If you Rip Van Winkled yourself through the first half of 2023, one of the things you might be wondering is if the recession everyone was worried about had come and gone. You would be reading stories of a Fed pause, major equity indices hitting multi-year highs, volatility hitting multi-year lows and technology partying like its 1999. Reality, of course, is more complicated. One thing we did not see happening was just what the artificial intelligence rush by Open AI’s roll out of GPT-3 would do to move the virtuous circle into overdrive, even as the word still works through the transition to 5G.
While the companies grabbing headlines and higher valuations earlier in the year have been the ones responsible for the development of these platforms, that shifted abruptly with Nvidia’s (NVDA-US) first quarter earnings release in May. What is interesting is that when you read through the release, you’ll find that it was 14% YoY growth in Data Center related revenue that investors focused on instead of the YoY 38% decrease in Gaming revenue as well as a 53% decrease in its Professional Visualization business. Interestingly, automotive related revenue was up 114%, albeit on a smaller dollar base. After the Nvidia earnings release, investors began to pay attention to other names like Super Micro Computer (SMCI-US), Advanced Micro Devices (AMD-US), Broadcom (AVGO-US) and Marvell Technology (MRVL) which were up 112.42%, 32.27%, 28.96%, and 48.15%, respectively, in May alone.
With an apparent AI revolution underway, we can say with confidence that the Virtuous Circle is alive and well. Regardless of what final form AI technology takes and when that final version emerges, there will be a lot of time and money spent getting there. It is our belief that we are relatively early in this AI led development and buildout phase and while this current surge will not be perpetual it will set the stage for the advancement of the Virtuous Circle.
While AI is front and center, Digital Infrastructure is multi-faceted ecosystem and the global 5G rollout is still ongoing, not to mention a space we have been talking about for the past few quarters. That space is a maturing Internet of Things (IoT) market which we see continuing to drive incremental growth. The global IoT market is projected by Fortune Business Insights to reach $3.35 billion by 2030, growing at a CAGR of 26.1% from $662 billion in 2023. Adoption in industrial, retail, healthcare, agriculture, transportation, and other data-intensive end markets should translate into meaningful bandwidth consumption, fostering our view that network capacity limitations will be a persistent catalyst. As the IoT market accelerates, it should drive favorable demand dynamics for connective chip companies that range from Qualcomm (QCOM) and Skyworks (SWKS) as well as mobile infrastructure chip companies like Marvell (MRVL).
Moving up to a 30,000-foot view, the first half of 2023 presented a fair amount of uncertainty with the Federal Reserve, and other central bank’s ongoing struggle to wrangle inflation and drag it back down toward the long-stated 2% target rate without triggering a recession. The combination of the current equity rally and economic data is beginning to create some cognitive dissonance. Major US equity indexes are posting multi-year highs, but these figures are being generated by an extremely narrow rally evidenced by the disparity of returns between the SPDR S&P 500 Trust (SPY) [6.01%] and the Invesco S&P 500 Equal eight ETF (RSY) [-1.15%] on a total return basis for the year-to-date period through May 31. Similarly, the ETF that tracks the Nasdaq 100 Index, the Invesco QQQ Trust (QQQ) is up 30.89% on a total return basis for the same period while the First Trust Nasdaq-100 Equal Weighted Index Fund (QQEW) shows a gain of 14.63%. An impressive gain on its own, but it pales in comparison to its market cap weighted cousin.
On the economic data front, there are signs that inflation is starting to moderate. The latest US reported hourly earnings growth rate for May showed slightly lower growth which some are taking as a sign that we may be starting to move away from a potentially disastrous wage-price hike inflationary spiral. Recent Chinese manufacturing figures have disappointed and caused some turmoil in energy markets as well as some China centric data center names like GDS Holdings (GDS-US) which was down -37.15% in May and capped an overall roughly 60% decline YTD through the end of May. Despite these results, development in the rest of the world, including the ongoing AI revolution point to a robust second half of 2023. With the recent passage of the Fiscal Responsibility Act by both houses and President Biden signing it into law the first weekend of June, fears of a US default have disappeared, providing an additional boost to markets.
As expectations for the rest of 2023 get modified and stocks adjust to the latest “new normal”, investors with longer-term horizons can look to the history of the virtuous cycle that we’ve identified and have confidence that history should repeat itself.
Digital Infrastructure and Connectivity UCITS ETF (DIGI) seeks to capture companies that enable the digital applications of today and those that will redefine how people work, live, and play tomorrow. The ETF tracks the Tematica BITA Digital Infrastructure and Connectivity Sustainability Screened Index, which provides exposure to the explosive growth of the digital infrastructure virtuous cycle of expanding data, applications, and bandwidth that drives exponential network growth and development of new technologies.