s on the QQQ. If there’s strength through there, if it’s really powering up, well, then I think we’ll think, well, our base case is a bit too visible. And if it’s hard going and it’s faltering and thinking about turning over and hitting resistance levels, then I think we’ll think, okay, the cycle is done, and then we’re back into a bear market.

And I don’t have a religious opinion on that. I think we’ll just let the market tell us what it’s going to do. You know if the market is going to dump and you know how you know it? Because it starts dumping. You don’t have to be any kind of rocket scientist here, it tells you.

So, that’s a long answer. But in essence, I think, base case expectation here is it’s going to run up some more. And if I look at where could we be wrong, I think, where we could be wrong is, and what I’m most concerned about is turning to sell too soon.

I’m not concerned about the bottom is going to fall out of the market tomorrow and oh, dear, I didn’t sell anything, because you always get time to hedge or to sell. My concern is that we’re too cautious. And then in my own personal holdings and our callings in our research, we’re too bearish. And we say, “Okay, time to step aside and the market keeps on running up.”

Because that’s what’s happened to an awful lot of people since this time last year. They didn’t believe that the bull market was real and they just cost themselves a ton of money as a result needlessly. Whereas if they just watched the market and reacted as opposed to try and predict it, they’d have done much better.

We did two kinds of analysis. We do technical analysis, we do fundamental analysis and never the two should meet. If they coincide, it’s quite interesting and it reinforces the one and the other. But for price analysis, we start with technical analysis.

From a technical analysis perspective, we use this Elliott Wave and Fibonacci method. There’s nothing revolutionary about it. Lots of people use it. Many folks on Seeking Alpha use it. But if I just talk you through it, starting from the 2018 lows, as I just mentioned, suggests that we’re now in a wave five up. That’s a final run-up before a big sell-off.

But it doesn’t feel to me that that’s true because the U.S. economy is in pretty good shape. Inflation is coming down. It’s unlikely rates are going to go up. They might come down. Consumers in good health. Poor people aren’t in good health, but they never are.

Rich people are in very good health and rich people drive the market, poor people don’t. May not be nice, but it’s true. And it doesn’t feel like that technical analysis calling for a rollover soon is right.

But if you start those charts, the same method, the same Elliott Wave and Fibonacci charts from the COVID lows, then the sell-off in 2022 looks like what’s called a wave two down. So basically a big correction after initial run-up.

Whereas if you start at 2018, it looks like a wave four down, which is a final sell-off before the final run-up. Now, the 2022 sell-off was so deep in both the NASDAQ and the S&P, that it’s a perfectly righteous wave two, which tend to be pretty deep.

And so what that might mean maybe is that the S&P and the NASDAQ are currently in a wave three up. And if so, wave threes are really powerful and go a lot longer and a lot further and a lot further up than anyone expects them to.

And so, it’s on purely technicals. So, if you want to get into some very, very boring detail and it is boring. If we look at the base case on QQQ, then 2022 more or less all the year was a 0.618 retrace from the wave three high struck in the end of ‘21. That’s if you start at the 2018 lows, I appreciate this is incredibly boring.

Whereas if you start at the COVID lows, March 2020, and you say that the move up to the end of ‘21 was a wave one, then 2022 was a 0.618 retrace of that move, which again is a perfectly valid wave two. So there’s every chance, I think, that we’re in a wave three right now, not a wave five.

And when that becomes not boring is because if it’s a wave five, well, it’s going to roll over soon and sell, and we all need to be on our toes and ready for that. But if it’s a wave three, it’s got a ton of time to go.

And the mistake people will make is getting out too soon. And that is just giving away money for absolutely no reason. And so that’s why I think it, because the chart pattern says it.

And if you look, just look outside the window for a moment, does it look like – does it look and feel like 2021, when a – it’s pretty obvious a big sale was coming at the end of that year. It doesn’t look and feel like that. It looks like the early innings of a bull market, I think. And so, that’s why I think that.

So one, technical analysis, the chart says that that might be the case; and two, look outside the window. It doesn’t look like the end of days.

Rena Sherbill: AI and all the mania it’s seen in this past year, what would you advise investors in terms of trying to take advantage of that? Is it worth getting into Microsoft (MSFT), NVIDIA (NASDAQ:NVDA)?

Palantir (NYSE:PLTR) is a stock that’s bandied about a lot, it’s a favorite from a few analysts on this podcast. Curious your thoughts on the bigger players and then just the general approach to that part of the sector.

AK: Yeah, sure. I think the first thing to say is, well, the first thing to say, of course, we don’t give any advice, make sure to say that. So, I shan’t be giving any advice.

But the first thing to say about AI is, what it isn’t is a bubble. Obviously, some of the stock prices have rocketed along with that AI narrative, but AI in and of itself isn’t a bubble. And why I say that is because call it what you like, AI, large language models, parallel compute, pick a name, what’s happening here is a CapEx refresh cycle in the data center and beyond.

So about every decade, plus or minus, you see this in tech. So in the mid late 90s, enterprise size companies woke up and went, well, we haven’t got a website, or if we have, it looks like a brochure. We kind of need one. We better find out why we need one and what it needs to do. And, oh dear, none of our IT systems can run this.

Okay, we’re going to spend a lot of money on IT, and they did. And then those assets were depreciated over the next four or five years and became extremely profitable in the 2004/2005 period onwards. It’s 2010 and everyone suddenly requires the internet now to actually work.

And so, more people had broadband connections to their home and offices, more consumer activities were expected to be conducted online, people getting iPhones in ’07, which pushed up bandwidth requirements on the fixed line network, the backbone network massively.

And so another CapEx refresh cycle came around the 2010/2012 period. And that coincided with the rise of social, huge data center growth off the back of Facebook (META) and other social media sites and we’re there again. So, we’re another decade-ish on.

And if you think about the improvements and increases in compute power that arises from having this colossal collection of parallel processing units in the data center, well, what that’s going to need next, what has to happen next is improved networking. Because the only way to get the output from that massively upgraded compute plant that’s in the core of the network, the only way to get that to people’s devices is a network that is faster, lower latency, lower jitter, higher throughput, all those things.

And so what I expect us to see now is a network CapEx refresh. So that means in data center networking, the interlinks at that point, the wide area network, that means all the fiber that’s run by AT&T (T), Verizon (VZ), all the smaller players.

The in-office network, people’s home Wi-Fi networks, the security, so the endpoint devices. So, if you’re running a machine now at home that’s two, three, four years old, it’s going to start creaking because the software requirements and the software demands upon the system are increasing.

So, this isn’t some bubble dreamed up to shift NVIDIA stock, although clearly that’s been a beneficiary, it’s a real thing. And the CapEx spending, I think, is going to percolate way, way, way down through the tech value chain. It’s only really just started, in my opinion.

Now, stocks. We called NVIDIA as an accumulate opportunity between 100 and 150 again, there’s a public article on Seeking Alpha doing that last year, and it fair rocketed out of that zone. It’s hit some resistance right now, but it’s shot up from 150 to almost 500 really quickly. And I don’t think that that’s a bubble. Do I think that’s going to sell off a bit? Yeah, probably before another move higher.

But I think that if you look at the fundamentals of NVIDIA, it’s actually not a particularly expensive stock on the basis of a cash flow multiple given the growth in cash flows. This thing is growing at a percentage rate that’s just incredible for the size of business it is. That’s been the, obviously, the stock to back in this area.

Now, of course, there are smaller cap tickers that C3.ai (AI), a bunch of other things that happen to have shot up, but if you look at actual real businesses as opposed to speculative stocks, NVIDIA’s clearly been the one to be in to benefit from that.

There’s plenty of others. I think if you want to benefit from AI, the number one thing you can do is be exposed to tech, because AI will drive, in my opinion, again, CapEx flushing all the way through the tech value chain.

So frankly, being in the NASDAQ, will – you are exposed to AI by doing that. So you don’t have to go and pick some crazy stock that somebody tells you is going to be a big beneficiary of AI and somehow miraculously hasn’t been, but it’s about to take off tomorrow and it’s an undiscovered microcap, you don’t need to do that. You can if you want, sure. You don’t need to do that. The NASDAQ alone will give you any windfall benefits that flow from that AI CapEx refresh.

Palantir, I mean, I own Palantir, I own NVIDIA as well. I love Palantir as a fundamental business. It’s not a particularly good business. It looks like an old line enterprise software and services business, which is to say big bespoke projects, so-so margins and cash generation.

I really don’t love the continued founder selling. Every time the stock hits, you can tell the founders do technical analysis because they always sell as it reaches a technical high. Again, I do own it. I expect it to go higher, but I don’t think it’s the North Star for AI investing at all.

I think it’s a reasonably good enterprise software business, where enthusiasm for the stock will probably drive it higher. And I’m personally positioned that way. But it’s not a stock I would personally expect to own in five years’ time, because if you’ve been around enterprise software, just go and look at the numbers.

The numbers aren’t all that wonderful. It tells you that it’s going to struggle to ever be a really truly high-margin business. It kind of can’t grow that fast because the projects are difficult, bespoke, huge customers, government and enterprise customers. It isn’t a flywheel type software business of the kind that we see with pure cloud businesses, for instance.

So again, AI, I don’t think it’s a bubble. I think it’s a real spending. There’s continued benefit in the NASDAQ at large. NVIDIA stock I think, can keep going up. It wouldn’t surprise me to see some weakness first, but I think it can keep going up. I don’t think you need to get esoteric and overthink tech to get some AI exposure. As you mentioned earlier, Microsoft will give you AI exposure, so will Amazon (AMZN).

The key thing, I think, is technology for as long as I’ve been an investor has always been an incredibly strong performer. And that’s because it’s such a young industry that’s growing so quickly. And so, I think anyone that does not have tech exposure, that’s probably the biggest risk over the long-term. Obviously, you can get hurt in the short-term as 2022 taught everybody, but long-term, I think it’s incorrect, I believe, to have insufficient technology exposure.

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