Analyzing the underlying logic of the current market decline: The de-leveraging wave in the tech sector triggered by Nvidia's slowing growth

Author: @Web3Mario (https://x.com/web3_mario)

Abstract: Last week, the risk asset market faced certain pressures, especially on Friday after the release of key data such as the U.S. August non-farm payrolls and unemployment rate, which saw a significant pullback. However, from the data perspective, although it was below expectations, it was not particularly bad. Therefore, we need to analyze the price movements to understand what actually happened. Thus, I summarized the relevant logic over the weekend and would like to share some insights with everyone. Overall, the core reason for this round of decline is that the "non-farm payroll data rebound was below expectations," which triggered market concerns about a U.S. recession. Essentially, this was accompanied by the release of Nvidia's Q2 earnings report, which showed a slowdown in growth, leading to a valuation correction for Nvidia, a core driving force of this bull market. Consequently, capital accelerated its deleveraging in the tech sector to avoid risks.

U.S. Non-Farm Data Below Expectations, But Not Particularly Bad

First, let's take a brief look at the changes in non-farm payrolls and unemployment rates that contributed to the decline in the crypto market on Friday. The U.S. added 142,000 jobs in August, up from 89,000 in July. This indicates an improvement in the job market; however, it still falls short of the expected 165,000. The unemployment rate also saw a slight decline, dropping from 4.3% in July to 4.2%, which aligns with market expectations.

In my previous article, I analyzed that this data could actually be anticipated through the changes in initial jobless claims at the beginning of the week. In August, both initial claims and continuing claims showed a downward trend, indicating a good recovery in the job market. Therefore, I maintain a cautious stance on the notion that the non-farm data far exceeded expectations, which triggered severe panic in the market regarding a recession. The decline in the crypto market is likely a response to the deleveraging cycle.

So, why did this seemingly not particularly bad data trigger significant volatility in the crypto market? I believe the fundamental reason lies in the feedback from the deleveraging actions triggered by Nvidia's Q2 earnings report showing slowed growth.

Slowing Earnings Growth Rate Fails to Meet Capital Expectations, Nvidia Begins Valuation Correction, Accelerating Deleveraging in the Tech Sector

It can be said that the core driving force of this bull market is the growth of the AI sector represented by Nvidia. On August 29, Nvidia announced its Q2 2024 earnings report, which still showed growth; however, it triggered a market sell-off. The core reason was the accelerated decline in EPS growth rate, which caused panic and led to a valuation correction. To explain the underlying logic briefly, stock prices reflect the market's valuation of a company, assessing the asset's value through various financial data, forecasts, and market information. The core goal of stock valuation is to determine whether a company is worth investing in and whether the price matches its potential profitability or asset status. A basic valuation method is to calculate the price-to-earnings ratio (P/E Ratio) and compare it with the industry average to determine if the current stock price is overvalued or undervalued. The P/E ratio is calculated by dividing the stock price by the earnings per share (EPS), as the core value of a stock is its dividend rights.

This value can also be understood as the time it takes to recoup your investment based solely on the company's dividends. Typically, due to the high growth characteristics of the tech industry, the market assigns a higher P/E ratio standard, which is understandable, as the market believes that with continuous high growth, the company's dividend growth will accelerate. Therefore, this discount on future growth will reflect in the market's tolerance for high stock prices.

With this background clarified, let's look at what Nvidia's earnings report reflects. Essentially, the accelerated decline in EPS raised concerns about overvaluation in the market. From this chart, we can clearly see the impact: the upper part shows Nvidia's stock price, while the lower part shows the year-on-year growth rate of EPS. It is evident that the EPS growth rate in Q2 showed a significant decline compared to Q1, and the downward trend has intensified.

Recall that in the past six months, there has been widespread discussion in the market about whether Nvidia's stock price is overvalued. Each time the quarterly earnings report approaches, there are price fluctuations. However, Nvidia has consistently broken market skepticism with impressive growth data, allowing the P/E ratio to revert. This has created a certain cognitive inertia in the market; even when its market capitalization reached the top position, the high growth expectations remained. Of course, this is also related to the current restrictive interest rate environment, where most industries are under considerable pressure. Thus, this growth outlier has clearly attracted capital, which has chosen to band together to combat the high-interest environment. However, this time, the growth performance does not seem to meet the increasingly reinforced expectations of capital, failing to pull the PE back to around 46, which appears to be a reasonable range. This indicates that the stock price seems overvalued, leading the market to begin a valuation correction. Therefore, after the market fully digested the earnings report information on August 29, Nvidia's stock price quickly fell after the market opened on September 3, adjusting the P/E ratio to around 46. However, whether it will decline further depends on the outlook provided by various institutions. Currently, it seems that the attitudes of all parties are still relatively optimistic, with no further bearish information.

In previous articles, I have mentioned the yen as a cheap source of funds in the entire high-interest environment, as well as the relationship between the Japanese semiconductor industry and Nvidia. Therefore, during the rise of Nvidia's stock price, the yen was a core source of leveraged funds. However, with the onset of valuation corrections, we can see that despite the Bank of Japan's repeated reassurances, the market has effectively reopened deleveraging operations to avoid risks. Since September 3, the USD/JPY exchange rate has rapidly dropped from 147 to 142, challenging the early year's low of 140.

The rapid appreciation of the yen further raises the cost of leveraged funds, which will further squeeze the profits from arbitrage operations, thereby stimulating deleveraging actions. Therefore, we need to be vigilant about the negative feedback risks that may arise from this.