The best performing stocks in the S&P 500 index paint a fascinating picture of how Wall Street is betting on artificial intelligence. We talk about that, and set you up for the final Federal Reserve meeting of the year.
This transcript was prepared by a transcription service. This version may not be in its final form and may be updated.
Jeremy Owens: Hello, and welcome to On Watch by MarketWatch. I'm Jeremy Owens. 2024 will go down as a record-breaking year for the stock market. The S&P 500 Index is heading toward its biggest market cap gain on record, more than $11 trillion. Barring drastic change, it will be the second straight year of more than 20% gains for the S&P. That hasn't happened since the dot-com boom years of the '90s, but what drove that performance? Well, I took a look at the top-performing stocks in the S&P 500 this year and found a trend among them you may have heard of, artificial intelligence. While there's still time for some jockeying on the final list, four stocks are solidly in the top five of the index for percentage gain. Two pretty obvious AI plays, NVIDIA and Palantir, and two stocks you may not know about Vistra Corporation and Axon Enterprise. And to me, these four stocks really illustrate how Wall Street bet on AI this year. And I knew just the person to call to talk about it. MarketWatch's investing columnist Phil Van Doorn, he joins us today to break down where the money is headed in AI and what you should do about it. Let's start with NVIDIA.
Phil Van Doorn: The NVIDIA growth story has really been taking place since July of 2023. So, we're really a year and a half into what is an amazing new market for graphics processing units being used to support the development of generative artificial intelligence technology.
Jeremy Owens: For sure. And NVIDIA has been on that list for a few years even before that, but it was really once ChatGPT came in, that's what convinced everybody to jump in and start buying NVIDIA gear, including Microsoft and Google and everybody else. And that's where it really shot off.
Phil Van Doorn: NVIDIA already had an amazing business dominating graphics units for PCs, especially for gaming, but this is a whole new world. For example, if we look at the months for NVIDIA's fiscal quarter ends, April 2023 sales were 7 billion. In only a year and a half sales have more than doubled, almost tripled. It's really an incredible story. It's a whole new category that they created, which is why this stock's explosive growth has been backed up by reality.
Jeremy Owens: Well, Phil, beyond NVIDIA, there are other semiconductor companies that are seeing big revenue gains right now. What did you find when you looked for the biggest sales gains expected for semiconductor companies coming up?
Phil Van Doorn: Our colleague, Emily Barry, and I, started with a group of about 60 semiconductor manufacturers and related companies, including the 30 that are in the iShares Semiconductor Exchange Traded Fund. And when we looked at that list, NVIDIA was still at the top. We looked at estimates for sales growth during calendar 2025. So, NVIDIA is expected to increase sales by 55% next year. And the second one on the list is Micron at 38%. And then, we have Silicon Laboratories at 38%. Marvell Technology, 33%. Then we have three solar companies at around 30%, First Solar, Enphase, and SolarEdge. Then AMD expected to have 27% sales growth. SiTime Corporation, 27%. And the last on the list is Taiwan Semiconductor, expected to increase sales by 26% in calendar 2025.
Jeremy Owens: And that's a fascinating mix of really large-cap chip companies, some more speculative plays. Number two on that list, Micron, has been a very much up-and-down stock over the past decade or so.
Phil Van Doorn: One reason Micron is on the upswing is that they're making products specifically designed to be installed hand-in-hand with NVIDIA's GPUs. So, this is a cyclical company as are its memory competitors, but now they're into something new with generative AI, and this company is expected to book 40.8 billion in revenue next year. It is a major player.
Jeremy Owens: Yeah. And AMD, TSMC, these are two of the biggest names in semiconductors right now. AMD obviously challenges NVIDIA. They also have graphics chips. They also have the same PC chips and server chips as Intel. TSMC basically makes all of these chips. They are the biggest chip manufacturer in the world right now challenging with Samsung.
Phil Van Doorn: It's a fascinating company, Taiwan Semiconductor, because the threat from China looms. Meanwhile, this company runs factories in China. So, it's a complicated web. I have no idea how the political conflict could affect this stock long term.
Jeremy Owens: The next one I want to talk about on this list is Palantir, and what I've tried to explain to people is all this money is going into hardware for AI. A lot of that hardware is being used to generate the next generation of software that people will pay for and use. Palantir actually has already developed AI software and I think that's why people have gravitated toward it. Since being created, basically, Palantir has been focused on AI software for big spenders like governments and others. So, that one more than quadrupled so far this year, that stock.
Phil Van Doorn: The quadrupling of the stock isn't really well-supported by the growth trajectory for Palantir's operations. What's so interesting about Palantir is that the valuation is so high and even analysts who work for brokerage firms have soured on the stock. In the case of NVIDIA, you have high valuations, but they're supported by an incredible increase in sales and earnings quarter after quarter with very high profit margins, but you don't have that for Palantir. The company's estimated to increase its sales by 26% this calendar year and 25% in calendar 2025. But if we look at the forward price-to-earnings ratio for Palantir, it's 152, that compares to 22 for the S&P 500, and the forward price-to-earnings ratio is 34 for NVIDIA. So, it's in a completely different realm when it comes to that sort of valuation, and that is why 35% of the analysts polled by FactSet rate the stock as sell. NVIDIA has 93% buy ratings. So, Wall Street has soured on the stock not because of operational problems with the company, but because the valuation is just too high. People got too excited about Palantir. So, you've been warned.
Jeremy Owens: Yeah, Phil, that's actually a very fascinating thing to talk about because we hear people say that the valuations have gotten stretched, the AI boom has brought in so much investment that now you have to operate even better than you expect to come anywhere close to justifying that valuation. And Palantir is an excellent example of that. They've continued to put up good numbers through the last couple of years. They can tell the story about how people are going to need their AI software. And investment has just continued to roll in, but now Palantir is at a place where it's going to be very difficult, if not impossible, to justify that valuation in the next couple of years. While NVIDIA on the other hand, is already showing the type of growth that justifies its valuation.
Phil Van Doorn: Getting back to NVIDIA, the expected sales growth is more than double that of Palantir. So, you have a much lower valuation, much higher expected sales growth. NVIDIA is running a more capital-intensive business because they're making equipment, big pieces of equipment with tens of thousands of parts. Palantir is software company.
Jeremy Owens: Yeah, software is known to be a high-margin business. If we're talking about a high-margin versus a low-margin business and talking about chips versus software, I would imagine that the software is the high-margin business and the chips are the low-margin business. And just not the case right now.
Phil Van Doorn: Not now because Palantir is in an earlier growth stage. If we looked at gross margins, they're neck and neck, but operating margin points to a longer growth runway for Palantir. It is possible that this stock will work out fine for investors who go in now and stay in for 10 years, but to me it seems a bit frightening because there are all these different valuation aspects stacked against it, where NVIDIA still seems like a reasonable play despite all the growth.
Jeremy Owens: I think the point to really take from this is that these software companies are in position to make more money eventually or be out there more, be more visible in an AI era. But if you notice the revenue growth on the software side is not coming anywhere near the revenue growth on the semiconductor side when you look at these top 10 lists, and that's because we have seen revenue already grow on the semi side, while with software we're still waiting for it to bake in a lot.
Phil Van Doorn: But now take a step back for a second. What you're saying is that we have not gotten to the implementation, the application development stage, the monetization of AI. Now think back to where we were in the mid-1990s when we were all starting to use the internet. We did not have it on our phones yet. We were starting to order books from Amazon.com because what we wanted might not have been in stock in a local store, but look where we are now. So, I would say the sky's the limit for AI. You and I cannot predict how we're going to be using this technology 10 or 15 years from now, and we have no idea who the big players will be. There will be new companies coming in, offering unanticipated services such as the ones that Facebook and Google turned out to offer. There's all sorts of different business models that can be created using AI. So, I cannot guess what's going to happen, but I am quite a believer in the power of AI to make a lot of money for all of us over the years to come.
Jeremy Owens: We're going to take a quick break. Coming up, we'll tell you about a less obvious AI play that was hot this year. Stay with us. Welcome back. Before the break, we talked about two obvious AI plays that ended up among the top performing stocks of the year. NVIDIA and Palantir are already showing large revenue totals and profit from AI, but investors interested in AI also jumped on two other more speculative stocks. They could be years away from big AI-influenced gains though, if they get there at all, because they're trading on an AI story not entirely on results. The stock closest to Palantir for the lead in year-to-date gains is Vistra Corporation, a Texas-based energy company. Now, what does that have to do with AI? Well, Vistra is really into nuclear energy and there's a thought that the energy needs of AI data centers will require a renewed investment in nuclear power. But Vistra is a very speculative play, so speculative that I wanted to instead focus on a different stock with maybe a nearer-term AI story, and that's Axon Enterprises. Perhaps you would know it by its former name, TASER, as in the tasers that police officers carry. The company also makes police body cameras and other equipment and has told a pretty convincing story about how it will use AI to change police work. Specifically that AI software sold with the body cameras could produce the written reports that take up so much of officer's time. So, let's get back into that conversation with Phil.
Phil Van Doorn: This business of helping police officers produce reports based on body cam footage is fascinating. Similar technology is being used by Morgan Stanley to transcribe phone calls or video calls between advisors and their clients. So, the software transcribes a report, boils down a report, which the advisor can then edit and send to the client. So, it gives a more detailed feedback to the client with less work for the advisor. Now, you may have something similar going on with Axon's technology for police officers. Something else that I read about recently, there was a shooting in Florida in a condominium building, a high-rise, which was detected by local scanning software that the police were using automatically.
Jeremy Owens: Yeah, it's ShotSpotter. It's a public company that makes technology that detects gunshots. It's been a popular AI play at times in recent years, but has struggled to land some deals. ShotSpotter's technology has not always worked perfectly. We do have it out here in Oakland where I live and there's been some issues. There's been some interesting studies and reports on how well ShotSpotter actually works. The company believes that AI technology is just going to make ShotSpotter better at what it does, more desirable. But I'll say for this and other companies, just because you have a good story to tell does not mean you're going to end up making a ton more money, and it doesn't mean you're going to live up to the gains you're getting on that stock just because you have that good story.
Phil Van Doorn: It also might be too narrowly focused. Even though it's great technology, we want to make money.
Jeremy Owens: Yeah. I mean, I don't want to encourage our listeners to jump in on speculative AI plays or anything like that. This is more information to let you know where the money is flowing, but you really do need to think about where you sit on your risk profile. That's why I thought this was an interesting thing to look at these four because we have a range of speculation there, but you should be figuring out where on that range you want to be in terms of putting risk on at this point.
Phil Van Doorn: Well, you're already there. If you hold shares of an S&P 500 Index fund, 7% of your money is in Apple, close to 7% of your money is in NVIDIA. So, two stocks, 14% of that money. Investors need to learn more about what they are doing. An S&P 500 Index fund is easy and it is cheap and it rewards success and punishes failure. These funds have performed beautifully well over the last five and 10 years, but it means since you have 7% of your money in NVIDIA, you may not need to buy shares of NVIDIA. Maybe you have enough exposure already.
Jeremy Owens: That is something to also think about at this point. If you're thinking about where to put investments in 2025, these are all ideas, but if you're getting just the S&P 500 Index funds, you're getting all of that.
Phil Van Doorn: And you might not want more than 4 or 5% of your money dedicated to any one company. I've had enough problems over the years. I've seen bond defaults, suffered from them, suffered from bankruptcies as an investor, and I know people who have had this happen as well. Remember, we had those three bank failures early in 2023. So, a company such as First Republic, everyone thought that was a solid bank, but you had seven preferred stock issues that went to zero. So, you don't want too many eggs in one basket. So, since 7% of your S&P 500 money is in NVIDIA and seven in Apple, it means you need to diversify by asset class or by geography or both as well.
Jeremy Owens: Yeah, we talked about this recently looking for some maybe small cap, mid-cap type ETFs, some international-focused ETFs, things like that. And also you can get an equal weighted S&P 500 ETF that tries to balance that out a little bit more.
Phil Van Doorn: Yes, and it should be less volatile than the cap-weighted index, but it might underperform over time as well. So, then that gets down to your personal goals. If you're building a nest egg over several decades and you're pouring money in from your paycheck every two weeks or twice a month, then a market crash can be your friend because you pay lower prices for a while before the market recovers. But if you're close to retirement, if you need to start generating income from your investments to live on, you should anticipate that maybe a little bit early and start adjusting your allocation more towards bonds and less towards stocks to play it safer.
Jeremy Owens: Well, Phil, that's a great way to set people up for getting into 2025. Thank you so much for joining us today.
Phil Van Doorn: Thanks, Jeremy.
Jeremy Owens: Before we go, it's time for what we are watching. A look at the news you need to know for the rest of the week and beyond. This week we're going to focus on a single flashing red headline, next week's Federal Reserve meeting. We asked Greg Robb, our economics editor here at MarketWatch, a few questions about what to expect next week and what he and the Fed will be watching in the new year.
Greg Robb: I think the labor market is the worry still for many people. They would like to see the Fed get rates down a little bit lower and sort of help the labor market just to make sure that activity can stay on that good place. They think that rates are just a little bit high, too restrictive on demand. But on the other side of the fence, there are just a lot of people saying, "Look around, the stock market is just booming, going gangbusters. Growth is going to be 3% in the fourth quarter. Inflation is stuck above 2%. So, exactly why are you cutting rates?" So, that's the big debate. We'll get to hear from Chair Powell and his press conference on the 18th. We'll learn a lot then. And they have to do their forecast for the year ahead, so we'll get to ask them some questions about that too.
Jeremy Owens: It's interesting that they will lay out what they expect for the year ahead. And in terms of cuts, what does that year ahead look like? What do we expect to see?
Greg Robb: Well, the most important thing they do in their forecast is they put down where they think interest rates are going to go. The whole outlook for the Fed is unsettled since the election. So, the most thing people should think about now looking forward for interest rates are that they're not likely to go much lower than where they are now. Probably not much lower than 4%. So, people shouldn't think that we're going to get to this era of low mortgage rates and stuff like that. That doesn't seem to be in the cards. In general terms, I think they have four quarter point cuts next year, so a cut at every other meeting. That seemed to be the pace they wanted to get on next year.
Jeremy Owens: I mean, the concern there would be if the Fed continues to move to cut interest rates, which could have an effect on inflation, and the Trump administration is making moves that could push inflation higher, you're kind of setting yourself up to ruin what has been a strong comeback from the inflation spike of a couple of years ago.
Greg Robb: I think the worst outlook for the Fed is that they want to cut, but then they can't because of inflation and tariffs and this outlook for inflation. I think they're hoping against hope that that isn't the process. If the labor market starts to weaken, the Fed will want to cut rates, but then they're going to maybe sort of be like deer in front of the headlights from this inflation worry. So, that is something that we're going to be watching. Hopefully things will happen gradually enough that the Fed can keep moving rates a little bit lower and the economy can keep on this path that we've had coming out of the pandemic.
Jeremy Owens: And that's it for this episode. To keep following the latest financial news, head to marketwatch.com. Have questions about the news and the economy? We want to hear them. You can reach us at On Watch at marketwatch.com. You can subscribe to the show wherever you get your podcasts, and please do. If you like what you heard, please leave us a rating or review. It really helps others discover the show. The show is hosted by me, Jeremy Owens, and produced by Alexis Moore. Isaac Gaines mixed this episode. Melissa Haggerty is the executive producer. We'll be back next week with a new episode, and until then, we'll be watching.