Things have changed so much from 2021. The era of cheap money is over. We are now in a world-wide tightening cycle. It is squeezing the air out of asset prices. Global supply chain strains, combined with China’s strict Covid restrictions and the war in Ukraine have added to the already increasing costs for consumers and businesses alike. Russia is upping its war rhetoric, sounding the alarm for a potential nuclear war. That can’t be good for anyone or anything, especially growth assets. That’s the challenging backdrop for today.
This week was the heart of Earnings Season. It’s a refreshing period where facts can outweigh emotion. It’s not always the case as there are times, like now, where global issues can weigh heavy on economic and emotional activities. 2022 is that kind of year. But logic and facts need to stay in focus. There’s a great deal of emotion and uncertainty right now. As my favorite philosopher Yogi Berra reminds me time and again, “the future ain’t what it used to be.” We investors need to stay nimble and control what we can control. There’s so much that we can’t. We take what the Market gives us, with eyes beyond the now. We invest for a better tomorrow.
The thing about earnings is, what is reported is already in the rearview mirror. Stocks have a discounting mechanism. The Market prices things in anticipation of what’s ahead. It’s not based on good or bad. It’s all about better or worse. Wall Street runs on expectations. So far, the message from Corporate America is a strong reopening demand from consumers, particularly around travel and dining out. But inflation is eating away at those Dollars in their pocket. More money is being sucked out at the grocery store and the gas pump. Those are Dollars taken away from other activities that fuel America’s Economy. That’s a problem that is driving head-on into our nation’s finances, its social engagements, and its politics. It’s a problem on Main Street.
The intersection of Main Street and Wall Street is highly trafficked. It’s Corporate America’s zip code. What happens on Main Street drives Wall Street and vice versa. This week, 160 companies in the S&P 500 reported quarterly results. That is 1/3 of the components accounting for half the overall value of the US Stock Market. Apple, Amazon, Microsoft and Google were among them. These are the 4 largest companies in Corporate America, by a long shot. They account for roughly 1/4 of the S&P alone. They’re the Tech Titans. They’re the Stock Market Generals. It’s an understatement to say they matter. They matter.
Microsoft reported a double-beat, with earnings up 13.8% and revenue up 18.5% year-over-year. That beat the Street estimates for their fiscal third quarter, driven by cloud-related sales rising 32% from a year ago. CEO Satya Nadella said something very interesting and significant on the conference call: “Our digital technology will be the key input that fuels the world’s digital output. In an inflationary environment, the only deflationary thing is software. I don’t hear businesses looking to their IT budgets for cuts.” That’s important. Evidence of that was found in Microsoft’s Azure cloud business. Revenue grew 49% from a year ago and the number of deals worth at least $100 Million more than doubled during the quarter. It wasn’t the 50+% growth from previous quarters, but Azure grew faster than last quarter. This is stellar growth nonetheless. Microsoft keeps executing in a tough environment.
Google parent Alphabet reported Q1 numbers that missed expectations. But all things considered, they were still really solid. Revenues rose 23% overall to $68 Billion on the back of strong results in Google’s Search and Cloud businesses. The miss came from its YouTube platform where growth fell short of estimates. Advertising revenue on YouTube grew 14% which missed the 25% estimate. Companies have been cutting back on advertising with the macro uncertainties ahead. Even Google is not immune. But that isn’t stopping the company from seizing opportunities. “We’ll keep investing in great products and services, and creating opportunities for partners and local communities around the world,” CEO Sundar Pichai said. The company believes in itself and the future ahead and is putting its money where its mouth is. Alphabet is buying back an additional $70 Billion worth of Google stock. That’s a big buyer in the open market.
Apple also reported a double-beat. It was another impressive quarter for the iPhone maker, with revenues coming in over $97 Billion and earnings of $1.52 per share. The Street expected $94 Billion and $1.42. This was the third-highest revenue report in company history, which is saying a lot. iPhones account for over half the company’s revenue at $50 Billion. CEO Tim Cook is a master operator and has effectively navigated through supply chain challenges that put Apple in a better place than its competitors. China plays a huge role in Apple’s success. Over 80% of its products are assembled in China and 20% of its revenue comes from there too. The lockdowns have been a major issue, slowing production and demand. The company is executing in this tough environment. It’s really quite impressive. Apple also raised its dividend and announced an increase to its stock buyback program by $90 Billion. I repeat, $90 Billion. Apple could buy out all of Starbucks or 2 Twitters with that. It’s a really big number.
Amazon reported a very solid quarter, but it wasn’t enough to excite the Street. Revenues of $116 Billion beat estimates, but only slightly. The company failed to turn a profit in the quarter for the first time since 2015. That will be a headline. But that was mostly due to a markdown on its Rivian stock ownership. Rivian is the electric truck company in which Amazon is heavily invested. The core business of Amazon is chugging along just fine. Its cloud business, known as Amazon Web Services (AWS), grew revenues by 37%. Corporate America continues to aggressively invest in an increasing digital presence, which the pandemic accelerated the necessity of mobile access. AWS is a big player there, along with Microsoft and Google. Its consumer retail business is strong and pervasive but is feeling the pinch of inflation. It was also inevitable that the surging growth the company experienced the last 2 years during the pandemic would trail off as Americans left their homes and were out and about. America still buys on Amazon, and there’s no sign of that stopping.
The Market is more focused on risk. Slowing growth and rising prices are the biggies. In this risk-off environment, Tech stocks continue to struggle. The corrective price action has been directed squarely at Growth. It’s a process. The Tech Titans keep plugging along and don’t manage their businesses quarter-to-quarter. They’re doing what they need to do to survive and then thrive. Strong management teams seize opportunities and look beyond the now. Their stocks have felt the pain. It’s part of the cycle. Quality companies; Bad environment. Stocks are for sale. These periods are about survival. It’s happening.
Low Tech is working now. Coca-Cola reported an impressive quarter, showing the company can deliver despite the global adversity. The company reported 18% organic revenue growth in Q1. Case volume grew an impressive 8%. Coke is a big beneficiary of the reopening after the lockdown crushed consumption at restaurants, movie theaters, concerts and sporting events. Importantly, Coca-Cola raised its dividend for the 60th consecutive year. It’s one of the crowning members of the Dividend Aristocrats. Dividend hikes are a seemingly sleepy yet very attractive way to grow your money. Coke is one of those Boring Blue Chips that can play an important job in a portfolio: Stability and predictability.
The war in Ukraine is still a major issue. Moscow cut off key gas supplies to Poland and Bulgaria, threatening to do the same for other “unfriendly nations” that refuse to pay for fuel in Russian Rubles. That triggered more stagflationary dangers for Europe, though flows to Germany continue regular way. Why Poland and Bulgaria, you might ask? The two nations represent the weakest spots in Eastern Europe that are the first to receive gas as it flows into Europe. Poland has been one of the most critical nations of Russia in the Western alliance and has been one of the biggest supporters of Ukraine in terms of refugee intake, military support and weapons transfers. That has angered Vladimir Putin.
Cutting off energy to Europe is the biggest economic weapon that Putin has. The Kremlin wants to inject economic pain and get Western nations to think twice about helping Ukraine. The thing is, this hurts Russia too, sorely in need of revenue to pay for their war and support its economy. European countries already outlined intentions to reduce dependency on Russian energy and efforts are currently underway on steps to restrict oil imports from Russia. Divisions within the European Union have complicated those efforts. Germany is the biggest and most influential consumer of Russian gas. However, German Economy Minister Habeck said this week that a full embargo would be “manageable,” potentially setting the stage for an EU-wide ban. That would be massive. Efforts are now accelerating to replace Russian energy with new sources. That would come in the form of Liquified Natural Gas (LNG) imported from the United States and the Middle East. Gas can also be piped in from Norway and North Africa. High energy prices have been stressing out the European economies causing huge inflation. Something’s got to give.
The US Economy shrunk for the first time since the Covid Crash. That wasn’t expected. Gross Domestic Product (GDP) declined by 1.4% decline in Q1. Slow growth was expected, to the tune of 1.1%; Definitely not no growth. The US Economy came to a screeching halt following the torrid Q4 6.9% pace. The decline had a lot to do with a reduction in private inventory investment. That accounted for things like cars and other manufactured goods. That was highly anticipated after Americans scrambled to buy stuff early on during the pandemic. Remember the used car rush? It’s coming to an end. Importantly, personal consumption increased at a 2.7% annual pace. Today, people are buying less stuff and spending their money on travel, events and services. The trade deficit increased. Exports fell. Government spending did too. With high inflation and slowing growth, the Fed has its hands full. The May meeting is next week. A ½ point hike has been priced in. A ¾ point hike can’t be ruled out. Inflation is still running hot. The Fed needs to get ahead of the curve, and fast.
Earnings Season has come in largely expected, with some beats and some misses. With this Market, it’s still all about the Fed. The switch from cheap money to aggressive tightening has created some serious turbulence and recalibration for the Market. The Tech-heavy NASDAQ has now declined 20% from its highs, officially in Bear Market territory. All of its 2021 gains have been erased. In addition, China Covid lockdowns and the Russian invasion of Ukraine is exacerbating concerns about global growth and supply chain strains. The Dollar has gone parabolic in 2022, increasing pretty much every day in April. It is now at its highest level in 2 decades. The super-strong Dollar is playing into tighter financial conditions. That is weighing heavy on stocks too. But resolution could be near. The strong Dollar could also start to weigh on commodities, driving prices lower. They have to stop going up first. Peak inflation could be close. Recent data reported indicates it’s not here yet.
The Market remains extremely volatile with 2+% daily moves the past few days. It’s become the norm to an extent. This is what happens when the VIX (volatility index) hits 30+. Liquidity dries up and the Market can swing wildly both up and down, but inevitably it remains a downward bias until volatility cools. It’s a process.
Yogi might be right, the future might not be what it used to be. But history proves it pays to keep the faith. To quote another famous New Yorker, Billy Joel, “the good ole days weren’t always good and tomorrow ain’t as bad as it seems.” We continue to navigate through the choppiness and are hanging in ok.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
