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Hi Everyone 👋,

We had an action-packed week as Wall Street starts heading out for summer.

The Fed raised 25bps (as expected), and JPOW dropped a BOMB:

“Given the resilience of the economy recently [Fed staffers] are no longer forecasting a recession.” - Jerome Powell

We also had Megacap Tech enter earnings with mixed reactions. Markets are squaring off fundamentals with YTD performance.

Who will win this tug-of-war? Interest rates or Tech?

So far, it’s looked like a team of sumo wrestlers (Tech) vs. kindergarteners (Rates).

Can the dominance continue?

This week, in <5 minutes, we’ll cover Tech earnings and the FOMC meeting:

• The Setup 👉 Tug of War

• Earnings 👉 Meta, Microsoft, Google

• FOMC Meeting 👉 JPOW Brought the Fireworks

Let’s get started!

1. The Setup 👉 Tug of War

Tech kept beating rates last week and extended its astounding YTD rally. Everyone seems to have forgotten that Tech wasn’t supposed to do well in higher-rate environments.

Oh well?

The proper way to think about this, though, is expectations. Every economist knows how expectations shape consumer behavior and is a wildcard in econometric models. Expectations matter for markets because they are real-time pricing mechanisms.

When everyone expected rates to taper off, it became a time to return to Tech stocks. Yes, this has been fueled by AI hype, but cooling inflation and the hope of lower rates are vital pieces of the puzzle.

Investors are also paid to comb through earnings and assess how those earnings compare to the market's expectations for performance. Surprises to the upside make stocks go up, and disappointments make them go down.

All a game of expectations.

When it comes to Tech, this earnings period is pivotal. The market is trying to reconcile expectations against the cyclical nature of IT spending. A kiss of death for any growth stock is not negative revenue growth. It is a deceleration in revenue in ways that don’t align with expectations.

Investors are starting to ask themselves, when is it safe to fully return to the table on these names? Many concluded that January this year was the time, but can fundamentals improve to match sentiment now that multiples are stretched?

2. Earnings 👉 Meta, Microsoft, Google

Microsoft

Microsoft’s results were in the “good, but not good enough” category.

While Intelligent Cloud, Personal Computing, and Productivity & Business Processes businesses beat, guidance fell short of expectations. They missed revenue estimates by 1.1% and only met 25.5% YoY cc Azure growth estimates.

Microsoft was at the center of the AI hype, given its investment in OpenAI. You must deliver on your guide when the bar is this high. The stock sold off despite solid revenue and profitability (35.8% net income margins!).

A lot of focus across Big Tech has been declared in the cloud. Cloud is the infrastructure on which most software is built. If you’re thinking about how demand for software is doing, cloud revenue amongst the majors (Azure, GCP, and AWS) is usually a solid macro indicator. Deceleration is inevitable due to the law of large numbers, but investors were left wanting more.

Key Graphic:

By the numbers:

• Revenue of $56.2B was up 10% YoY cc, with the intelligent cloud solution growing 14.89% YoY, while the PC segment fell 3% YoY.

• $224B in CRPO (think of this as bookings) rose 18.5% Y/Y.

• OpEx increased 2% YoY but would have been flat without a payment to the Irish Data Protection Commission.

• GAAP EBIT was strong at 43.2%, and Net Income margin was 35.8%.

Meta

Meta issued a textbook, “Beat and Raise”. It topped revenue estimates by 3% and guidance by 4.1%. Ad demand is recovering. Platform engagement is also trending in the right direction. Monthly active users totaled 3.88 B, and daily active users topped 3.1B.

That means 38% of the global population is on one of Meta’s apps daily. Don’t forget that Facebook is blocked in China, which has a population of 1.4 Billion.

With Meta, the core products are turning around, and a new roadmap with Threads, Reels, Llama 2, and other AI products is showing great traction. Unfortunately, that’s not true for Reality Labs and the Quest, but we’ll look past that now.

Key Graphic:

By the numbers:

• Revenue of $32B represented an 11.1% YoY increase, the strongest YoY growth figure since Q421. This figure beat estimates by 3%, and guidance also beat by 4.1%.

• Strong ad demand came from China retail exports, Gaming, Entertainment & Media, and CPG.

• Overall costs rose 10% YoY to $22.6B. Without restructuring and legal charges, operating costs YoY would have fallen by 2.4%.

• Meta’s $2.91 GAAP EPS beat estimates by $0.07, and they beat FCF estimates by 78%.

• Reality Labs has lost more than $21B since the start of last year.

Google

An easy way to avoid missing guidance is by not providing it. Google followed that tune from Meta and reported revenue that was 2.5% above estimates. The company is in strict cost management mode and has significantly slowed hiring. Both the top and bottom lines looked strong.

Google saw similar dynamics as Meta. Ad spending continues to improve on Search and YouTube. Revenue growth outpaced cost growth, and investors clapped for the operating leverage.

It looks like the initial panic from the existential threat of ChatGPT has dissipated for now. Google makes a point of reminding everyone how long they’ve been working on AI to make investors feel they shouldn’t be worried.

Chalk up another win for internet-based ad companies vs. back-end software.

Key Graphic:

By the numbers:

• Total revenue of $74.6B beat estimates by 2.5%, growing 7.2% YoY.

• Search and YouTube ads grew 4.7% and 4.4%, respectively, YoY, while Google Cloud grew 27%.

• GAAP EBIT margin of 29.3%, with the dollar figure 9.4% ahead of estimates.

• YouTube shorts MAUs up to 2B vs. 1.5B last year.

Summary

Microsoft and Google executives mentioned some form of AI 145 times across the two calls.

The ad tech companies are using AI to improve targeting metrics, providing a much-needed boost to advertisers following Apple’s extremely restrictive privacy tracking policy. Software builders are also using these tools for productivity applications and to bolster the revenue potential of their product portfolios.

While AI generates a lot of sizzle, operating margins are putting food on the table. You have to drive bottom-line profitability to fund other growth initiatives, and each of these giants is doing this in spades.

3. FOMC Meeting 👉 JPOW Brought the Fireworks

Every month or so, we watch a guy with thick-rimmed glasses whip around $46 trillion. I’m referring to JPOW and the total market cap of US Stocks.

The Fed followed through this week and raised rates 25bps. Interest rates are now in the 5.25%—5.50% range.

This is the first time since January 2001 that rates have been this high! Non-transitory runaway inflation forced the Fed’s hand, but things are finally under control.

The most recent CPI reading was 3.0%, down from a peak of 9.1% in June 2022. The numbers are finally trending in the right direction.

The FOMC meeting on Wednesday brought little in terms of the strikethrough comparison, with not a lot of red/blue ink:

Outside of the hike, the only information we could glean from the released statements is that economic activity growth has been upgraded from modest to moderate.

Aren’t those the same thing?

Anyways, the fireworks came when JPOW dropped the no-recession BOMB statement. Here it is in its beauty:

"The staff [economists from the central bank] now has a noticeable slowdown in growth starting later this year in the forecast, but given the resilience of the economy recently, they are no longer forecasting a recession... My base case is that we will be able to achieve inflation moving back to our target without the kind of really significant downturn that results in high levels of job losses that we've seen in some past, many past instances... The Federal Funds Rate is at a restrictive level now, so if we see inflation coming down, credibly, sustainably, then we don't need to be at a restrictive level anymore... You'd stop raising [rates] long before you got to 2% inflation and you'd start cutting before you got to 2% inflation, too."

More Fed committee members are starting to read Jan Hatzius’ reports.

Does anyone sense that the Fed is trying to get ahead of not being “behind the ball” on disinflation? Just a hunch.

We don’t have another meeting until September 20th, which should give committee members plenty of time to visit Barbenheimer over the summer.

Between now and then, the market will be glued to two CPI readings (Aug 10, Sep 13) and two Payroll releases (Aug 4, Sep 1).

One of JPOW’s favorite inflation indicators hit the tape on Thursday: PCE.

Core PCE came in at 3.8% QoQ, below estimates of 4.0%, and the last reading of 4.9%.

Lastly, there’s GDP! GDP annualized QoQ came in at 2.4% vs. expectations of 1.8%. Is growth back?

Wrapping Up…

We’re not out of the earnings woods yet, with Amazon and Apple to report. Will the operating leverage bonanza continue?

Inflationary readings and messaging at Jackson Hole are more important for market direction. The next month is a skip month for the Fed.

In a market rally dominated by multiple expansions, sentiment matters most.

Moderating inflation, a return to growth, no recession, and dovish Fed messaging could paint a strong bull case.

The Bears are calling rate cut hopes overblown.

Choose your animal spirit wisely.

Until next time. Always Yours. Incessantly Chasing ROI.

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