31 Jul Capital 19 Catch-Up

Weekly Index Movement

S&P500	+1.0%
Nasdaq	+2.1%
Aussie All Ords	+1.2%

All three of the major averages closed last week with gains as upbeat results and forecasts from Alphabet (GOOGL) and Meta (META) led the tech-heavy Nasdaq higher. For the year, the Nasdaq Composite is up nearly 37% while the S&P 500 is up 19% and the Dow Jones Industrial Average, fresh off a historic run of 13 positive trading sessions, has gained nearly 7%. The last time the Dow went 13 consecutive positive sessions in a row was 1987. Did anyone say bull market?

As economic data continues to surprise to the upside and inflation declines, there’s growing sentiment among economists that not only will the widely projected 2023 recession not happen, but the recession many thought would come after the Fed’s interest rate hiking cycle may be significantly subdued if it happens at all. They are always a long way behind reality but they get there eventually. We’ve all known there was no recession coming for well over a year now.

This is why Fed Chair Powell dropped another 25bps rate increase this week. This was widely expected and the market didn’t flinch. Traders think he is done here and that will be the last one. The Fed funds rate is now at its highest level since 2001 as the Fed attempts to bring inflation back to its 2% target. Fed Chair Jay Powell held a pretty newsy press conference on Wednesday, telling the assembled media that the Fed is not planning to raise rates every other meeting, that the economic staff at the Federal Reserve no longer expect the economy to fall into a recession this year.

“It is a good thing headline inflation has gone down a bit,” Powell said. “I would say that having headline inflation move down that much … will strengthen the broad sense that the public has that inflation is coming down, which will, in turn, we hope, help inflation continue to move down.”

During the post-FOMC meeting press conference, Powell told markets that further rate hikes are still on the table (but the markets don’t believe him). He also poured cold water on the idea that rate cuts will start in the first half of next year. On a happier note, he believes the US banking system is getting back to a solid footing after the March mini-crisis.

Fun fact: the S&P 500 is now up 3.5 percent since the first rate hike of the cycle in March 2022. That reflects a still-resilient US economy, but the Fed’s job is still not done with respect to inflation Fed Funds Futures took Chair Powell’s press conference comments as slightly dovish regarding rest of year monetary policy decisions. Odds of another hike are now sub-50 percent.

But of course the big news of the week came from company earnings announcements

Megacap tech earnings kicked off with Microsoft (MSFT), which reported a 1% revenue beat (constant currency revenues +10% YoY versus +8.5% estimated) with all segments beating revenue estimates and EPS 5% higher than expected; capex was higher than expected but still fell 30% YoY. Cloud revenue growth has slowed to 9% YoY from more than 30% in Q1 ’22.

It was another stellar result from a perennial favourite. I must admit to not fully understanding how a company the size of Microsoft can continue to grow revenues and profits year after year. 10% revenue growth when you already make $300billion? Where else do you see this?

The impact of AI is not yet known but expected to add more growth. Then there is the increasing possibility of closing the acquisition of Activison-Blizzard which will make Microsoft a bigger games machine than Sony.

It’s a company everyone should own if they want growth.

We also heard from another company everyone should own last week.

Alphabet (GOOGL) reported revenues 3% higher than expected; operating income was far higher than expected beating by 9% with operating margins a full percentage point higher than expected. The company also announced CFO Ruth Porat would become CEO, replacing current CEO Sundar Pichai. Results are a good sign for ad market resilience. Second-quarter revenue rose 7% from the year-earlier period. Cloud revenue climbed 28% year over year.

Meta (META) announced jaw-dropping losses in its business tied to the “metaverse” with reality labs racking up a brutal $3.74bn loss (1% larger than expected). But a combination of strong user engagement (daily average users beat by 1%, monthly average users beat by 1%) and strong ad revenue (total ads 4% above estimates; average revenue per user 3% above forecasts) led to a 2% EPS beat. Guidance for Q3 was also good with revenues seen 3% to 11% above consensus, but management expects to “continue to invest in opportunities including AI and the metaverse” which means mounting losses. 2024 reality labs losses will “increase meaningfully” which is impressive given that segment has already lost $7.7bn and counting this year.

After seeing 100 million users join the platform in 5 days, Meta’s Threads app has seen more than half of the users leave the platform. The main complaints for users leaving the platform were the lack of content and limited functionality of the app. This should come as no surprise as Threads is in its initial stages of development.

I still see too much risk in the Meta business model and the fickle nature of social media users as demonstrated by the rapid sign up then quit of users on its Threads platform, means unreliable future income streams. I’d avoid this one even though it is up 160% so far this year.

Back home in Oz, Rio Tinto has set what’s likely to be the tone for the world’s biggest miners: lower profits and dividends as China’s wobbling economy casts a shadow over the entire sector. Meanwhile, iron ore’s rally over the last couple of months is looking increasingly brittle as hopes fade for the type of big-bang, infrastructure-heavy stimulus that Beijing used to deploy.

It’s starting to sink in that China’s economic growth isn’t going to be what it once was, or what the nation’s government wants it to be. Policymakers unveiled enhanced measures to help the country’s property sector and increase consumption. The new moves came after Beijing announced Monday that China’s GDP grew 6.3% year-over-year in the second quarter, well below the expected rate of 7.3%. Still, the Chinese government was otherwise short on details about what it would do next.

While on the subject of commodities, Oil giant Shell reported a steep decline in profit for the second quarter, as commodity prices have fallen globally. Analysts had expected the decline, since profits last year were astoundingly high, but the adjusted profit figure of $5.1 billion came in well below the $6 billion estimate. Shell’s results accompanied those of French oil giant TotalEnergies, which also reported a big decline in earnings.

So it’s a good time for everyone to buy an Oil company. Go for Woodside (WDS) in Aus if you want dividends or Petrobas (PBR) in Brazil. I also like Chevron (CVX) in the US for growth.

Oil has been steadily falling for the past year but there are signs it is now bottoming out.

The thing with oil is the producers control the price. Whenever it drops to the mid 70’s OPEC just cuts production. The US flooded the market with oil last year by releasing barrels from its strategic reserve. It was a smart move at the time to bring down inflation. But it will need to replace those barrels which means an extra buyer in a tight market.

I can see a possible nightmare scenario coming for central banks. What if oil was to increase back to $100/barrel? Maybe China starts stimulating or the way growth is coming back in the US that could be enough on its own. That would increase inflation by 3 or 4% again and we’d be back to 50bps interest rises except we would be starting from 5.5%. Things could get very ugly and stocks would tumble just like 2022.

One way to hedge against this risk is to have a portion of your portfolio in Oil. You still get nice dividends from it even if it doesn’t happen.

This week will be another big earnings week for US stocks with reports from Apple and Amazon.

Apple stock has soared nearly 50% this year heading into the report, recently breaching $3 trillion in market cap and trading near an all-time high. While there is brewing discussion whether Apple shares, like those of other tech giants, have been bid up too high entering earnings, Goldman Sachs analyst Michael Ng sees the iPhone maker delivering earnings above consensus forecasts.

“With AAPL up 48% year-to-date, driven entirely by multiple expansion, we recognize investor concerns around valuation and downside risks, but continue to believe that Apple’s growing iPhone installed base serves as the foundation for growing monetization per user driven by ASP (average selling price) increases,” Ng wrote in an earnings preview on July 25.

For Amazon, the focus will likely be on the company’s Amazon Web Services unit and whether or not growth will re-accelerate at the cloud leader.

“We view Azure’s deceleration in 3Q as a slightly cautious read for AWS especially since AWS started seeing optimization later than Azure,” UBS Lloyd Walmsley analyst wrote in a note on July 26.

With roughly half of the S&P 500 having reported earnings, we’ve reached the midway point in second-quarter earnings season in what should turn out to be the low point in the earnings cycle.

Warning

Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account and might not be suitable for you.