SUMMARY
Markets were volatile but steady the first half of last week. However, sentiment took a turn for the worse off the back of mixed earnings during the week from Mag 7 companies MSFT, META, AAPL and AMZN. Weaker-than-expected US economic data was the final nail in the coffin on Thursday and Friday, as the sell-off in risk assets accelerated and safe haven assets were strongly bid.
The FOMC stood pat on Wednesday, while the Bank of England decided to reduce its policy rate by 25bps at its Monetary Policy Meeting on Thursday. This was the order I had expected rate reductions to materialise at the beginning of the year: ECB first, BoE second and Fed last.
ISM’s PMI manufacturing data in the US was much weaker than expected for July (here), coming in at 46.8% on Thursday with the market expecting 48.8%. This was the first economic shoe to drop, followed on Friday morning with the second – a significantly worse-than-expected July jobs report (discussed further below).
In spite of the FOMC sitting tight at its policy meeting last week, signs of economic weakness in the US are emerging and broadening, rattling risk markets.
The VIX (measure of US stock market volatility) has been heading higher, skyrocketing on Friday to an intraday high nearing 30, before closing at 23.39, its highest closing level since May 2023.
Credit spreads have also been widening, especially in the more credit-sensitive non-investment grade (“high yield”) arena as investors seek safety.
UST yields plummeted last week as investors more aggressively price in expectations of a near-term reduction in Fed Funds and a slowing US economy, aided of course by flows into the ultimate safe haven asset class.
And speaking of safe havens, gold touched record highs last week, too.
Economic growth was slightly better-than-expected in the Eurozone in the 2Q2024, but this did little to stop contagion from weaker US economic data spilling over into European equity markets.
As the Yen sharply strengthened off the back of the BoJ monetary policy decision (first part of week) to raise its overnight rates and gradually cut its QE programme in half in the next three quarters, Japanese stocks tumbled as I have been expecting, down a sharp 4.7% WoW and now lower more than 10% in the last month.
It is surprising how quickly pundits have pivoted, turning negative on risk markets and blaming the Fed (again) for not reducing the Fed Funds rate last week. Is it certain that inflation has been vanquished and the US is nose-diving into a recession, the one we have been waiting on for over 12 months now? I have doubts, because tighter monetary policy has an unpredictable lag and has been targeted to get inflation back to target level, with the known cost being slower economic growth.
Friday’s Jobs Report
Any way you slice it, the July’s jobs report – released Friday morning before the open – was a massive miss on the downside. With only 114,000 jobs added (vs expectations of 175,000 to 185,000) and an increase in the unemployment rate to 4.3% (from 4.1% in June), risk markets simply puked while bond investors cheered. Prior months’ data was revised down, too, to add fuel to the fire. Wages increased less than expected, a welcome sign in the battle against inflation. Bad economic news is now translating to bad news for risk markets, when for many months, risk markets cheered any sign that a Fed rate cut was imminent. Now we are almost certain to get a 25bps reduction in the Fed Funds rate at the mid-September FOMC meeting, and some pundits are suggesting we might see a 50bps reduction. However, the reality of a near term and potentially more aggressive reduction in interest rates is now being overwhelmed by the reality that a weak US economy is not good for corporate earnings, which is heavily weighing on global stock markets. You can find the BLS jobs report for July report here.
MARKETS LAST WEEK
Global equities were poor, with only Chinese equities eking out a gain. For the second week running, the worst performer was the Nikkei 225 – down 4.7% WoW – which is being effected by a strengthening Yen and contagion from weak US economic data and the selloff in risk assets.
US equities were sharply lower across the board, with tech weakness again being a major culprit. The small cap dominated Russell 2000, which posted the best performance in July, also fell sharply due to growing economic concerns.
US Treasury yields were sharply lower across the curve last week, really taking a turn down on Friday. The policy-sensitive 2y UST yield fell 48bps, and the 10y UST yield fell 40bps during the week. Duration looks to have been the best place to be (which I am not), with total returns on both the intermediate and long-term UST indices now moving into the black YtD.
Corporate credit spreads started to widen mid-week, as investors moved into US Treasuries. I only have credit spread reads through Thursday, but spread widening was evident both in investment grade and high yield corporate bonds, with US HY spreads gapping out 25bps.
Gold touched record highs as investors sought safety, no doubt also helped by a worsening situation in the Middle East. Similarly, oil prices rose sharply, but then settled and ended up lower to close the week, as clouds gathered on the global economic horizon. Higher global risk contributed to a decline in the Dollar being less than perhaps otherwise (-1.1% WoW), with the Yen on fire, climbing 4.9% last week and over 10% MoM. Bitcoin was down nearly 10% WoW, behaving more as a risk asset than a safe haven in this time of heightened volatility.
WHAT’S AHEAD
We have more earnings this week and a smattering of economic data, but I believe investors will mostly be digesting the slew of last week’s earnings and economic data. The wild card remains a potential broadening conflict in the Middle East, an impossible event to predict although increasingly likely, and undoubtedly unfavourable for risk assets.
MY TRADES LAST WEEK
I was active last week, arguably too early on several of my trades. I added to existing positions in PG (off of weakness following earnings, defensive), MSFT (also following earnings, because I consider this company A++), LLY (scrap) and ASML (way too early, mid-week). I also took off the covered call component on my NVDA shares at virtually nothing, and am left with in-the-money puts (110) on my entire position until after the company’s earnings (Aug 28). I have a similar strategy in place on AAPL (235 calls / 210 puts), although I will likely let the calls run off next week. I also lightened early in the week on the Nikkei 225 index. Of course, there was nowhere to hide on Friday, but the positions that have really clobbered me this year have been LULU (keeps heading lower) and CRWD (idiosyncratic risk that I didn’t see coming). Thank God the weekend has arrived!
COMMENTARY LAST WEEK (VIA EMAILS – MUST BE SUB TO HAVE RECEIVED)
The commentary below is from two emails that I sent out during the week, covering earnings of the four reporting Mag 7 companies, and central bank decisions by the Bank of Japan, the Fed and the Bank of England. These went out on Tuesday and on Thursday, should you have missed the emails.
EARNINGS MAG 7 COMPANIES WEEK OF JULY 29th
Microsoft earnings
Before I even looked at the numbers, I watched MSFT shares plummet in the aftermarket as soon as the figures were released after the NY close. I looked at the quarterly results (4Q2024 for MSFT) and was stunned at how good they were, knowing of course that the devil is in the details, and that the all-important post-earnings management call with analysts – which had yet to occur – would matter more to investors than the last quarter’s results.
Firstly, you can find the results here. I was looking for areas of weakness as I read through the press release, and none emerged based on management’s commentary and comparing the quarterly results to the prior quarter and prior year. Both top- and bottom-line results beat analysts’ consensus expectations. The fly-in-the-ointment seemed to be cloud growth, which increased 29% YoY when analysts were projecting 31%. On top of this, management seemed to fall in line with GOOG as far as significantly ramping up capex to address expected growth in AI (good for chip company stocks as the post-market revealed). In fact, MSFT said capacity constraints as far as AI were the culprit behind cloud growth just missing expectations.
A portion of the post-earnings initial decline in the stock was clawed back, with the stock landing at $411.25/sh in the aftermarket, down $11.67/sh (2.76%). At this level, the trailing P/E ratio of MSFT is 34.7x, and the price-to-sales is 12.5x. The forward P/E ratio is 30.9x. These are nose-bleed levels for most stocks, but I think (unlike TSLA for example), it is deserved. MSFT has a dominant position in its key markets, consistently delivers strong top- and bottom-line growth, is on the leading edge of AI and cloud, and is a defensive stock. What’s not to like? For investors new to individual stocks, I consider MSFT the mother-of-all core positions. For existing investors, it will depend on your existing holdings of the shares. Although a large holding of mine, I will be adding at the open. MSFT is 12% off its highest closing level in early July, which to technical investors represents a decent entry point I would think.
META, Amazon and Apple earnings
On Wednesday following the market close, META delivered quarterly results as impressive as MSFT and GOOG, but CEO Mark Zuckerberg did a much better job on the post-earnings analyst call of “word-smithing” META’s adoption and use of AI, and the substantially higher capex this will require going forward to stay on the cutting edge of AI. Having said that, META did deliver impressive growth on the top- (+22% YoY) and bottom-lines (+78% YoY), also beating analyst’s consensus expectations and guiding analysts higher for the next quarter. META’s shares were up nearly 5% yesterday, even as the indices got trounced.
I have been in and out of META since the company went public, but soured on the company at perhaps the wrong time, mainly because I think the overuse of social media is becoming increasingly toxic. Unfortunately, that biased view is but one reason, and it is certainly contrary to the reason I have owned META twice in the past – the company must have more customers than any company in the world (over 3 billion in a world of 8.1 billion, which is quite decent penetration to say the least). I suppose this is a principled view, similar to avoiding fossil fuel companies for environmental reasons, but it also looks terribly wrong. The simple truth is that not owning META – like not owning NVDA – has been a mistake this year if you monitor your investment performance against a market-cap weighted index like the S&P 500.
AMZN and AAPL reported earnings last night after the close, and presented a mixed bag. Let’s start with AAPL, a stock I have owned for decades but have recently become concerned about the company’s growth prospects in spite of its global dominance especially in consumer products / hardware. This round of earningsmight have proved those thoughts wrong, as revenues increased 5% and EPS increased 11% (both YoY). The company not only had impressive year-over-year growth, but it also beat analysts consensus expectations (including EarningsWhispers.com’s more aggressive outlook) and nudged its guidance for the next quarter higher. The positive surprises were iPad, iPhone and services, all of which recorded growth that was better than expected. AAPL shares were up slightly in the post-market following the release of results, but are now flattish pre-open.
As far as AMZN, it was more of a mixed bag and – in a market in which sentiment is changing for the worse – the shares got hammered in the after-market post earnings, and are down nearly 8.5% pre-open as I write this. AMZN beat analysts’ expectations convincingly on the bottom-line, but revenue growth fell short of analysts’ expectations (although the company did deliver YoY revenue growth of 4.4%). AWS (cloud) had solid growth albeit trailing that of MSFT and GOOG. What is more concerning was the sluggish growth in retail sales and advertising revenues in the most recent quarter, which I consider an indicator of the direction of the all-mighty US consumer. In fact, this is probably what caused management to revise down expectations for the coming quarter, which also hit the shares.
I am doing some rudimentary work on valuations of the Mag 7 now, which I will publish later. However, should this downdraft in risk markets persist, some or perhaps all of these expensive stocks will be vulnerable to drifting lower, converging towards market averages as far as valuations in the coming weeks.
CENTRAL BANK MEETINGS
Bank of Japan comes out firing on all cylinders
It has been anticipated for some time that the BoJ would eventually fall in line with central banks in other peer countries by tightening monetary policy, but the bank had remained steadfast meeting after meeting, clobbering the Yen. However, in the run-in to the just-concluded meeting, the Yen had been strengthening as expectations that the BoJ might tighten increased. And indeed, this time was different.
The BoJ raised its overnight borrowing rate to 0.25% (+15bps), and also agreed to rachet downs its QE programme, from ¥6 trillion/month in JGB purchases currently to ¥3 trillion/month by 1Q2025. You can find the official BoJ press release here. Also worth reading is the BoJ’s revised Outlook for Economic Activity and Prices (July 2024).
The BoJ has chosen to finally begin the normalisation of its monetary policy to help guide inflation – above 2%/annum since April 2022 and projected to be 2.5%/annum for all of 2024 – back towards the target 2%/annum by 2025/26. The central bank’s tightening regime is contrasted against central banks in other parts of the world, some of which have already started to loosen monetary policy while others are on the doorstep. Also, it is interesting that the BoJ is tightening monetary policy into an economic slowdown domestically. Recall that 1Q2024 GDP growth was negative 0.5% as the economy shrank for the second quarter out of the last three.
This morning (Europe/US), the ¥/$ exchange rate is ¥152.63/$1.00, well off the lows just over two weeks ago of ¥161.60/$1.00, a 5.6% jump. The effect on other Japanese markets has been muted, mainly because I believe that – in spite of the press saying otherwise – this move was not unexpected. The yield on the 10y JGB rose to 1.07% after the decision, an increase on the day but only 1bps higher that the yield at which the 10y JGB closed last week. The Nikkei 225 closed up 1.49% (at 39,102) on the day post-decision, indicating that perhaps the run in Japanese stocks is not over. It is counter-intuitive to me, although the Japanese equity market is apparently skewed towards banks and other financial institutions according to one article I read, a sector which should of course benefit on paper from higher interest rates. I did some research on this and was not able to verify the percentage of financials in the Nikkei 225 although it is well known that Japanese banks and insurance companies are in many cases both domestic and global giants.
Japan is a unique market well beyond the scope of this update to delve into. As for me, I will probably lighten slightly into the BoJ move (Nikkei 225 ETF), especially on its strength today.
FOMC decision
The FOMC decision on Wednesday was as expected, with the Fed not budging on interest rates but carefully laying the groundwork for a likely reduction in the Fed Funds rate in September. Mr Powell was as non-committal as always as far as future monetary policy actions in his discussion with the financial press following the decision, but the confluence of economic data suggesting a soft landing is likely to spur the Fed into action sooner rather than later. The CME FedWatch Tool is now forecasting 25bps reductions in the Fed Funds rate at all three of the remaining FOMC meetings this year, the next of which is Sept 18. And in 2025, there are another 125bps of Fed Funds rate reductions projected. The bond market saw it coming with yields across the curve lower by around 20bps already this week. Intermediate- and longer-maturity yields are reflecting growing concerns about US economic growth, as the data seems to be suggesting that the jobs market is worsening (we will find out more this morning) and US manufacturing growth is deteriorating.
Bank of England decision
In the UK, the Bank of England decided to lower the Bank Rate 25bps on Thursday, its first rate reduction since March 2020 (onset of pandemic). Investors were very much on the fence prior to the decision, which was close at the Monetary Policy Board, with five MPC members voting in favour of a rate cut and four voting against. MPC chief Andrew Bailey was quick to remind investors that they should not expect further reductions soon, as the Bank wants to first get a grip on the future direction of inflation, with services inflation being particularly problematic still. Gilt yields were lower across the curve following the decision. The FTSE 100 was flattish but is down sharply in this morning’s session, most likely a follow-through to yesterday’s weak session in US equity markets.
_________________
**** Follow E-MorningCoffee on Twitter, and please like and comment on my posts right here on my blog. You need to be a subscriber, so please sign up. Thanks for your support. ****
Commenti