Another Fed meeting yielded another aggressive bounce for stocks on Wednesday, following a slew of earnings reports that helped recoup recent losses. Chairman Powell and the team recognize that a slowdown is already upon us. GDP has now been negative for two straight quarters, an often-used metric that determines if we are in a recession. One can bicker with terminology, but it is quite clear that growth has slowed. Whether this fits in with a perfect definition of recession matters little to investors.
Chairman Powell’s tone was one of a more dovish stance, to the point that the Fed can slow the pace of rate hikes and await incoming economic data. Consider his tone a shift to any Fed Funds increases being much less aggressive going forward. Markets now expect 50bps in September and only 25bps in November and possibly December, where inflation data may be moving in a much more favorable way. This could mark the end of our rate hiking cycle. We don’t need to see 2% CPI reports immediately, just a trend to get back there. Anything that prevents Fed Funds from getting closer to 4% is welcome news for investors. In fact, many market indicators are calling for only 1 more rate hike now. The Nasdaq and cyclical/growth stocks led the charge, spiking 4% following the Fed announcement. This was the best day for that index in nearly two years. In June, the S&P 500 was down 24% for the year. Today, it is down 14%. A decent comeback so far.
As we’ve noted, inflation and the unemployment rate are lagging indicators. What matters more is what inflation will look like at this point next year. Following massive commodity price collapses, rising unemployment claims, declining home prices and hiring freezes, it makes sense to let the dust settle and not be as aggressive now that they have caught up to market rates. Fed Funds are at 2.5% while the 10-year Treasury is at 2.75%. Markets have priced in a slight recession. That may now be considered a “soft landing”, as opposed to the Fed pushing too hard on the yield curve inversion already here and forcing a possible depression.
While the Fed plays catchup to current market conditions, corporations are reporting second quarter earnings and providing forward guidance. There are two key items for investors:
• Earnings and interest rates matter
• Reactions to newsworthy events are more important than the news itself. When stocks stop going up on great news and stop going down on worse than expected news, it is time to pay attention.
In that vein, it has been a mixed bag with respect to quarterly updates. Typically, companies guide conservatively and set themselves up for a likely besting of those estimates. When companies miss on their guidance, there had better be an acceptable excuse (currency being one of them). Here is a very brief synopsis of some of the more widely held leaders:
Microsoft#: I can’t remember the last time this company missed on revenues or earnings per share. They lowered guidance mid-quarter, which also hasn’t happened in a while. They missed on both the top and bottom line, proving even the best of the best can’t win forever. Initially, the stock dropped, but their “excuses” were acceptable with respect to a slowing PC market (who doesn’t know that by now?), an even stronger than expected U.S. Dollar and supply chain dynamics from China’s Zero Covid policy. This bad news was more than priced in, offering some relief, and Microsoft stock actually advanced ~7% on the day. It was up 5% before the Fed announcement that helped tack on more gains. MSFT trades at 25x next year’s earnings which are expected to grow 13%.
Alphabet (Google)#: Another company where recent headlines have been concerning: hiring freezes, cost concerns, advertising slowdown and a looming recession. This has been reflected in a 30%+ drop in Google stock this year. Results and guidance were better than feared. Cost cutting should help maintain margins above the most bearish forecasts even if ad spending slows on YouTube and Search. Their cash flow helped buy back over $15B in stock which will lend support. The stock bounced ~8% following the earnings announcement (the stock was also up 5% pre-Fed). GOOGL trades at 17x next year’s earnings which are expected to grow 15%.
Semiconductors: Multiple earnings reports came out this week with a consistent theme. Consumer end-markets are slowing, PC sales have peaked and low-end cell phone markets are drying up. All of this was well expected. Inflation hits low-income consumers the most, as Walmart# can attest to, so they slow discretionary spending on items like laptops and phones. On the other hand, auto and industrial “Internet of Things” orders are still above what can be supplied. Call this a mixed bag, but semiconductor stocks have generally reacted well to earnings updates. Many are trading at multi-year valuation lows, with solid, long-term secular growth themes yet to come. Selectivity is key here. You want exposure to specific end markets that are growing.
Meta Platforms (Facebook)#: The company reported their first ever quarterly drop in revenues, albeit currency induced. Ad revenues actually grew faster than Google search. However, their outlook was much worse than anticipated as the company is worried about a strong ad slowdown during a recessionary period while foreign exchange rates knock off 600bps of growth. On the positive side, user growth is back on track, expenses are being pulled in and time spent on their platform (Facebook, Instagram, WhatsApp) continues to dominate. Currently trading at $160, this is a bear case price with $155 being critical support that should hold if a bottom is forming. META rose 7% during Wednesday’s rally but gave back most of that yesterday. The stock trades at 12x next year’s earnings which are expected to grow 22%.
Apple#: CEO Tim Cook and team reported a fractional beat on all metrics last night, although they have been reduced throughout the quarter and profits are down 10%. This was their worst quarter since the pandemic period prior to the 5G phone launch. Wearables and some other lines are seeing softness. When money is tight you still buy a phone, but maybe not that fancy watch. Still results were much better than feared. The stock is rallying by 2% pre-market and trades at 25x next year’s earnings which are growing at 6%. Apple is a slower growth leader but turning into a staple these days.
Amazon#: New CEO Andy Jassy’s first year on the job has not been easy to say the least. Last night they reported above expectations on revenues and earnings. They also guided in line with the street estimates, which in this market is a stellar report. This is basically 2 conglomerates. One is the retail business where the bulk of true profits comes from Prime membership fees, ala the Costco# model. The other side is cloud hosting via Amazon Web Services which is nearing a $100B revenue run rate. AMZN stock is popping 12% in the pre-market. AMZN is spending massively and under earning their potential with a 50 P/E, but growing at a 60% clip over the next three years.
Truth be told, this has been a very mixed earnings quarter to say the least, but the response for stocks has been nothing short of amazing. The S&P is on track to be up ~8% for July. While top-line earnings are still growing for most, many are below what management and the analyst community expected, and inflation is eating into profits. In a bull market, these kinds of downgrades to future prospects would be met with aggressive selling. Now that stocks have already been sideswiped, much of the bad news is priced in. Seeing such a strong response to not-so-great earnings updates is quite positive.
That does not fully get us out of this bear market though. These older, mega-cap leaders are still range-bound and not breaking out to the upside. However, just stopping the bleeding and holding support levels increases the likelihood that this bear market is nearing an end. By Summer of next year, many stocks will have reconfirmed that floor and resumed their normal chart paths, up and to the right. It has been an incredible turnaround so far.
How I Met Your Mother star Josh Radnor turns 48 today. Star Trek fans can celebrate Wil Wheaton’s 50th birthday. Nearly 40 years ago, National Lampoon’s Vacation premiered. Many likely saw this in a drive-in movie complex. The good ole days!
James Vogt, 610-260-2214