In the first episode of the new year, we discuss what has changed since the holidays and preview the Q4 2022 earnings season.
The episode is based on yesterday's newsletter which is available on Substack.
A transcript of this podcast, with relevant images and quotes, is available for all subscribers only after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, YouTube, and Amazon Music.
Show Notes
00:00:00 Introduction
00:00:08 A Cooling Down
00:01:55 Inflation Cooling in Europe
00:03:03 Inflation in Services
00:05:52 A Hunkering for Fries
00:06:49 The AI revolution
00:09:19 Weakening Data Center Demand
00:11:15 Earnings Season Preview
00:12:40 Conclusion
Transcript
Introduction
[00:00:00] Scott: Welcome everyone to a new episode of the Transcript podcast. You've got me, Scott Krisiloff, I'm editor of the Transcript, along with Erick Mokaya, who's our lead author.
A Cooling Down
“Regardless of industry, as the macro uncertainty has increased, right, they're being a little bit more cautious. So we're seeing some delays in decision-making. We see changes in the pace of spending, and we're seeing some pausing of the smaller deals. And all of this impacts the smaller deals more” - Accenture (ACN 0.00%↑) CEO Julie Sweet
We sent out a new issue of the newsletter yesterday, and it's the first newsletter of the new year. We had a full and shortened work week last week and so there weren't a ton of quotes but still we came into the year kind of seeing the same things that we were seeing towards the end of last year when we took a break for the winter where we saw business starting to slow down. Really saw a few quotes of things continuing to slow, and then the Fed is still coming into the new year on a relatively hawkish note. Erick, any thoughts?
[00:00:39] Mokaya: Yeah, I think it's just the same, continuation of the same trend. But what's surprising though, is a lot more businesses talking about a slowdown. Towards the end of last year where we left it off at is that everything was cooling down, slowing down, coming down, and the start of the year is just the same. It's slow. Everything is slowing down, businesses are slowing down. And I mean, one of the other things for me that was notable, at least for the Fed, is the Fed acknowledging that there's a possibility for a recession in 2023. What's your feeling at the beginning of the year as we start this new year? Do you feel the same?
[00:01:17] Scott: I mean, I think that recession odds are going to be heavily dependent on the way that the Fed is acting and the Fed continues to signal hawkishness, the intent to raise interest rates. You know, Neel Kashkari talked about interest rates getting to 5.5% by the end of the year. And so as long as the Fed is putting pressure on capital markets, it becomes increasingly likely that a recession is going to happen. And in fact, the Fed may just be angling for a recession where they, you know, the recession may be the indicator that they're actually looking for where they can pull back. And so as long as they're hawkish, that seems to be, that's still my base case for 2023.
Inflation Cooling in Europe
[00:01:55] Mokaya: So maybe a bit of perspective from away from the US is that, at least in Europe it seems like inflation is coming down. It's been a bit of a milder winter, so that feels like energy prices have come down a bit. It's not been as bad as many people predicted. So I think the forecast, as you can see as the ECB governor in that quote was talking about that they may get inflation down to 2% between now and the end of 2024. Pretty ambitious. Right now it's around 9.6%. It was around double digits in November. So I think a bit of cooling down in Europe. So I don't know if that extends to the US but that's a feeling you get around Europe. China is reopening. So I don’t know what that also does to inflation in terms of demand for energy for oil globally and how that also plays out to the US and all. But all in all, I think inflation, as we noted just before we went for the break, was cooling down in the US. It seems to be cooling down elsewhere. I don't know if it's cooling enough to stop the central banks from raising rates. That doesn't seem to be the case so far. Do you agree?
Inflation in Services
[00:03:03] Scott: Yeah. I mean, one thing that I actually noticed in the ISM surveys last week that I thought was very interesting is that on the manufacturing side, the prices paid component is at 39 which would suggest that a fairly significant slowing in price increases, actually prices decreasing at a fairly significant rate. However, if you look at the ISM service index, that's at 67. So there's a big gap. I mean, there's a 27-point gap in terms of what people are seeing on the services side versus on the manufacturing side. So, you know, we have been picking up inflationary trends coming down primarily on the manufacturing side, looking at commodity prices and some commentary there for manufacturers, but we haven't been as much focused on what's going on on the services side, where like labor would be a large component that could still be pushing inflation. And so that actually was the first time I realized that potentially some of the things that we've picked up about consumer spend shifting from goods to services actually may also be tracking with inflation, where you're seeing inflation still on the services side, which would suggest that inflation may not be coming down as much as you and I were thinking. And may mean that the Fed actually does need to stay tighter for a little bit longer here.
[00:04:15] Mokaya: That actually does strike me as something we've not been paying attention to the past couple of weeks because that's harder to get in terms of quotes from earnings calls. So I think that would be interesting as something to keep an eye on this earning season, especially as the big banks start reporting this week.
[00:04:31] Scott: I think so, and I think this is something that we have picked up, we just haven't really highlighted it or really put the two things together. So maybe this is just something that was base for us. We have picked up how tight labor markets still are and obviously this is something that the Fed is looking at. Anecdotally I was out this weekend in Los Angeles a couple of times to different restaurants and the city was jammed. It was noticeably busy. We're hosting the college football championship tonight I think. So it may be like a lot of people came in and were out and about and at restaurants and things like that, but it was noticeable how crowded different entertainment restaurant venues were.
[00:05:09] Mokaya: I mean, certainly from Delta, I think one of the quotes is about holiday traffic being very strong. It also feels like generally services is not, apart from Southwest, which had a terrible holiday period, it seems like most airlines were having an occasion where people are traveling as normal, people are spending as normal. The things that are challenged are things to do with the electronics and something you noted about hardware also having a bit of a tough time, but it seems like services as a whole is doing well. There's a lot of demand and because of that demand and limited supply, that means that prices are up. And of course, that inflation will be a bit stickier than say what we notice normally about goods that is much easier to track at the end of the day. Do you agree?
A Hunkering for Fries
By the way, one other thing that I also noticed Americans are spending on which we picked up was also fries being that they're being a kind of, a bit of an excessive demand for fries and the fries attachment rate being the rate at which people order fries as they go to restaurants being a bit higher than normal and even higher than pre pandemic. So I was a bit surprised by that. Are you guys that attached to fries in the US?
[00:06:20] Scott: I mean, I can't speak for other people, but I can say for myself, I love french fries. So I actually am surprised. I didn't realize Lamb Weston, I've heard the name many times, but never actually looked at the company. I didn't realize we have a pure french fry company in public markets. So I think I gotta maybe invest in Lamb Weston, given my own love of french fries. At any rate, I mean, stuff like that definitely suggests that people are still spending or that people aren't completely pulling in. But yeah, we'll just, we'll have to try attract the consumer going forward.
"As expected, casual dining and full-service restaurant traffic in the quarter was down versus the prior year, although trends also improved sequentially versus our fiscal first quarter -- The fry attachment rate, which is the rate at which consumers order fries when visiting a restaurant or other food service outlets remained above pre-pandemic levels" - Lamb Weston (LW 0.00%↑) CEO Thomas Werner
The AI revolution
[00:06:49] Mokaya: There's so many things to pick up this week, I think, and I want us to maybe pick a few here and there, and then we'll finish up, especially with the outlook for banks. So one is AI. It's been big talk about chat GPT and how that's going to replace Google. Do you feel like it's time for Google to die the death of Yahoo?
"AI is truly the most important mega-trend for the future of tech. And at its simplest, AI leverages the power of high-performance computing to analyze and interpret massive amounts of data to uncover patterns and make predictions on future outcomes." - Advanced Micro Devices (AMD 0.00%↑) CEO Lisa Su
"...we're excited about our OpenAI partnership is just the beginning I think of this next generation of AI where we're built very unique infrastructure in fact the best AI infrastructure is on Azure which trained models like GPT" - Microsoft (MSFT 0.00%↑) CEO Satya Nadella
[00:07:06] Scott: I don't know about Google specifically. Obviously, they have fairly significant capability in machine learning and AI going on internal to them. But I think it is worth just noting and remembering that technology cycles, even though we price them as if they're going to last for a very long time at their peaks, in reality, technology cycles are very, very fast, and the winner of a certain technology cycle usually doesn't end up being a winner of multiple technology cycles. And if you just think about it, the best example of this may be the VCR, VHS tapes, moving to DVDs, moving to just streaming media consumption. You know, for a good five years there or something, DVDs looked like they were a dominant player in media distribution. And now DVDs are basically extinct. So, you know, you can have Google as well search and the way that the construct of the internet, the web browser, all of this it's very easy for that to actually go away and potentially be replaced by better forms of search or better forms of web browsing, which I think is honestly to Facebook's discredit or maybe credit, I think that is what Zuckerberg was trying to do with the metaverse was get ahead of potentially a disintermediation of the web browser. But AI certainly having a moment right now that is likely to continue to expand. It's really a significant technology.
[00:08:32] Mokaya: I think the key of course is AI has been there for a while. It's just like, I think in the past two or three months, given ChatGPT’s prominence and the role it's playing in people's lives, I think it's now suddenly come into the mainstream and people are talking a bit more about it. I think AMD, Microsoft and Nvidia, the quotes we picked up this week, are all about, okay, how can we leverage this technology to actually be able to deliver services to people at the end of the day? Because yes, you may have the AI at the end of the day, but you need to use that to deliver a service which people can pay for and then that's where you generate something you capture your profits from. So I think it's an exciting time and it's an exciting space for our readers to maybe check out. We are actively exploring at The Transcript how we can also make our earnings calls readings actually better using AI. So I think that's something that we are actively checking out.
Weakening Data Center Demand
“from expectations of 6 months ago, the demand environment for data center customers has deteriorated for 2023, and that is partly reflected in our overall view of what will happen in this segment in 2023 calendar year" - Micron Technology (MU 0.00%↑) CBO Sumit Sadana
Something else I wanted to ask you about was about the weakening data center demand which is very interesting. It's something notable, which I think Micron noticed it, and I think we've picked up here and there bits and pieces of some of these companies struggling in the data center area. Any thoughts on that? And I know Nvidia is heavily exposed to data center. 60% of their business is actually data center business. They did not talk about anything. I read their earnings call, at least I read the latest transcript. There was nothing from the CFO about any issues with demand. They didn't talk about demand, but Micron has kind of notified us that there may be an issue with demand. So maybe that may play out in Nvidia's Q4 earnings calls bound to happen later this month. Any thoughts?
[00:10:05] Scott: Yeah, I think on AI going back to that, for public markets investors, it certainly seems like two of the beneficiaries in this trend are Microsoft and Nvidia. it. Both of them have pretty hefty market caps and PE multiples even after selloffs last year and there's a lot of other things going on in both of those companies’ businesses, so it's hard to really have pure play in public markets, at least exposure to machine learning, AI but both of those, Microsoft via its investment in open AI and Nvidia’s GP as being core both would seem to benefit. On the data center side, it's interesting just to read comments about a decrease in data center spend. It's not surprising. And if you're going into a recession or if people are pulling back on it then you would see weakness in these areas, but data centers have been an area of significant growth and seemingly unstoppable growth for at least gotta be a decade now. And so to see that potentially reaching some sort of saturation or at least cyclical point is different from I think what we've seen for many years for data centers.
Earnings Season Preview
[00:11:15] Mokaya: Yeah, definitely. So this is the beginning of the earning season this week. Any thoughts on what to look out for? I know it's big banks reporting this week. Jamie Dimon, of course, and Mike Mayo will be facing off once again as they do every quarter. So I think lots of things to discuss with regard to bank's rising funding costs, IPO pipeline is dry, so investment banking may be impacted. Of course, net interest income would be up. And something very interesting also about layoffs. I think Goldman's is one of the ones which has been very open about laying off close to 3000 employees in the business. Anything that you are looking out for actively as may be heading into the earning season?
[00:11:55] Scott: Yeah, I'm curious, especially for the banks, what their commentary is on the health of the consumer, consumer spending and their credit card and debit card businesses. Delinquencies, although I don't expect delinquencies to pick up in any way. Also comments on excess deposits that had built up from Covid era stimulus. I think JP Morgan talked about last quarter, those starting to be on the decline and probably on the pace towards normalizing mid-2023. And so we're two quarters away from potentially seeing those start to get back to a more normal level. If that's the case, I would expect to start to see some of that dynamic happening in the fourth quarter and more people talking about that on the banks and that's a big, big issue for the economy potentially.
Conclusion
[00:12:40] Mokaya: So think on that note, maybe we close this week's podcast. And thank you so much for joining us this week. We are starting off the year with a big bang. Hopefully, we want to double or triple our readership. So do share our podcast, do share our newsletter, and help us to grow as much as we can this year. Looking forward to the earning seasons. We'll be here to give you all the updates that you need on our podcast and on our newsletter. So check out. Thank you so much. See you next week.
Has Anything Changed?