Weekly Investment Update (08/02/2024)
- The Fed and labor market: The emphasis from the Federal Reserve on risks to both sides of its dual mandate can allow for a more dovish reaction as the labor market softens.
- U.S. earnings: Second quarter earnings reports overall strong though mixed.
While economic and financial data are critical elements to consider when evaluating markets, it is important to look past the noise. Friday’s employment report was weaker than expected, prompting a sharp market decline, but it does not suggest a meaningful change in the economic narrative in itself; the labor market was already softening and continues to do so. Prior to this week’s unemployment report, we received fresh readings on both initial and continuing unemployment claims. While volatile, these data series have historically proven to be good leading indicators of the overall direction of the labor market. Both readings, on the surface, were meaningfully weaker than expected. For example, initial claims increased by 14,000 to a total of 249,000 — the highest reading since last August. However, mid to late July is known for seasonal-related volatility associated with education and auto manufacturing retooling. The four-week moving average is likely a cleaner signal, which rose a less concerning 3,000 — it is clear to us that the labor market is softening, but it is important for investors to consider nuances in the data, which are more mixed.
Conversely, S&P 500 company earnings appear quite strong, but further analysis may indicate more softening than appears on the surface. Of the 378 companies in the S&P 500 that have reported, about 79% beat earnings expectations. Only 48% of companies, though, have beaten revenue expectations. Therefore, solid earnings growth is supported by further cost controls (improving margins) while some signs of weaker demand and waning pricing power are impacting sales.
On balance, our analysis supports our view that the economy is growing, while the pace of growth is noticeably slowing. Earnings growth looks stable, but we are monitoring pressure on revenues. Bessemer portfolios continue to favor companies that benefit from powerful secular trends and strong competitive advantages, which we believe will lead to consistent earnings growth over time.
The Federal Reserve Signals a September Rate Cut, Latest Jobs Report Increases This Likelihood
What is happening: This week, the Federal Reserve left interest rates unchanged at the Federal Open Market Committee (FOMC) meeting for the eighth consecutive meeting, while the unemployment rate rose to 4.3%. The opening statement from the Federal Reserve had several dovish tweaks, stressing a focus on risks to both sides of its dual mandate – inflation and maximum employment – a switch from the single acknowledgement of the risks to inflation that we have seen throughout this hiking cycle. Fed Chair Powell struck an even more dovish tone in his press conference, emphasizing that the upside risks to inflation have subsided and a rate cut is on the table in September.
The labor market showed more signs of softening; the U.S. economy added 114k jobs in July, below the 175k expected. The unemployment rate rose to 4.3% from 4.1% in June, driven in part by the increase in the participation rate. Job gains were concentrated, and a few sectors had employment declines. We note that the response rate was weak at 57%, below the average of 71% over the last five years, so this report could be subject to revision.
Why it matters: With the Fed clearly signaling it is evaluating both sides of its dual mandate, the state of the labor market will be pivotal to monetary policy going forward. Powell’s emphasis on the totality of incoming data means that the Fed could cut rates even if inflation does not fall significantly from current levels in the near term.
The chances of a September rate cut appear increasingly likely, and the market is now pricing in four interest rate cuts before year end relative to the Fed’s projection for two interest rate cuts. The weakness in the July jobs report paired with a mosaic of weakening labor market data may prompt the Fed to be more aggressive than initially signaled. Looking forward, we can expect a more dovish reaction function from the Fed, and a 50-basis point cut is on the table for September.
Busy Week for U.S. Company Earnings Shows Pockets of Strength and Some Emerging Weaknesses
What is happening: This week saw almost 40% of the market capitalization of the S&P 500 report second quarter earnings. Overall, revenues have been slightly weaker than expected though margins have remained robust due to careful cost controls, resulting in largely healthy earnings. Differing performances across companies, however, paint a nuanced picture of economic conditions.
Among the “Magnificent 7” companies, Meta emerged as the standout performer, with revenues growing 22% year-on-year to $39 billion, outpacing a 7% increase in costs. Capital expenditure came in $1 billion below expectations of $8 billion, although full-year spend was forecasted to increase by an additional $2 billion to $37 billion-$40 billion. Mark Zuckerberg, the firm’s chief executive officer, stressed that the risks of underinvesting in artificial intelligence (AI) in the near term outweigh those of overspending, a sentiment echoed by Microsoft. The software giant highlighted that approximately half of its capital expenditure this year relates to infrastructure needs, including the building and leasing data centers, news that supported AI semiconductor stocks.
Among consumer companies, Chipotle reported an impressive 18% year-on-year growth in revenues with demand increasing across every income group. In contrast, McDonald’s experienced a different picture with sales falling 1% compared to the previous year, due to reduced spending by lower-end consumers. This bifurcation was mirrored in the luxury goods market. Hermes, the French leather goods maker, saw revenues grow by 13% year-on-year, whereas LVMH saw only 1% growth.
Why it matters: Earnings for the broader market, excluding the "Magnificent 7" stocks, have shown growth for the first time since 2022. Over the next four quarters, consensus expects revenues for the S&P 500 to grow between 5.2% and 6.2% each quarter. This broadening of growth should ultimately help support overall market levels, particularly benefiting some of the smaller-cap and more cyclical stocks. However, it is evident that some companies are struggling to maintain pricing power with consumers substituting purchases, and the weakness that started with the low-end consumer last year has begun to creep up the income spectrum. It is now not only the low-end consumer that is slowing down as consumers across many income levels appear more discerning. However, companies that offer value for their money, such as Chipotle and Costco, are showing they can gain market share.
The Bessemer All Equity Portfolio maintains an underweight to the consumer discretionary and staples sectors and an overweight to the technology sector. Bessemer’s portfolio managers continue to focus on high quality businesses that can capitalize on opportunities offered by artificial intelligence and other secular growth trends.
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