Slowing Rate Increases
Hope that the Fed will slow its pace of rate increases buoyed the capital markets last week
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Succinct Summary: Capital markets were buoyant last week thanks to the hope that the Fed will slow its pace of rate increases. It was also the height of earnings season, punctuated by reports from large tech companies. From a macro perspective, consumer spending remains resilient despite some caution. However, there were some noteworthy shifts in sentiment in the technology and real estate sections of this week’s newsletter.
Macro
Consumers are feeling cautious
"...the macroeconomic environment remains challenging worldwide. The continuing impacts of broad-scale inflation, heightened fuel prices and rising energy costs have impacted our sales growth as consumers assess their purchasing power and organizations of all sizes evaluate their technology and advertising spend. As the third quarter progressed, we saw moderating sales growth across many of our businesses as well as the increased foreign currency headwinds I mentioned earlier, and we expect these impacts to persist throughout the fourth quarter." - Amazon.com (AMZN 0.00%↑) CFO Brian Olsavsky
"Due to concerns about the high price of everyday goods and gas, a potential recession, rising interest rates, and declining personal savings rate, we are seeing a more cautious consumer today, but one that is willing to purchase an offering that provides good value." - Newell Brands (NWL 0.00%↑) CEO Ravi Saligram
"Over the last few months, I've visited markets around the world, hearing from employees, franchisees, and restaurant teams about how the challenges we face globally impact our restaurants locally. Three themes came through loud and clear. There is increasing uncertainty and unease about the economic environment," - McDonald's (MCD 0.00%↑) CEO Chris Kempczinski
"The short story is that the industry is volatile. Inflation continues to be an issue, the dollar remains strong, the war continues, and consumer confidence appears to be tepid." - Logitech (LOGI 0.00%↑) CEO Bracken Darrell
“Consumer confidence retreated in October, after advancing in August and September. The Present Situation Index fell sharply, suggesting economic growth slowed to start Q4. Consumers’ expectations regarding the short-term outlook remained dismal” - The Conference Board Senior Director of Economic Indicators Lynn Franco
Some companies are seeing consumer weakness
"I would say consumer spending continues to be weak. Even in the month of October, we have seen lower consumer spending. I called that out as those trends where the inflation is impacting the consumer, I think, remains through the holiday season, as well as how inventory levels are adjusted by retailers is something that we will have to watch." - 3M (MMM 0.00%↑) Chief Financial and Transformation Officer Monish Patolawala
But overall spending has remained resilient
"The headline is that consumer spending remained resilient and cross-border travel continues to recover -- overall consumer spending has remained resilient, although we are seeing some shifts in what consumers are buying. Looking at our switched volume trends. Domestic volumes remained steady, showing growth relative to 2019 levels relatively consistent with the second quarter of 2022. The trend towards spending on experiences continues." - Mastercard (MA 0.00%↑) CEO Michael Miebach
"As you alluded to, I mean, right now, we are seeing nothing but stability and it’s been true over the last numbers of quarters." - Visa (V 0.00%↑) CEO Al Kelly
"If you raise rates and slow down the economy to fight inflation, the expectation is you have a slowdown in consumer spending. It hasn't happened yet. So it could happen, but it hasn't happened yet. You're seeing a mitigation of the rate of growth, not a slowdown. Not negative growth." - Bank of America (BAC 0.00%↑) CEO Brian Moynihan
Consumer balance sheets are still strong
"Thus far in 2022, consumer financial health has remained positive versus pre-pandemic conditions, supporting growth across TransUnion, especially in our emerging markets. Consumer employment, income, spending, balance sheets, and credit performance have been strong year-to-date. However, the dramatic increase in inflation globally, especially in our developed markets of the U.S., the U.K., and Canada, has begun to pressure household finances, leading to a reduction in savings rates, increasing credit balances, and modestly higher credit delinquencies." - TransUnion (TRU 0.00%↑) CEO Christopher Cartwright
“So a high consumer balance sheet, high amount of support that people have experienced in COVID, low unemployment which continues” - Barclays (BCS 0.00%↑) Group CEO & Director Coimbatore Sundararajan Venkatakrishnan
And so inflationary pressures remain persistent and broad-based
"As I have noted over the last several quarters, inflationary pressures remain persistent and are broad-based. Therefore, we continue to experience year-on-year headwind with a Q3 cost increase of approximately $225 million or a negative impact of 2.6 percentage points to operating margins and $0.31 to earnings." - 3M (MMM 0.00%↑) Chief Financial and Transformation Officer Monish Patolawala
"So it's about 1/4, a little more than a quarter, a little less than 1/4 in a restaurant that we're having to take $1, $2, $3 increase in starting wages just to make sure that the restaurants were staffed. So with what the Fed is doing, you think that the higher interest rates are going to have an impact on the labor market. And so that would be good news in terms of access to labor. But it's a bit well-cut. Right now" - Chipotle Mexican Grill (CMG 0.00%↑) CFO John Hartung
But many are expecting the Fed to start slowing rate increases
"...our view is that Fed funds are going to peak sometime in the first quarter of 2023. But the headwinds that we’ve got now are not just going to disappear overnight. We think that it’s going to take into early 2023 to resolve some of that, and we’re still going to have a relatively tough issuance comp in the first quarter." - Moody's (MCO 0.00%↑) CEO Rob Fauber
Could we avoid recession?
"As we have said before, we are not economic forecasters. Clearly, there’s a high risk of a global recession, but we do not have a specific point of view on if, when, or the kind of recession we might have. For internal planning purposes, we are assuming no recession." - Visa (V 0.00%↑) CFO Vasant Prabhu
International
The global economy is softening faster than in the US
"In the third quarter, the global economy softened, especially outside the United States. International and freight forwarding volumes were challenged" - United Parcel Service (UPS 0.00%↑) CEO Carol Tomé
"It's also clear that macro headwinds are likely to continue and potentially worsen in Europe and China. Our base case in this environment remains to prepare for the worst and hope for the best." - The Sherwin-Williams Company (SHW 0.00%↑) CEO John Morikis
"...the market in China has been impacted by lockdown restrictions and weak consumer confidence." - Unilever ($ULVR) CFO Graeme Pitkethly
However, there’s resilience in global consumer spending too
"What I would say about Europe is it obviously a wider range of scenarios because the context is not consistent -- I would tell you that we're not necessarily in any meaningful change in terms of trends across the continent, in terms of how the spending patterns are taking place. The consumer generally -- back to our comment earlier around consumer being resilient and strength in consumer, that's certainly the case." - McDonald's (MCD 0.00%↑) Senior EVP of Strategic Initiatives Kevin Ozan
"I have to say that one of the things that we've really appreciated the most during the quarter was the fact that in spite of this very strong dollar and the difficult FX environment, we have seen very strong performance in many international markets, particularly some very large emerging markets where even in reported currencies, so in U.S. dollars, we're seeing very strong double-digit growth in places like India, Indonesia, Mexico, Vietnam, many places where we've done incredibly well. And obviously, in local currency, those growth rates are even higher." - Apple (AAPL 0.00%↑) CFO Luca Maestri
FX is creating a ~5-point headwind to revenue growth
"Third quarter total sales were $8.6 billion or down 3.6% year-on-year, which included headwinds of 5.1% of $450 million from foreign currency translation" - 3M (MMM 0.00%↑) Chief Financial and Transformation Officer Monish Patolawala
"As I look ahead to guidance for Q4, I think the biggest individual factor is still going to be foreign exchange. This guidance includes 460 basis points of unfavorable impact year-over-year." - Amazon.com (AMZN 0.00%↑) CFO Brian Olsavsky
"FX impacted company results in line with expectations. With the stronger U.S. dollar, FX decreased total company revenue by 5 points." - Microsoft (MSFT 0.00%↑) CFO Amy Hood
There is high potential for growth in Africa
"I just recently took a trip to Nigeria and the Democratic Republic of the Congo. Africa is a place that’s not going to help us in 2023 or 2024 necessarily, Bob. But the last -- we now have offices, I think, in 13 countries there in the last five or six offices we have opened there, opened around the world in Africa." - Visa (V 0.00%↑) CEO Al Kelly
Financials
Corporate debt issuance is down 30% this year
"And as everybody’s aware, during the third quarter, macroeconomic and geopolitical conditions continued to deteriorate. And that further suppressed the global debt issuance markets from the already subdued levels that we have seen in the first half of the year -- We expect that these macroeconomic and geopolitical conditions will continue to mute issuance levels, at least through year-end. And in light of this, we’re updating our guidance for 2022 MIS rated issuance to decline in the mid-30s per cent range." - Moody's (MCO 0.00%↑) CEO Rob Fauber
Companies may have room to take on more leverage
"U.S. corporates are in pretty good shape from a leverage standpoint. When we look at free cash flow to debt, that’s one way to look at it across our rated U.S. corporates. It’s at about 11%. That’s the best that it’s been since 2011. So that, to me, means that corporates still have some room to take on some additional leverage." - Moody's (MCO 0.00%↑) CEO Rob Fauber
People are still paying their phone bills on time
"Bad debt levels look to us consistent with 2019 pre-pandemic levels, and 2019 was one of our best years ever -- So we have seen a creep up from those pandemic levels but only to one of our best years ever -- so far, we're not seeing it in anything outside the norms." - T-Mobile (TMUS 0.00%↑) CEO Mike Sievert
Contactless payments are growing
"The preferential contactless payments that grew over the last 2 years continue. More than half of the in-person switch purchase transactions are now tapped up from approximately 1/3 pre-pandemic. And this trend will be bolstered by the adoption of new technologies such as Tap on Phone." - Mastercard (MA 0.00%↑) CEO Michael Miebach
Consumer
Lower-income consumers are changing spending habits
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Advertisers are pulling back on spending
"On the second quarter earnings call, we noted a pullback in spending by some advertisers in YouTube and Network, and these pullbacks in spending increased in the third quarter." - Alphabet (GOOG 0.00%↑) SVP & Chief Business Officer Phillipp Schindler
“We're certainly in a period right now where we are seeing a slowdown in advertising demand, and that correlates with a lot of things that we're seeing outside of just our sector here, including rising inflation and supply chain issues sort of more broadly across the economy.” - Meta (META 0.00%↑) Incoming CFO Susan Li
The holidays are coming up
"Let me start with the holiday. So we're ready to roll. We've got the best selection we've ever had. Stock levels are really high. Delivery speeds are getting very close to where we want them to be. And we're ready to have a really good holiday season with our consumers this year -- but we're realistic that there are various factors weighing on people's wallets. And we're not quite sure how strong holiday spending will be versus last year." - Amazon.com (AMZN 0.00%↑) CFO Brian Olsavsky
Technology
Facebook’s stock got hammered on news of continued investment in the Metaverse
"I mean, look, I get that a lot of people might disagree with this investment. But from what I can tell, I think that this is going to be a very important thing, and I think it would be a mistake for us to not focus on any of these areas, which I think are going to be fundamentally important to the future. So we're going to try to do this in a way that is responsible and matches the way that the rest of the business is growing over time." - Meta Platforms (META 0.00%↑) CEO Mark Zuckerberg
But most of the investment is in AI and Datacenters
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And, notably, Facebook may be taking share from TikTok
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Meanwhile, Amazon and Alphabet both appear to be slowing investment spend
"You'll see that we've lowered CapEx year-over-year. We probably cut about 1/3 of our budget from what we originally thought for 2022, while still focusing our capital dollars really on the AWS business and increasing customer demand or capacity for increasing customer demand in our stores business." - Amazon.com (AMZN 0.00%↑) CFO Brian Olsavsky
"In the fourth quarter, we expect headcount additions will slow to less than half the number added in Q3. Within this slower headcount growth, next year, we will continue hiring for critical roles, particularly focused on top engineering and technical talent." - Alphabet (GOOG 0.00%↑) CFO Ruth Porat
There are some signs of weakness in cloud computing markets
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PC markets remain slow
"In our consumer business, materially weaker PC demand from September will continue, and impact both Windows OEM and Surface device results even as the Windows installed base and usage grows -- In Devices, revenue should decline approximately 30%, again, roughly in line with the PC market." - Microsoft (MSFT 0.00%↑) CFO Amy Hood
AI is making its way into more applications
"...in AI, we are turning the world's most advanced models into platforms for customers. Earlier this month, we brought the power of DALL-E to Azure OpenAI service, helping customers like Mattel apply the breakthrough image generation model to commercial use cases for the first time." - Microsoft (MSFT 0.00%↑) CEO Satya Nadella
Waymo is coming to Los Angeles
"Briefly on our Other Bets, Waymo announced that Los Angeles will be its third ride-hailing city, joining Phoenix and San Francisco. Waymo will begin by mapping several neighborhoods in LA as it prepares to serve people there." - Alphabet (GOOG 0.00%↑) CEO Sundar Pichai
Spotify is taking on Apple
"We do not want a gatekeeper or a monopoly in the way to dictate how we communicate with our customers. The second part of that is we think that there ought to be payment method choice by this. So really allow us to use whatever payment method we think is the optimal one and that the customer wants to use. And that's important -- short gist of it is Apple keeps putting up roadblocks of just stopping us more and more and more. I think the app was rejected 3 or 4 times at present moment, really despite us having lawyers in the room to make sure we were compliant with this." - Spotify (SPOT 0.00%↑) CEO Daniel Ek
Industrials and Transport
Supply chains are still not normalized
"Significant supply chain issues delayed many new equipment deliveries during the quarter. We continue to work diligently to manage the current supply chain environment." - Kirby (KEX 0.00%↑) CEO David Grzebinski
"Supply chain issues continue to ease gradually, although they remain a challenge and the operating environment remains dynamic. We continue to face persistent inflation pressures, costs increased in the quarter and are well above prior year and pre-pandemic levels." - Timken (TKR 0.00%↑) CEO Richard Kyle
"While year-over-year cost inflation remained very significant in the quarter, we were encouraged by a modest sequential decrease in raw material costs. The industry supply chain also continued to stabilize, though conditions remain tight" - The Sherwin-Williams Company (SHW 0.00%↑) SVP, IR & Corporate Communications Jim Jaye
"Before the pandemic, we can open up a restaurant from the time that we go see a site, we like the site, we start serious negotiation to when we get that restaurant open, it could be a 14- or 15-month period. We're now looking at 20, 21, and 22 months. So I mean it's a significant increase, and it's because of all the factors that I mentioned in my prepared comments. So the biggest challenge we've had is, frankly, supply. I mean, if it's components, for example, for a walk-in cooler or the HVAC, you can't get the restaurant open. There's just no chance of doing that." - Chipotle Mexican Grill (CMG 0.00%↑) CFO John Hartung
Raw materials are also easing but not yet back to pre-pandemic levels
"So we've seen interesting with our raw materials, a lot of the raw materials have really started to come back down, and they're not back down to where they were before the pandemic. But the big spike in increases, we have not seen that recently." - Flexsteel Industries (FLXS 0.00%↑) COO Derek Schmidt
"It does seem like things are getting closer to stable right now. The areas where I would say there is more upward pressure would be in terms of beef, in terms of our cooking oil. I mean that's still significantly affected by the situation going on in Ukraine and Russia because so much of the oil that we use comes from that area. And then tortillas as well is another area that we're concerned about." - Chipotle Mexican Grill (CMG 0.00%↑) CFO John Hartung
Construction and industrial demand appear stable
"...there were relative bright spots with continued strength in professional construction and industrial customer demand, as well as incremental progress unlocking global supply chain constraints." - Stanley Black & Decker (SWK 0.00%↑) CEO Donald Allan, Jnr.
"...we continued to see healthy demand across most of our end markets during the third quarter." - Caterpillar (CAT 0.00%↑) CEO Jim Umpleby
Automotive markets are strong
"Turning to our expectations for the fourth quarter we expect that most of our end markets will decline sequentially, with the exception of the automotive market -- I think that Industrial is probably something we're looking to soften a little bit in 2023. And Automotive at the moment is just -- there's no sign of that. It's very strong. We're in a year where the market size for Automotive" - Texas Instruments (TXN 0.00%↑) Head of IR & VP Dave Dahl
"We saw continued strength in automotive, the softening in consumer electronics." - 3M (MMM 0.00%↑) CEO Mike Roman
UPS is accelerating investment in RFID
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Materials & Energy
Oil companies are posting record results
“We delivered another quarter of strong financial performance with return on capital employed of 25 per cent -- During the third quarter, we continued to make progress by delivering a return on capital employed in the mid-twenties returning more than $5 billion to shareholders for the second quarter in a row And investing to grow both our traditional and new energy businesses” - Chevron (CVX 0.00%↑) Chairman & CEO Mike Wirth
"We are delivering robust results at a time of ongoing volatility in global energy markets -- Today we are announcing a new share buyback programme resulting in an additional $4 billion of distributions, which we expect to complete by our Q4 2022 results announcement. Furthermore, we plan to increase the DPS for the fourth quarter, which will be paid in March 2023, by an expected 15%” - Shell (SHEL 0.00%↑) CEOBen van Beurden
“Our strong third-quarter results reflect the hard work of our people to invest in and build businesses critical to meeting the demand we see today” - ExxonMobil (XOM 0.00%↑) CEO Darren Woods
Oil and gas supply is tight
"Oil and gas supply remains fundamentally tight due to multiple years of underinvestment. This tightness is apparent in historically low inventory levels, production levels well below expectations, and temporary actions such as the largest-ever SPR release. Against tight supply, demand for oil and gas is strong, and we believe it will remain so. While broader market volatility is clear, what we see in our business is a strong and growing demand for equipment and services. There is no immediate solution to balance the world's demand for secure and reliable oil and gas against its limited supply. I believe that only multiple years of increased investment in existing and new sources of production will solve the short supply. The effective solution to short supply is conventional and unconventional, deepwater and shallow water, new and existing developments, and short- and long-cycle barrels. All of it." - Halliburton (HAL 0.00%↑) CEO Jeffrey Miller
“Overall, from a demand perspective, you're obviously seeing a really tight market. We saw in Europe, the building of inventory and how that has driven prices in Europe, building of inventory ahead of the winter. And so structurally, we would say there's going to continue to be a tight market until supply and demand come into equilibrium, right, in that there's only 2 ways that happen, either more supply or reduced demand and supply, especially supply of LNG does take time to bring online. It isn't something that is just a spigot that can be turned on overnight” - ExxonMobil (XOM 0.00%↑) CFO Kathryn Mikells
Real Estate
Higher interest rates are weighing on real estate
"The rise in interest rates over the past 7 months is certainly weighing on real estate driving prices down and reducing sales volumes. The slowdown has been broad-based across property types and geographies. Office vacancy rates continue to climb as companies continue to recover from the pandemic. And a significant number, but a minority of workers continue to work from home. In the third quarter, vacancy rates rose to 12.4%, that's approaching historic highs. Inflation-adjusted rents are well below normal levels and rent growth is at a 10-year low. Net absorption has been negative for 7 of the last 10 quarters. Office vacancy will continue to rise and rents will continue to likely experience negative pressure." - CoStar (CSGP 0.00%↑) CEO Andrew Florance
Housing markets have deteriorated
“While we reported a significant growth in our third-quarter earnings, demand clearly slowed in the period as dramatically higher interest rates created financial and psychological hurdles for potential homebuyers,” said Marshall. “In response to today’s more challenging market conditions, we continue to adjust our sales, construction, and investment practices as we work to turn inventory and balance our housing starts to appropriately match the pace of sales.” - PulteGroup (PHM 0.00%↑) CEO Ryan Marshall
"Mortgage rates are rising to their highest level in years. Combined with double-digit home price gains over the past 2 years, affordability has deteriorated to levels not seen in more than 30 years -- home sales are tumbling & prices are falling" - CoStar (CSGP 0.00%↑) CEO Andrew Florance
Distressed property sales may rise sharply in the next few years
"Generally, once buyer and seller's expectations align again, sales volumes increase and distressed sales grow significantly. Currently, distressed sales rates are at multiyear lows, but believe they will significantly climb in the intermediate term. In 2008, the year of significant economic dislocation, there were only about 2,900 distressed commercial property sales, and distressed sales took years to peak with about 16,000 distressed sales in 2012. Year-to-date, similar to 2008, there's only been about 2,178 distressed sales. I would not be surprised if the number of distressed property sales quadrupled over the next few years," - CoStar (CSGP 0.00%↑) CEO Andrew Florance
Nuggets of Wisdom
Speed is the only competitive advantage in tech
“And the key, again, is the only real competitive advantage, I think, in tech, is to move faster than everyone else. So this is also part of the reason how you should look at our backdrop of investing so much as we have done in this past year because we want to move faster." - Spotify (SPOT 0.00%↑) CEO Daniel Ek