Stocks rose yesterday closing at session highs. The gains largely reversed the drop late Wednesday after Federal Reserve Chairman Jerome Powell threw a bucket of cold water on the idea that a Fed Funds rate cut was likely in March. I’ll offer two thoughts to that statement. First, how much economic importance should one attach to whether the first cut is in March or May? Second, Fed officials, and that includes Mr. Powell, have proven to be pretty bad prognosticators of the future path of interest rates or the economy, even over as short a time period as six weeks. If inflation continues to moderate and there is evidence that the economy is slowing down a bit by the next FOMC meeting in March, then you can bet that a rate cut will absolutely be on the table. Mr. Powell claims to be data dependent. If the data says, “it’s time to cut rates”, he’ll cut them.
Besides the aftermath reaction to Wednesday’s FOMC meeting, there was economic data suggesting no evidence of recession. Manufacturing data showed slow but steady performance. The highlighted number was an uptick in orders suggesting that inventory liquidation is winding down, again support for the notion of a soft landing.
This was to be the week of big earnings reports from five of the Magnificent 7. Actually, we should call it the Magnificent 6 from now on dropping Tesla from the list. It isn’t just disappointing earnings from Tesla that causes it to lose its luster. While the company wants investors to look at it as much more than a car manufacturer, the reality is that none of its other business interests are even approaching scale of any significance. And, other than the Cybertruck, hardly a mass market product, Tesla has introduced no new models in three years and doesn’t plan to until late 2025 at the earliest. The Magnificent 7 are not only the largest companies by market cap but they are the true innovators using technology to drive growth at rates 3-10 times as fast as the overall economy.
Tuesday night we heard from Microsoft# and Alphabet#. Investor expectations for Microsoft were extremely high. It is viewed as the AI leader and, if anything, widening its lead. Its cloud services business is accelerating in large part due to AI tools it offers clients. I would grade its results an A. Stock market reaction was muted given the enormous expectations but there was nothing in its report that should suggest any diminution in future growth over the next year or two. AI features like Co-Pilot, which are additive to its broad set of business applications we all use daily, will quickly boost revenue potential in a big way. Alphabet’s results beat published estimates but weren’t as spectacular as those of Microsoft. While its AI and cloud initiatives did fine, its core digital ad business growth missed some expectations. Its shares gave back some recent gains. But there was nothing in the report to suggest that growth is going to diminish any time soon. We’ll grade Alphabet’s report a B+.
That set the stage for last night’s trio, Meta Platforms#, Amazon#, and Apple#. The star of the show last night was Meta Platforms. It blew past all expectations. It wasn’t that long ago that its shares were down close to $100 amid investor fears that TikTok would eat its lunch, and that the company was spending too much money on the metaverse, whatever the heck that was going to be. What Meta has proven in the interim, is that good managements find ways to fight back and protect market share. TikTok has run into its own set of problems, but give Meta a lot of credit. New platforms like Reels and Threads, developed in response, have worked. And don’t forget AI. Economically, Meta and all its platforms are advertising businesses. Advertisers are interested not only in the number of eyeballs watching but detailed information on who is watching. If you go to a Lululemon website, sure enough the next time you log into Facebook, a Lululemon ad is likely to pop up. But with added AI tools, why shouldn’t ads from other makers of active apparel also show up. They will. The other part of Meta’s recent success has been its rationalization on spending. Zuckerberg hasn’t given up on the metaverse but he has moderated his spending as a percentage of revenues. The net result has been such a huge jump in cash flow that Meta has now initiated a dividend while extending its stock buyback program by another $50 billion. Rate its report an A+. The stock is likely to jump over 10% at the open.
When I look at Amazon today, I start by looking through an Andy Jassy lens. He is the CEO who replaced the larger than life Jeff Bezos. Andy Jassy is to Amazon what Tim Cook has been to Apple. Neither could match the charisma or magic of Bezos or Steve Jobs. But most were masters of logistics and cost management. While Cook has been accused of lacking the innovation prowess of Jobs, Apple’s product development cycle has been less flashy but hugely incremental. Jobs gave us the iPhone. Cook gave us Apple Pay, Apple Music, cloud storage, a much better camera, a much-expanded App store, while also enhancing computers, headphones and the watch along the way, integrating all into an ecosystem that ensures customer loyalty. Back to Jassy. Bezos wanted size. He wanted leadership. Profits, hopefully would follow. Jassy, of course wants to grow the business. And he is expanding into healthcare and other fields. But at its roots the retail side of Amazon is a logistics business. It services not only what it sells but has its own ecosystem of third-party sellers. It has become ever more vertically integrated, now shipping the vast majority of what it sells. It has become more efficient, bringing more dollars to the bottom line. And it has used its size and scope to build a huge and very profitable advertising business. All this is in addition to Amazon Web Services, the giant cloud servicing firm. While its growth rate doesn’t match Microsoft’s and its AI initiatives haven’t been as robust as Microsoft’s to date, it will focus on this area adding value and growth opportunities. Let’s grade it a B+.
That leaves Apple itself. Apple’s results slightly beat published expectations. It grew its sales for the first time in five quarters largely on the back of a 6% increase in iPhone sales. That occurred despite a double-digit drop in China where Huawei has surged 71% on the back of a new line of very competitive phones, helped by government rules banning the iPhone from use in government business. Given no major new products on the horizon for Apple beyond the Vision Pro being rolled out today, Apple is a lot more dependent on the overall economy than the other four that reported this week. Apple still has some arrows in its quiver including strong growth in service revenues. Maybe someday it will be bigger in the automotive or medical arenas, but that won’t happen anytime soon. That doesn’t mean Apple has lost its luster. Walk past an Apple store and there will be more people inside than all the other stores on the same block combined. Apple customers love their iPhones, even if they don’t use the phone feature very much anymore. The company also generates more free cash than anyone else and it returns that cash to its shareholders. But it might be fair to conclude that of the Magnificent 6, Apple is likely to be the slowest grower for the foreseeable future. Right now, Apple sells for about 26 times 2025 expected earnings. Procter & Gamble, which has raised its dividend for over 60 consecutive years, sells at 23x. So, is Apple overpriced? Maybe slightly, but it isn’t out of line with the market. I’ll give the Apple earnings report a B-, not great but not that bad either.
Pulling this all together, one comes to a singular conclusion. The Magnificent 6 collectively are the growth engine to our economy. They accounted for all the earnings growth in 2023. The other 494 member of the S&P 500 had down earnings last year. Hopefully, that won’t happen again, but given what we have seen this week, it’s hard to make the case for massive rotation to stocks of other economic sectors. To be sure, there are plenty of pockets of strength elsewhere in the economy. Homebuilders had a superb 2023 and will likely have an even better 2024. EVs and AI will require massive amounts of additional electricity. Companies that service those needs have bright futures. A standout performing group in January was the insurance industry. Climate change has led to multiple very expensive disasters from fires to tornadoes to hurricanes. 2023 wasn’t as bad as 2022 allowing these companies to hike rates faster than payouts. Insurance brokers, who make a percentage of premiums, also benefited. Datacenters have an obviously bright future. Big retailers had a nice Christmas season as the consumer kept spending.
But when you step back, the driver of growth has been technology. It is the driver of productivity gains, over 3% just in the last quarter. Fewer workers can get more things done. How can Amazon ship you stuff now in one day? It wasn’t long ago that 2 days was insanely efficient. The trucks don’t move any faster. It’s all about better logistics. It’s about using greater intelligence, a function of faster chips and better software, from the shelf to your doorstep. When you can get something sent to you in one day from Amazon (or even the same day in some cases) instead of 3 days from Macy’s, how long will you tolerate that? If Macy’s can’t match Amazon’s efficiency, it will either have to lower prices or lose business. No wonder Amazon keeps gaining share.
In the stock market, it’s all about exceeding expectations. AI is expanding expectations. This week’s results suggest that the promise of AI and other technology tools hasn’t been fully reflected yet. I haven’t mentioned one member of the Magnificent 6 yet, Nvidia#. It doesn’t report earnings until later in February, on or about the 21st. Its chips are the engine to all this growth. Right now, it’s the 800-pound gorilla, maybe something even larger than 800 pounds. Will another company find a way to take share from Nvidia someday? Maybe. But if that company exists today, it isn’t obvious. Intel wants to be there and so do the Chinese. But for now, it’s Nvidia’s universe. It can’t meet all demand. When demand exceeds supply, one adjusts by raising prices…and margins. It’s hard to see how Nvidia disappoints later this month. How long can that continue? Aah, that’s the $64,000 question. But that’s a story for another day.
Today Shakira turns 47.
James M. Meyer, CFA 610-260-2220