Today marks the end of January. So far, the Dow is up about 2% for the month while both the S&P 500 and the NASDAQ Composite are up over 3%. All are likely to take a breather this morning after modest negative reactions to earnings reports last night from Microsoft# and Alphabet#. I say modest because the overnight trading declines simply erase a few days of gains achieved in anticipation of good earnings. While no earnings report for a company as large and complex as these can be perfect, the key message is that AI is real and beginning to drive a new era of growth that will offset any slowdown in traditional growth arenas like personal computing or advertising. Markets also got another piece of good news yesterday as The Treasury’s anticipated funding requirements over the next few months are slightly less than previously anticipated and will continue to be skewed toward the short end of the curve. That helped pull long-term interest rates down a bit, a tailwind for stocks.
Today concludes a two-day FOMC meeting. There will be no change in rates today. What investors will focus on are any hints that a rate cut is near at hand, perhaps as early as the next meeting in March. At the moment, futures markets indicate that markets have a slight bias toward keeping rates steady in March with a first cut coming in May. Economically, there is likely very little difference whether the first cut of 25 basis points comes in March or May. Recent data suggests a stronger economy than was anticipated over the past several months. If there is any slowing happening now, it will be based on anecdotal data and probably won’t be sufficient to change course immediately. The January employment report doesn’t come out until Friday, it will, therefore, be a non-factor today.
The other topic for discussion today is the future of QT (Quantitative Tightening), the process of deliberately lowering the size of the Fed’s balance sheet. There is a large school of thought, which I buy into, that the size of the balance sheet itself has no real economic importance. Rather, what matters is the change in size that correlates closely to changes in money supply, a key variable of future growth. Reducing the size of the balance sheet, either via outright sales of securities or simply letting them roll off at maturity, not only is a headwind to growth, but it risks causing liquidity-related accidents in debt markets. Continuing QT while lowering interest rates would seem rather contradictory. On one hand, easing rates is meant to stimulate economic activity, while reducing M2, the key measure of money supply, would serve to constrain growth unless, for some reason, the rate money turns over (velocity) rises enough to offset the impact of lower M2.
It isn’t hard to figure out what markets want. Markets always want easy money conditions or anything that can stimulate growth as long as inflation is contained. Inflation continues to move lower although recent modest increases in oil prices could slow or even reverse the trend on headline numbers if energy cost increases are passed through to consumers. So far, the only impact is a $0.10-0.20 rise in the price of a gallon of gasoline from recent lows, hardly a game changer.
With Microsoft and Alphabet earnings out of the way, all eyes turn to tomorrow evening when Apple#, Meta Platforms# and Amazon # report. The biggest of the three is likely to be Apple, not only because it is the largest by size, but because it has been in the news so much lately. Apple’s stock has remained high, despite recent pullbacks and slowing iPhone sales for two reasons. First and foremost, Apple has become an adept manager of free cash rewarding its investors via larger stock buybacks and a solid dividend. Second, while phone sales are flat or even declining, Apple has done a good job adding service revenues from existing customers, anything from cloud storage, to Apple Music, to ApplePay, to Apple+ TV, etc.
But will that be enough? It’s shares still sell at a healthy premium to the overall market while its projected earnings growth rate is pretty close to the S&P 500 average. Investors are always hopeful that future products can boost growth. Apple Vision headsets start selling on Friday. It’s deepening penetration into auto and healthcare markets offers some promise. But those opportunities are vague, at least today. Investors will give Apple some leeway given its historic record, but not forever. How investors react to tomorrow’s news will be illustrative of what to expect going forward. Microsoft has overtaken Apple as the world’s most valuable business franchise. My guess is that over time, unless Apple can reaccelerate growth, it’s P/E multiple will gravitate toward market averages. That may not mean today. But history suggests that leadership companies, particularly very large ones, eventually lose their premium multiples.
Today, Justin Timberlake is 43. Nolan Ryan turns 77.
James M. Meyer, CFA 610-260-2220