The Federal Reserve Bank is finally saying what Wall Street has been waiting to hear.
One of the driving forces behind the current market rally is excitement regarding the implications of artificial intelligence (AI) and the promise of productivity gains that will boost profits. However, the adoption of this groundbreaking technology has been measured, thanks to historically high interest rates, as the Federal Reserve Bank has been battling persistently high inflation. However, comments made in a speech today by Federal Reserve Chair Jerome Powell suggested the end is in sight.
As of 3:28 p.m. ET on Friday, chip designer Arm Holdings (ARM 4.56%) had rallied 4.7%, chipmaker Nvidia (NVDA 4.55%) had jumped 4%, semiconductor foundry Taiwan Semiconductor Manufacturing Company (TSM 2.91%) had climbed 2.6%, and semiconductor giant Broadcom (AVGO 2.48%) had risen 2.1%.
A check of all the usual sources — earnings results, regulatory filings, and changes to analysts’ ratings and price targets — turned up little in the way of company-specific news that helped drive these AI stocks higher (more on that in a moment). This suggests that investors were focused on the shift in Fed policy and what it means for the future.
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Persistent and stubborn inflation
The last remaining remnant of the downturn has been the Fed’s ongoing battle with inflation. Just last week, the U.S. Bureau of Labor Statistics reported the best read on inflation in years. The Consumer Price Index (CPI), the most widely followed measure of inflation, rose 2.9% in July compared to the prior-ago period, while prices increased just 0.2% sequentially. This marked the lowest rate since early 2021. The “core” data, which strips out volatile food and energy prices, was up 3.2% compared to this time last year and 0.2% quarter over quarter.
Powell’s comments today showed a dramatic policy shift is at hand. Citing recent cooling in the job market, Powell said, “The time has come for policy to adjust,” signaling rate cuts should begin next month. “The direction of travel is clear,” Powell continued, “and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
Investors cheered the decision, as lower interest rates will make it cheaper for businesses and consumers alike to borrow money, which will provide a boost to the economy.
The AI wildcard
There was one other development that contributed to Nvidia’s rally. Evercore ISI maintained its outperform (buy) rating on Nvidia while increasing its price target to $150. This represents potential gains for investors of 21% compared to Thursday’s closing price. The analyst pointed to heavy capital spending by cloud infrastructure providers suggests Nvidia will report blockbuster results when it reports next week.
Beyond that news, each of these four companies is well positioned to profit from the increasing adoption of AI:
- Nvidia provides the graphics processing units (GPUs) that provide the computational horsepower needed for AI systems.
- Arm Holdings supplies the next-generation CPU cores included in Nvidia’s processors, a critical component in AI processing.
- TSMC is the world’s largest foundry, producing many cutting-edge AI chips and counting Nvidia and Arm among its biggest customers.
- Broadcom supplies many of the processors used in data centers and cloud computing, occupying an important place in the AI space.
AI has made plenty of headlines since early last year, and the world’s largest data centers and cloud infrastructure providers have been gearing up for the surge in demand. However, smaller businesses have been reluctant to take on additional debt or spend money on new technology until there was more clarity on the state of the overall economy. Powell’s comments are the clearest sign yet that we’ve turned the corner, and lower interest rates will likely spur additional spending on AI adoption.
However, enthusiasm about the potential for these AI-centric stocks has pushed valuations higher. Arm Holdings, Nvidia, Broadcom, and TSMC are selling for 87 times, 47 times, 35 times, and 26 times forward earnings, respectively. With valuations of this magnitude, these stocks aren’t for the faint of heart.
Nvidia is the poster child for AI and has delivered four consecutive quarters of triple-digit growth, with another widely expected next week, so its premium valuation is well deserved. Arm has had four consecutive quarters of record results, driven by its unique position in the AI ecosystem. Broadcom and TSMC are even less expensive and are also well positioned to benefit from the accelerated adoption of AI.
Danny Vena has positions in Nvidia. The Motley Fool has positions in and recommends Nvidia and Taiwan Semiconductor Manufacturing. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
