Why we should not worry about Nvidia's stock price correction

Nvidia, the world's hottest stock, has been hit with a reality check as its shares have cooled down. But that does not mean it is time to press the panic button. Some analysts agree that the downturn was expected, but given the hype surrounding artificial intelligence , which has powered the industry and Nvidia's well-oiled machine, things stand to stabilise soon. Strong rallies are usually tailed by noticeable downturns, especially in red-hot stocks. However, any decline that persists beyond levels enough to turn investors' heads, would signal a reconsidering of positions. “It’s correct that AI innovation played an important role in Nvidia’s future evaluation and market behaviour, but we think that the whole AI tech is still the early stages of development,” Mazen Salhab, chief market strategist for the Mena region at broker BDSwiss, told The National . As a result, AI shares may have “short-term correction and aggressive volatility”, he said, which is typical result of early stage market stocks. A stock correction happens when shares fall by 10 per cent to 20 per cent after a recent high. It is a natural reaction to investor fears or economic factors on stocks in sectors that are not well established. When these happen, investors are more likely to sell than buy stock. With Nvidia's stock sinking more than 6 per cent on Monday, that is a typical response. A correction is also less painful than a bear market, which results in deeper losses and lasts for a prolonged period, typically several months. Monday's trading session marked the third consecutive session in which the chip maker's stock fell, declining by more than 12 per cent during the three-day slide and exceeding the correction threshold of 10 per cent. However, Nvidia is expected to remain a “core thematic name in portfolios”, Chris Weston, head of research at broker Pepperstone, told The National . “AI has far further to go and we are still exploring and evolving with the movement, but it has run very hot and priced a scenario that even many in the industry would never have felt possible at this stage in the cycle,” he said. “Nvidia remains the epicentre of this world and pushes the boundaries like few others, with scale and brand working to the point where they retain their monopolistic qualities.” Although a correction is a cause of concern for investors, it is not that uncommon. From 2002 to 2021, a stock market drop of at least 10 per cent happened in 10 out of 20 years, which is equal to 50 per cent of the time, with an average pullback of 15 per cent, data from US financial services company Charles Schwab shows. In two additional years, the retreat was slightly short of the 10 per cent threshold, the Texas-based company said. But despite these short-term declines, shares have climbed in the long run, with positive returns in all but three years, with an average gain of about 7 per cent, the study revealed. That bodes well for Nvidia: given the craze for AI in the present and the foreseeable future, its stock rise is not over, Mr Salhab said. “The rally has been based on the perception of stronger demand for AI chips that Nvidia creates and whole euphoria in AI-based assets,” he said. However, the company's massive gain was not expected to be “fully sustainable and was not fully based on fundamentals and, somehow, driven by buying the future than realistic economics”, Mr Salhab added. It is not that Nvidia's value is at all in jeopardy: Its market capitalisation remains at a very healthy $2.91 trillion – although it has slipped behind Apple and No 1 Microsoft, both of which it surpassed this month in a span of two weeks. “The fundamentals [in Nvidia] haven’t changed one bit, and the 16 per cent slide, with other AI names following suit, is a pure exercise in understanding market positioning and an incredibly saturated and over-owned holding,” Mr Weston said. Nvidia has also lost more than $400 billion in market capitalisation since then. But given the strength of its business, it could soon recoup its losses. The company has forecast about $28 billion in revenue for the second quarter, which would be more than double compared with the same period in 2023. Microsoft and Apple are expected to record growth of 15 per cent sales and 3 per cent, respectively. “But nothing has changed. In fact, if we look at the options market, traders have been better buyers of Nvidia one-month call-implied volatility than put volatility, which suggests once we turn to the new quarter, many see the risk that this pullback will offer new upside potential and a reversal higher is likely,” Mr Weston said. “So, while we could see further downside in the near term, this pullback is purely premised on positioning and stretched technicals.” Mr Salhab expects Nvidia's market capitalisation to rebound – “not to forget that we may have more mergers and acquisitions is this sector in the months ahead, not only by Nvidia and/or in the US market”. Red-hot stocks that decline provide an opportunity for investors to buy more shares, especially when they remain promising, as in the case of Nvidia. “There has been no bad news regarding the company’s fundamentals, no analyst downgrades, no soft forecasts, no rumours of slowing sales. It’s just that the end of last quarter and the first half may have brought some investors to take some profit and go to the sidelines,” Ipek Ozkardeskaya, a senior analyst at Swissquote Bank, wrote in a note. The period of weakness had been expected, with analysts believing that the drawdown into the end of the quarter was sooner than expected. However, this does present an opportunity to run the stock hot into Nvidia's second-quarter earnings, scheduled on August 23, where investors can expect another movement of 7 per cent to 8 per cent on the day, Mr Weston said. “The issue for quarterly earnings is while we should see another quarter where Nvidia easily beats estimates … this quarter will mark the time where gross margins pull back towards 75 per cent, where they will plateau,” he said. “But we will get confirmation of peak margins – and that should limit the upside chase going forward. “It is an out-and-out momentum play, so the time to buy is when the market falls in love with it again and the price is ripping to the upside. It feels wrong but when it's hot, that is the time to chase.”

Why we should not worry about Nvidia's stock price correction

With advanced AI still in its early stages, it is normal for stocks to have short-term and aggressive volatility