Trade The Journey

Trade The Journey

Is Stagflation developing?


Good Afternoon Traders! I hope everyone is enjoying their weekend and gearing up for the upcoming week. This past week we saw some market fluctuations triggered by major tech earnings, along with the GDP report, and notably the PCE, which is the Federal Reserve’s preferred inflation gauge. The recent CPI report, heavily influenced by shelter costs, has rose for a third consecutive month, diminishing hopes for a rate cut in June.

Just last month, the likelihood of a 25 basis point cut in June was at 63.7%, but has now plummeted to just 10.8%. For the July meeting, the probability of a 25 basis point cut stood at 48.3%, with a 32.5% chance for a 50 basis point reduction. Now, the markets have postponed the anticipated first rate cut to September. This adjustment may need reevaluation as the economy might be weakening more than current data suggests. The initial GDP estimates from last week hinted at potential stagflation, marked by slower growth coupled with rising prices.

Meanwhile, inflation’s rise, alongside a robust economy, suggests that interest rates may remain elevated longer as Treasury yields continue to climb. The two-year yield is nearing 5%, with the ten-year yield encountering resistance at 4.870% and currently sitting at 4.67%. Over the past month, the ten-year yield has swung over forty-three basis points, and within the last three months, it hit a low of 3.87% in early February. The thirty-year yield closed the week at 4.78%, with the yield curve remaining inverted, though it has shown signs of narrowing recently.

Copper prices reached a new high of $4.5875, surpassing a pivot high of $4.57, reflecting a year-long steady uptrend as China displays signs of a patchy recovery. Copper hit $5 back in 2022. Gold has significantly retreated from its highs as geopolitical tensions have lessened, ending the week at $2,349.60. The U.S. dollar is at $106.093 and appears set to climb further, which could make commodities more expensive and has recently dampened their performance.

In global news, China has maintained its one- and five-year rates at 3.45% and 3.95%, respectively. Last week, China reported a 4.3% rise in industrial profits, a noticeable improvement over February but still lower year-over-year, with notable gains in the computer industry and several other sectors. Signs of revival are evident in China’s large cap ETF, which recently surpassed its 200-day SMA as the 50-day SMA looks set to cross the 200-day SMA soon. China remains a leading consumer of copper.

Next week, we await the Caixin and NBS manufacturing and non-manufacturing reports. In Japan, investment in foreign bonds and stocks has weakened over the past month. The Japanese manufacturing PMI edged up to 49.9 in April, indicating a slower contraction pace, while its services PMI continued to expand, reaching 54.6 — the highest this year.

Though there have been discussions of a possible rate hike, the Bank of Japan has kept rates steady at 0.1%. Japan’s CPI has declined year-over-year, ending two consecutive months of rates above 2%. The weakening yen has led markets to anticipate possible currency interventions, with the yen recently hitting $158.327, a peak in recent years, prompting a shift away from the currency. In Europe, prospects for a rate cut by June are growing, but opinions on further reductions remain mixed.

The HCOB manufacturing PMI contracted to 45.6, slightly down from March. While general activity such as new orders and backlogs remain weak, input prices are moderating. The HCOB services PMI continues to rise, hitting a yearly peak as new orders increase and employment reaches a ten-year high. Despite inflation easing, the service sector’s outlook is dimming, even as both manufacturers and service providers report falling input costs.

Earnings

While the market lowered the bar for companies reporting earnings, forward guidance has taken on an increased importance. This week featured a heavy slate of companies reporting earnings but none more important than Big Tech earnings. There have been talks of an AI fueled bubble as the market tries to assess the future profitability and companies return on their investment in Artificial intelligence.

First quarter year-over-year growth in earnings was 3.5% for the S&P 500. 77% of the S&P 500 reported positive earnings surprises, which is in-line with expectations. 60% of the companies that have reported beat revenue forecasts. Company guidance remains largely cautious, however earnings growth over the year is forecasted to increase 10.8%.

Currently, the leaders in earning performance are healthcare, communication services, information technology and consumer staples. So far, 100% of healthcare companies have reported earnings above forecasts and 91% for communications services. Earnings surprises have thus far been seen in consumer discretionary and communication services.

Meta: Beat on Earnings and Revenue Forecasts

Meta Platforms’ Q1 2024 financial results showcased substantial growth, with total revenue reaching $36.5 billion, marking a 27% increase year-over-year, driven by strong performance in their Family of Apps segment. This segment alone accounted for $36.0 billion in revenue, reflecting the same percentage increase. The revenue growth was significantly propelled by advertising revenue, particularly from online commerce, gaming, and media sectors, which amounted to $35.6 billion.

Despite these strong financial outcomes, Meta offered a cautious outlook for the upcoming quarters, highlighting potential challenges related to the regulatory environment in the U.S. and EU, which could materially impact their business operations and financial results. They also noted ongoing legal issues, particularly a lawsuit concerning their use of facial recognition technology that could result in significant financial repercussions.

The company emphasized its ongoing investment in AI and infrastructure, noting that substantial capital would continue to be directed towards these areas, suggesting further increases in capital expenditures to support their ambitious AI developments. This investment is critical as it underpins the company’s strategic focus on enhancing AI functionalities within its platforms, despite acknowledging that revenue generation from these innovations may take time to materialize.

Google: Powered through Earnings and Revenue Forecasts

Alphabet’s financial performance in Q1 2024 was robust, with total revenues reaching $80.5 billion, a 15% increase year-over-year, fueled by strong contributions from Search, YouTube, and Cloud services. Google Search & other advertising grew by 14%, and YouTube ads, saw a 21% increase. The operating margin expanded significantly to 32%, reflecting efficient cost management and strong revenue growth.

Notably, Google Cloud exhibited impressive growth with a 28% increase in revenues, signaling Alphabet’s deepening commitment to infrastructure and AI capabilities, which are key drivers of its Cloud and Search innovations. Despite the financial successes, Alphabet maintains a cautious outlook primarily due to ongoing global macroeconomic uncertainties and potential regulatory changes that could impact operations, particularly in their advertising and Cloud segments.

 The company also continues to make significant investments in AI and infrastructure, which, while necessary for long-term growth, could affect short-term profitability. These factors contribute to a guarded guidance as the company navigates potential challenges while striving to capitalize on its strong market position and technological advancements.

Microsoft: Beat on earnings and revenue forecasts

Microsoft’s Q3 FY24 performance showcased substantial financial achievements, predominantly driven by the expansive growth of its cloud sector, notably Microsoft Cloud, which surged to $35 billion in revenue, reflecting a 23% increase. The firm’s strategic advancements in AI technologies, specifically through offerings like Azure AI and GitHub Copilot, have markedly enhanced productivity and development capabilities, illustrating Microsoft’s commitment to integrating AI across its services.

 The success in these sectors not only underscores Microsoft’s operational efficiency but also highlights its ability to scale and innovate within the competitive tech landscape. Despite the positive financial turnout, Microsoft maintains a cautious outlook, considering the unpredictable macroeconomic environment and ongoing investments in AI and cloud infrastructure, which could impact short-term profitability. The guidance for upcoming quarters suggests continued investments in technological advancements, particularly AI, which is expected to drive future growth.

Economic Data Week Ahead:

Tuesday: Employee Cost Index, House Price Index

Wednesday: MBA weekly Index, JOLTS – Jobs Openings, ISM Manufacturing, ADP Private Employment

Thursday: Factory Orders, Initial Claims, Challenger Job Cuts

Friday: Employment Situation Report, ISM Nonmanufacturing

Economic Data Insights

The week started with housing, building permits and housing starts which showed building permits falling 4.3% in March. Permits are 1.5% above the level measured a year ago. Single-family permits fell 5.3%. Over the past year, permits are up 17.4%. For multi-units, permits fell 10.3% and have been flat over the past year.

Housing starts also fell, 4.3% below February levels. Single-family starts fell 12.4% but are up 21.2% over the past year. Mult-unit starts fell 20.8% over the past month and 43.7% over the past year. Single-family units under construction rose 0.3% this past month but are down 2.7% over the past year. Mult-units under construction fell 1.8% this past month and 1.6% over the past year. Completions fell for both single and multi-family units, only positive over the past year.

Clearly, higher rates are constraining builders and dissuading homeowners from moving or taking on a new mortgage. Housing prices are also much higher. The MBA weekly applications index showed that mortgage application volume fell 2.7% from the week prior. The refinance index fell 6% and the purchase index declined by 1%. The average rate for a thirty-year fixed conforming loan rose eleven basis points to its highest level at 7.24%. The average rate for a thirty-year fixed jumbo loan rose five basis points to 7.45%.

In March 2024, sales of new single-family houses in the U.S. increased 8.8%  from the revised February rate of 637,000 and an 8.3% increase from March 2023’s estimate of 640,000. This growth in sales highlights a positive trend in the housing market, indicating continued buyer interest and market recovery.

The median sales price for new houses sold in March 2024 was $430,700, with the average sales price higher at $524,800. At the end of March, the seasonally adjusted estimate of new houses for sale was 477,000, translating to an 8.3-month supply at the current sales rate. This level of inventory suggests a relatively balanced market that leans slightly towards buyers, with sufficient supply to meet demand without significant shortages or excesses.

The March durable goods report showed total shipments of durable goods remained relatively stable with a marginal increase, indicating a steady demand within the industry. New orders for durable goods saw a more notable rise, suggesting an anticipation of increased manufacturing activity. The transportation equipment sector, notably including nondefense aircraft and parts, showed significant activity with a 15.1% increase in unfilled orders year-over-year, underscoring a robust demand in this area.

This might be indicative of rising investments in aerospace technologies and recovery in global transportation logistics. Similarly, the inventory levels in this sector increased, possibly reflecting a build-up in anticipation of continued market growth.

On the technological front, the computer and electronic products sector displayed growth in shipments and new orders, suggesting a sustained demand for technology solutions in both consumer and industrial markets. Specifically, computers and related products saw a notable uptick in shipments and new orders, highlighting the industry’s ongoing expansion and the integral role of technology in modern economies. Other sectors such as machinery and fabricated metal products showed more moderate changes, with machinery experiencing slight declines in unfilled orders, hinting at a balancing act between production and demand. In contrast, the primary metals sector remained relatively stable, indicating a steady demand for foundational industrial materials, essential for various manufacturing processes across different sectors.

In the first quarter of 2024, the U.S. real GDP grew at an annual rate of 1.6%, a slowdown from the 3.4% growth observed in the fourth quarter of 2023. This “advance” estimate, which is based on initial data that may be revised, shows a notable deceleration in economic growth. The PCE price index increased by 3.4%, compared with a 1.8% increase in the fourth quarter of 2023. When excluding food and energy, the core PCE price index—which is often seen as a more stable measure of inflation—increased even more sharply, by 3.7%, up from a 2.0% increase in the previous quarter.

The increase in GDP for the first quarter was driven mainly by higher consumer spending, residential and nonresidential fixed investment, and increased state and local government spending. These positive contributions were partially offset by a decline in private inventory investment and a rise in imports, which negatively impacted GDP calculations.

 Additionally, the deceleration in GDP growth compared to the previous quarter was influenced by slower increases in consumer spending and exports, a downturn in federal government spending, and an acceleration in imports, despite an uptick in residential fixed investment. The overall economic context is further elaborated with a 4.8% rise in current-dollar GDP, reaching $28.28 trillion, and increases in various price indexes, indicating inflationary pressures, particularly in consumer prices excluding food and energy.

The U.S. saw notable financial trends with a 0.5% increase in both personal income and disposable personal income. Personal consumption expenditures (PCE) rose by 0.8%, reflecting increased consumer spending, particularly in services and goods. Notably, spending on healthcare and housing utilities significantly contributed to the rise in services, while spending on gasoline and other energy goods drove the increase in goods. This dynamic indicates a healthy consumer sector possibly rebounding or reacting to broader economic conditions.

The PCE price index rose by 0.3% in the same month, signaling mild inflationary pressures. Excluding food and energy, the core PCE price index also increased by 0.3%, suggesting stable underlying inflation. Annually, the PCE price index escalated to 2.7%, with services prices rising notably by 4.0% from the previous year, which might indicate sector-specific pressures.

Technical Story

This Past week in Review:

This past week went well although there were some minor discretionary purchases. I mostly remained in-line with my expenditure forecasts for the week. I’m continuing to make progress on decreasing my credit card balance and my increased credit rating has reflected my efforts. I hope to continue making progress towards my goals this upcoming week.

Grade: C+

Reason: Some Improvement

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