In this episode, we discuss the Federal Reserve's potential future rate cuts, the surprising job market data, a soft European economy, and tech giants' AI-driven performance.
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 after the show notes below. Our podcast is available on Apple Podcasts, Spotify, Google Podcasts, and Amazon Music.
Show Notes
00:00:00 Introduction
00:00:15 Decoding the Fed's Signals
00:03:18 Soft Signals from Europe's Economy
00:04:21 Natural Gas Inventory Surprises
00:05:06 Tech Earnings and AI
00:07:58 Meta's Dividend Debut
00:09:16 Chips and Games: Industry Trends
00:10:51 Conclusion
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. We sent out a new issue of the newsletter yesterday. And last week was Fed week in addition to an extremely busy earnings week.
Decoding the Fed's Signals
"We believe that our policy rate is likely at its peak for this tightening cycle and that if the economy evolves broadly as expected it will likely be appropriate to begin dialing back policy restraint at some point this year. But the economy has surprised forecasters in many ways since the pandemic, and ongoing progress toward our 2 percent inflation objective is not assured. The economic outlook is uncertain and we remain highly attentive to inflation risks. We are prepared to maintain the current target range for the federal funds rate for longer if appropriate." - Federal Reserve Chair Jerome Powell
So there was a lot of data that was coming to markets last week. I think starting with the Fed, probably the most important thing was they signaled that rates are likely to come down at some point this year. They believe that we are at peak rates, but they said that not in March most likely. So expectations that they could start to be coming down soon may get pushed out a little bit. We had seen in past weeks that people's expectations of rate cuts in March starting to wane anyway, and people more thinking that rate cuts would be in the back half of the year. And so I think the Fed didn't necessarily surprise anybody here. The surprising data point from a macro perspective came at the end of the week when labor markets showed that new job creation was still really strong. And so that seems to change people's perspective a little bit on potentially persistent inflation with strong labor markets. Erick any thoughts on any of this?
[00:01:10] Mokaya: I think I agree. A very busy week last week. I think it was one of the heaviest I've seen. I haven't seen in a while where 5 tech companies are reporting in one week and in addition, we have the Fed. So I think the key takeaway is what you've picked out that it's probably not March, but sometimes this year, but it's very interesting, though. The feeling I get is that the market is waiting with bated breath when the Fed signals that we're actually cutting rates significantly.
But then there's one thing that stood out. The Fed chair talked about wanting to see six months of good data. I wonder at this point in time, don't they have enough data to see? What exactly is holding them back in terms of cutting rates? Is it that they don't want to signal to the market that we are done and dusted in terms of dealing with inflation? Any thoughts on that, on why exactly they actually haven't pivoted so far now, or at least cut rates so far?
[00:02:06] Scott: Yeah, it is interesting. It seems they are being a little maybe overly hesitant. It certainly seems like inflation has come down. But at the same time, Jerome Powell has shown in the past that his Fed will act over a longer arc than probably financial markets may be ready to proceed.
And I'm thinking specifically with respect to actually raising interest rates. As we saw inflation coming out of the pandemic, they were very slow to raise interest rates. It took them probably a year too long to raise interest rates, so they're risking running the same sort of mistake here on the other side of being overly tight for too long because I think that the inflation data and the markets are certainly hoping that they start boosting up soon.
[00:02:52] Mokaya: And there was a quote from New York Community Bank that says borrowers are also waiting on the sidelines for lower rates. It's like everybody in the markets is just waiting for that moment when the Fed cuts in order to be able to get back into the market. But interestingly, capital markets are opening up. We saw the quote from Lazard. So I think generally it's just a hold-your-breath kind of sentiment that you get in the market so far. Do you agree?
Soft Signals from Europe's Economy
[00:03:18] Scott: Yeah, I think so. One thing in the newsletter this week that I wanted to ask you about being in Sweden is UPS talking about weakness in Europe. What are you saying right now in Europe? Is the economy feeling any weaker? Any noticeable changes?
[00:03:35] Mokaya: I think what I've seen most significantly impacted, I was talking a bit to students who are almost joining the job market. It feels like the job market's a bit stagnant, especially to do with markets associated with real estate. Especially in Sweden, they've been significantly impacted by the very high rates so it’s a very soft environment.
The funny thing is that market prices are not that significantly impacted. It's just that this general lull now in terms of no new constructions are happening. I actually noticed some constructions nearby which have been going on since 2021. If this was before the pandemic, they would have been constructed really fast. But right now it's like everything is at a pause. In terms of purchases, you can feel in the economy, demand is a bit subdued. So I do agree. There's a bit of softness in Europe.
Natural Gas Inventory Surprises
“Gas is a little bit different. The inventories are high in the U.S. Inventories are high in Europe. We're kind of mostly through the wintertime, certainly through the riskiest period of the wintertime, and now, there's these questions that are not going to really weigh in the market in the near term, but maybe longer term, about exports out of the US and so all of that has got, gas markets under a little more pressure than oil markets or refined products and it's not unusual." - Chevron (CVX 0.00%↑) CEO Michael Wirth
[00:04:21] Scott: I did see though, Chevron said that natural gas inventories are high in the U.S. and in Europe. Has that filtered through to energy prices or are energy prices less burdensome than they had been?
[00:04:36] Mokaya: Yes, significantly this year there's been absolutely no talk about high energy prices. It's one of the coldest winters I've experienced in Europe, but there's been absolutely no talk about high energy prices around Europe. And if you look at the data the European Central Bank came out with, it seems like energy prices, the fact that they're lower this year than last year has helped a bit to cool the inflation, especially in Europe. So not talk about energy. People are very well prepared for this winter.
Tech Earnings and AI
But beyond that, it was tech week. So I think maybe we should discuss a bit of the tech week. And I think my key takeaway was issues to do with cloud optimizations. They're softening in that regard. And Cloud companies, especially the big three, are doing very well. A significant chunk of growth for let's say Microsoft Azure is coming from AI. So I feel like the beneficiaries of AI at this very early stage are mostly tech and the providers of shovels for digging, as we say. But the companies themselves, if I look on the other side, the companies are talking about AI, they're mostly talking about AI helping them do their tasks a bit more efficiently. So there's not many companies outside big tech are talking about new revenue generation streams because of AI. What's your takeaway from the tech earnings season?
"But that period of massive, I'll call it, optimization only and no new workload start, that, I think, has ended at this point. So what you're seeing is much more of that continuous cycles by customers, both when it comes to AI or whether it comes to the traditional workloads." - Microsoft (MSFT 0.02%↑) CEO Satya Nadella
[00:05:56] Scott: Yeah, I think what's going on at the data centers is really the thematic element for the big tech companies. And at the data centers, number one, there had been weakness in cloud spend from cost optimization. So you had other technology companies who were trying to rationalize their spend at the hyperscalers data centers. The hyperscalers were talking about that basically being done now. So companies are done cutting costs, which is his own macroeconomic indicator that companies are getting more bullish, ready to spend more and invest more in things like cloud. So that's a positive data point just for I.T. spend, the capex in general, capex budgets. So there's that.
"CapEx will go up in 2024. I'm not giving a number today, but we do -- we're still working through plans for the year, but we do expect CapEx to rise as we add capacity in AWS for region expansions, but primarily the work we're doing with generative AI projects…. the trend for most of the large percentage of the spend will be in infrastructure is going to continue into 2024." - Amazon (AMZN -0.03%↓) CFO Brian Olsavsky
And then the second big thing that's going on in data centers is obviously the transition to AI. And the investment in GPUs and compute that is capable of processing AI workloads. And so you're seeing major CapEx spend from the hyperscalers, from the big tech companies, the seven horsemen or whatever we're calling them these days. AI is a huge theme in tech.
[00:07:02] Mokaya: Definitely. But what struck me a bit was also the use cases that Amazon has found for AI in its businesses. The really interesting use cases, like, they have this AI tool that is able to read thousands of summaries for you. And then you don't have to read everything. I feel like the best use case so far for most AI products, especially for the consumer side is summarizing content for you so that you don't have to read the whole document. You're able to read a bit of it and still get a feel of everything.
[00:07:32] Scott: Yeah, it is, I think the game changer for our perceptions of AI obviously have been the large language models, which are very good at reading large amounts of written language and summarizing them. So it’s a clear, obvious use case for them but yeah, it's interesting seeing the way these things are going to be filtering into the economy.
Meta's Dividend Debut
[00:07:58] Mokaya: Let's talk Meta. You've been bullish. It's finally a dividend stock. It's joined the likes of Caterpillar now as a dividend stock.
[00:08:10] Scott: Meta is up now five times over the last 18 months. We highlighted that there were changes going on in the earnings call that people should be aware of. I don't know that I have much more to say than that, but nice one for The Transcript.
[00:08:26] Mokaya: Yeah, so for me, what stood out was the fact that they actually talked about the tens of billions of public videos and publicly shared images that they already have in the backyard to train their AI models on. So I feel like some of the companies are going to win in this are companies with unique data sets like that.
And maybe one more thing by the way. Apple and AI. Still not much talk in earnings in terms of what they want to do with AI, but the CEO did say look out for us in the next couple of months and we will be able to show you something. Apple is not known to talk about stuff in advance. So I guess they're keeping it low. So let's see how that goes. And Apple Vision Pro, of course, was launched last week. And it's going to be one of the categories in their wearable section going forward. So that's an interesting one to keep track of going ahead. Any other takeaways from earnings in terms of tech?
Chips and Games: Industry Trends
[00:09:16] Scott: Yeah, a couple of important ones within the tech section. One was that Microchip Semiconductor company was talking about weakness in all of their end markets. Just highlight that because Microchip has historically been a leading indicator for the broader semiconductor industry. When they talk about weakness, I always look twice at that. This time around it feels like it's a little bit more of a lagging indicator than the leading indicator, but still wanted to point that out.
"And in the gaming segment as we enter the fifth year of what has been a very strong gaming cycle and given current customer inventory levels, we expect revenue to decline by a significant double-digit percentage." - Advanced Micro Devices (AMD 0.03%↑) CEO Lisa Su
And then the second thing was AMD talking about extreme weakness in its video gaming segment. Down double-digit percentages, they said in 2024. I bring that up because it is an industry that is one to keep an eye on specifically with respect to GameStop. My mind goes back to being a legacy meme stock that still is carrying quite a bit of a premium to it from those days. If fundamentals are turning negative against it, that would be an area to be concerned about if you're a GameStop shareholder. Any thoughts specifically on that part of the video game stuff?
[00:10:19] Mokaya: I don't have much. It's interesting though that Microchip is struggling when others like AMD and Nvidia are really having a good time. I feel like AI has maybe overshadowed what would've been quite a tough period for some of these companies in the last year or so. So AMD and Nvidia are benefitting from data centers. So that's covering up for some of the weaknesses that are in the other pockets of the market. So I think that the chip industry seems to be going through a downturn save for AI which is boosting growth. And I think that's key.
Conclusion
A good place to close at?
[00:10:52] Scott: Yeah, I think that's a good place to close.
[00:10:55] Mokaya: Yeah, so I think last week was peak earning season, actually, so from now it's going to get a little bit easier. I think around 70 S&P 500 companies are reporting this week, so we'll be keeping an eye on all of them. Subscribe to our newsletter and be able to get top content from us every week. See you next week and thank you for joining us this week. Bye.
[00:11:07] Scott: Thanks, everyone.
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