Earlier this month, I essential strategies for navigating market volatility, focusing on two key principles, which are worth revisiting now:
Markets are forward-looking.
Sentiment is driven by expectations.
Imagine tossing $1 into a well, magically returning $5. You try again the next day, and the well gives you $10.
This pattern continues for 10 days, and on the last day, you throw in $1 and receive $1,000. If you return on the 11th day, how much would you expect? Likely more than $1,000.
This positive reinforcement pattern mirrors the Nvidia (NASDAQ:) investors’ experience.
The stock has rewarded investors consistently over the past years, often exceeding expectations. Yet, despite an outstanding yesterday, the stock closed 2.10% lower and dropper further in after-hours trading, leaving many investors concerned.
What Caused the Tumble?
The quarterly report was strong, with earnings and revenues soaring over 100% year-on-year – a truly remarkable achievement. The guidance was equally promising.
But we must remember the two points I mentioned earlier.
First, markets anticipate.
But what do they anticipate? In Nvidia’s case, the market reaction suggests concerns raised in the quarterly report, such as:
Production issues with the new Blackwell Chip.
The ROI of CAPEX, as investing in AI, though exciting, is costly (the other magnificent 7 can attest to that).
Expected Q3 revenue, which, while impressive, fell slightly short of (astronomical) expectations.
And this brings us to valuations.
High valuations come with significant downsides. First, high valuations today mean lower expected future returns. Second, when valuations are high, the best possible outcomes are already priced in.
This leads us to point number two: markets move on expectations. When a stock trades at 70 times earnings and nearly 40 times sales, those valuations likely already factor in the best possible scenarios.
It takes very little to shake confidence and crack seemingly unbreakable beliefs.
I had the pleasure of a few months ago, and he illustrated this with an example about two piles:…
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