Summary
- With the Ides of March over, investors are pondering the implications of last week’s hot inflation prints and another runup in Treasury yields.
- Our take is that equities stay in a narrow range until either inflation cools or the economy/employment slows, giving the Federal Reserve (Fed) cover to cut rates.
- Oracle Corp. caught a wave while another one knocked Adobe Inc. down. Together they illustrate how any explosive growth of the AI ecosystem requires having the necessary infrastructure in place.
- Only 13 companies report this week, but they could signal whether demand for commodity memory chips has bottomed yet (Micron Technology), and whether people are buying sporty wear to go with sports activities (LuluLemon and Nike).
Market Implications
- Stay long equities but be patient.
What We Learned Last Week
‘Beware the Ides of March’ was the beginning of the end for Julius Caesar.
With the 2024 edition of the Ides of March over, we amend those words to ‘Beware the aftermath of the Ides of March.’
Last week’s hotter-than-expected inflation prints and 20bp runup in the 10-yr Treasury yield (to 4.3%) notified markets again that the hoped-for rate cuts could come later not sooner. The Fed will almost surely confirm that message during its meeting this week.
Equities will struggle to rally much until investors form a firmer view about when the Fed will cut rates. As long as the economy and employment remain strong, we expect equities to trade in a narrow range until inflation cools further (Chart 1). If either start weakening, recession concerns will resurface and equities will sell off unless the Fed shows it will adjust policy to maintain the recovery.
Latest Earnings Test Our Theses
The latest batch of earnings confirmed and challenged our theses about AI and the retail sector.
AI Boom? We see many companies that hyped their AI-related potential have cut their 2024 outlooks, realising the hoped-for growth will come more slowly than expected. Adobe Inc. (ADBE) was the latest to run afoul of this trend. After rallying 75% in 2023, ADBE stock sold off 14% last week on concerns it will be unable to incorporate AI features into its creative suite quick enough to hold off emerging competitors (Chart 2).
On the other hand, Oracle Corp. (ORCL) stock jumped 12% when it announced strong growth in its cloud computing and infrastructure services, mostly due to companies trying to position themselves to leverage AI technology. ORCL said it could not increase capacity fast enough to meet demand.
Therein lies the problem for much if not most of the AI ecosystem – the necessary hardware, software, human expertise, useful apps, and other infrastructure needed to be in place yesterday (figuratively speaking) for most of those initial projections to pan out. Instead, it is only beginning to get put in place.
ORCL has stumbled at every earnings season over the past year because its cloud strategy never seemed to take off as advertised (Chart 2). It may stumble again if it falls behind schedule in building out new capacity.
We are likely to continue seeing this rally-and-stumble pattern repeatedly across many companies over the next year until the AI infrastructure buildout reaches critical mass.
Other Tech Is Soft – Many other tech companies less plugged into the AI ecosystem have reported soft outlooks too. The latest were communications network company Ciena Corp. (CIEN) and electronics contract manufacturer Jabil Inc. (JBL). Many of these companies report their customers are still working off inventory or have slowed their CAPEX plans. Reading between the lines, it appears many companies are shifting CAPEX dollars to AI-related projects and away from other technical needs.
The implication is that the broader economy is unlikely to get a meaningful boost from CAPEX spending unless overall CAPEX increases.
Discount Retail Is Hurting – Our other thesis has been that discount retailers are doing much better than full price counterparts as consumers offset inflation by bargain-hunting. Dollar Tree (DLTR) missing on earnings and announcing plans to close about 1000 stores tests that thesis. DLTR serves a lower income clientele struggling to keep up with inflation. Apart from cutting back, they have increasingly shoplifted in quantities sufficient to hurt performance.
Dollar General (DG), another discounter serving lower income people, also reported much higher shoplifting, and is consequently phasing out self-checkout at main stores. But its business is on firmer ground and plans to open 800 more stores in coming years.
Many other discount retailers have benefited from an influx of higher income customers. But that boost is limited. Discounters catering mostly to lower income people face challenges like full price retailers. Given that these people have nowhere else to go, it is a stark indication that they are under enormous financial pressure despite super-full employment and a healthy economy.
That is negative for retailers that serve this segment – but also has potential implications for the US presidential election campaigns in coming months.
The Week Ahead
Only 13 companies report this week. But that makes it easy to focus on the bellwethers. In tech, will Micron Technology (MU), the leader in signalling pain in the commodity memory chip business, signal that the bottom has been reached?
Dick’s Sporting Goods (DKS) reported a large beat and an above consensus outlook last week. Investors in Lululemon Athletic (LULU) and Nike Inc. (NKE) will hope people are buying sporty wear to go with sports gear.
And FedEx (FDX) provides colour on how goods are moving around the country and globe.
Some key reports this week:
Wednesday
- General Mills Inc. (GIS)
- Micron Technology (MU)
- Ollie’s Bargain Outlet (OLLI)
Thursday
- Darden Restaurant (DRI)
- FedEx Corp. (FDX)
- Lululemon Athletic (LULU)
- Nike Inc. (NKE)
