Stocks staged a solid rally yesterday as economic data showed a resilient consumer in August. A further boost came from the successful return to public markets by ARM Holdings via a highly anticipated initial public offering of stock.
ARM designs chips used in everything from smartphones to PCs to data centers. Its chip designs are used in almost every smartphone in existence. Notably, ARM is a chip designer, not a manufacturer. Its revenues are based on royalties. The company’s valuation as of yesterday was approximately double what it was when it went private 7 years ago, a nice return but below the average appreciation for semiconductor stocks over the same time period. ARM currently trades at a multiple times revenue that exceeds that of other semiconductor companies including Nvidia#. But that may not be a true comparison as its revenues come from royalties rather than chip sales. The closest public company to its economic model is Qualcomm# whose profits are also dominated by royalties. Both companies have large revenue concentration from their top 5 customers. Royalties are negotiated and often litigated when the customer feels they are being squeezed. More time than one day will need to pass to conclude what markets feel the real valuation of ARM might be. There are lots of reasons to be both positive and negative on the stock. But one conclusion that can be reached is that the success of the ARM offering should help a succession of other companies waiting to go public. One thing absent in the 2023 market rally has been a robust IPO market. ARM could be the catalyst for change.
The other big event overnight is the start of a strike by the UAW against the Big 3 U.S. auto makers. To conserve strike funds while making a big impact, the UAW is selectively striking at assembly plants owned by each of the Big 3. UAW’s leader Shawn Fain was elected in a close election earlier this year. Companies have proposed four-year wage increases close to 20%. The union has asked for close to 35% or higher. Teamsters won a well-publicized settlement earlier this summer from United Parcel but not for the numbers the UAW is asking. Clearly, that settlement plus a solid economy and tight labor market have reinforced the bravado of UAW leadership. Company leaderships have been frustrated as the UAW has spent more time bargaining away from rather that at the negotiating table. What this means for the economy obviously depends on the length of the strike. All three companies have built extra inventory in recent months anticipating the likelihood of a strike. But that won’t last long if the strike is prolonged. Should the strike last for weeks, there will be a multi-billion dollar hit to the economy, shortages of selected vehicles, and likely another resurgence in used car prices. The three auto makers account for about 42% of the U.S. market. While others can fill the void partially if the strike is extended, they won’t be able to close it. Any rapid shift in demand away from the Big 3 would quickly alter supply chains.
Historically, strike impact is viewed on Wall Street as a one-off event, a sunken cost that shouldn’t affect long term valuations. But the Teamsters settlement with UPS and a possible expensive settlement with the UAW could reinvigorate the labor union movement and put upward pressure on wages, something the Federal Reserve doesn’t want to see. But, at the moment, that’s a hypothetical. Union representation within the private sector has been in a long-term decline for decades. The auto industry provides a clear example. Foreign companies choosing to manufacture cars in the United States have often located plants in right-to-work states where unions are not favored. GM, Ford and Stellantis still have to compete with companies using non-union labor. They obviously compete on price. Markets effectively set price. GM can’t simply raise the price of a Cadillac to offset higher negotiated wages. It will either have to find other ways to offset the higher costs (e.g., more automation) or suffer lower profits.
At the moment, markets can look at the auto strike as an event isolated to the auto industry. But if the government is forced to shut down partially in a few weeks, and student loan repayments restart, the collective impact could change the GDP and inflation trajectories, at least over the next several months.
The other big corporate event this week was Apple’s# introduction of an array of new products. The most important were for new iPhone15 variants. For the most part, these were evolutionary, not revolutionary. Overall, iPhone sales have been rather flat for several years. These phones won’t change that. The new phones have faster chips (they always do), a better camera lens, and a new charging mechanism. Gone are the lightning connectors, replaced by USB-C. The change was motivated by a European requirement that essentially forced Apple to move to an industry standard. The wireless phone companies will use the new Apple models as marketing ploys to attract new customers. Look for new campaigns to surface well before Christmas.
The bond market could attract more attention from equity investors as rates continue to trickle higher. The 10-year Treasury yield this morning is up to 4.32% and the 2-year yield is back above 5%. Both are consistent with persistent economic strength and the conclusion that rates are likely to stay high for longer even if there are no further increases in the Fed Funds rate. Unless rates move materially higher or September economic data, which we will begin to see in a couple of weeks, points to a change in trend in economic activity, I would look to markets to continue to churn in a basically sideways direction with some volatility tied to particular events. The early 2023 leadership from the tech giants seems to have lost some steam. The response to earnings reports this week from Oracle# and Adobe# were muted, a sign that rising expectations have already been priced in. In the case of Oracle, a modest correction suggests that expectations had risen too far. If leadership in the market is to rotate, it remains unclear where.
Today, Prince Harry is 39. Dan Marino is 62. Both Tommy Lee Jones and director Oliver Stone turn 77.
James M. Meyer, CFA 610-260-2220