America’s $6.8 trillion monster has a China problem

Every three months, there’s an event that has the potential to blow up the US sharemarket and disrupt markets elsewhere. It has, however, once again been absorbed with relative equanimity.

That event is the release of Nvidia’s quarterly sales and earnings.

The world’s most valuable company, with a market capitalisation of more than $US4.4 trillion ($6.75 trillion) represents about 7.5 per cent of the value of all the companies in the S&P500. Where it goes, so does a market that is being powered by the boom in investment in artificial intelligence and its infrastructure – a boom in turn powered by Nvidia’s AI chips.

Nvidia’s second-quarter sales and earnings came in pretty much as expected, albeit lower than the most optimistic forecasts. Revenue was up 56 per cent, to $US46.7 billion, and earnings up more than 59 per cent, to $US26.42 billion.

As the barometer for the AI ecosystem, Nvidia’s results signal that the much-hyped AI sector is sustaining the hype. While fears that the AI boom is displaying some bubble-like qualities have intensified, there are no signs investment in it is slowing. Indeed, it continues to grow.

The so-called “hyperscalers” – Nvidia’s core customers like Meta, Google, Amazon and Microsoft – have been continually increasing their investment spends. Only last month Meta, said it would spend $US7 billion more this year than its previous guidance, and Google added $US10 billion to its planned AI-related capital expenditures. Microsoft is investing $US80 billion in AI data centres this year.

Nvidia’s Jensen Huang said he expects investment in AI infrastructure to reach $US3 trillion to $US4 trillion by the end of this decade, although there are some who would double those numbers. UBS has said it expects AI-related investment globally to be $US375 million this year and $US500 billion next year.

Between the chips, training models, data centres and the massive increases in the energy generation required to power the centres, the AI revolution has created an investment boom of extraordinary magnitude.

The boom is not just holding up US sharemarkets in the midst of Donald Trump’s trade wars and assault on the Federal Reserve Board’s independence – it’s also propping up an otherwise weakening US economy as well.

That’s why Nvidia’s quarterly insights into the state of the AI economy are such important indicators of the wider economy’s health and the sustainability of record sharemarket levels.

It is possible to argue about the valuations attributed to the companies engaged in AI-related investment, which is where the references to bubbles stem from. Will the returns on these investments ever justify the amounts being spent?

Earlier this month, a paper by an arm of the Massachusetts Institute of Technology rocked the markets when it concluded that, despite the enormous amounts being poured into the sector, 95 per cent of the organisations involved were getting zero returns on their investments.

In March, OpenAI – whose release of ChatGPT ignited the boom – was valued in a fundraising round at $US300 billion. Last week, it was reportedly seeking to sell some of its employees’ shares at a valuation closer to $US500 billion.

At face value, an escalation of that scale in that period while returns (other than Nvidia’s) aren’t remotely commensurate with the investment would appear absurd, and an indicator of a market in late-stage bubble territory.

Or, it might be that we’ve only just seen the earliest insights into the transformative potential of AI and the eventual profits that it will generate for those pouring their capital into the sector.

If Nvidia is a barometer of the sector’s health, it also provides a gauge for measuring the level of geopolitical tensions between the US and China.

America’s desire to protect advantage in advanced semiconductors has led to prohibitions on sales of Nvidia’s most advanced chips to China – a ban initiated by the Biden administration and continued by the Trump administration.

Nvidia had been selling a modified chip with less processing power (the H20) to China, but those sales too were banned by the Trump administration – until Jensen Huang met with Donald Trump and agreed to give the government a 15 per cent share of the revenue from sales to China. AMD has agreed to a similar deal.

Because of the export controls, Nvidia generated no revenue from sales of the H20 chip to China in the June quarter, and hasn’t factored in any H20 sales to China in the current quarter, while it waits for the US government to codify the regulations that will reflect the deal Huang struck with Trump.

Nvidia says that, if it is allowed, it could ship between $US2 billion and $US5 billion of its chips to China this quarter. China is the world’s largest market for chips, with half the world’s AI developers, and Huang has said Nvidia needs to be there.

Huang has also spoken with the administration about selling a modified version of its latest Blackwell chip – more advanced than the H20, but significantly less powerful than those it is now selling in the US.

Even with US approval, there is no guarantee that Nvidia can achieve its potential within China, despite massive latent Chinese demand for its chips. Even its H20 chips are several generations more advanced than those China can produce.

The Chinese government, concerned about the security implications, has “encouraged” its companies, or at least those with government links, not to buy from Nvidia.

The continuing trade negotiations between the US and China could, however, open up the market if Trump decides to make access for US chips a priority in any deal in order to get his 15 per cent cut of revenues.

The US Treasury Secretary, Scott Bessent, incidentally, has ruled out any plan for the government to demand a stake in Nvidia, a possibility raised by Trump’s ambition of acquiring (or being gifted) shareholdings in a range of US companies – from tech and defence to ship builders – after taking up a 9.9 per cent stake in Intel in exchange for Chips and Science Act funding the company had been allocated, but not paid.

With Trump, who said this week that he hoped to have many more cases like Intel – “I want to try to get as much as I can”, he said – nothing can be completely ruled out when a company badly needs the administration’s approval. The administration needs to shore up America’s public finances, which have been stretched by Trump’s deficit-swelling One Big Beautiful Bill’s tax cuts.

Whether it makes strategic sense to allow even the H20 to be sold to China is a different issue.

America has a very substantial and widening lead in the hardware of AI over China, thanks largely to Nvidia and some of its peers.

While China represents a large and lucrative market, why would the US surrender that advantage over the key technology of the century just to enable companies like Nvidia and AMD to make some (more) short-term profits?

For Trump, who loves a deal, a 15 per cent share of those sales to China might just sway the argument.

The Market Recap newsletter is a wrap of the day’s trading. Get it each weekday afternoon.