Barron’s Weekend Summary: The Federal Reserve is unlikely to lower interest rates in 2024
Cover:
-The Federal Reserve is unlikely to lower interest rates in 2024 due to elevated inflation, a resilient economy, and a softening labor market. This is because these conditions are expected to persist through year end. Despite an inflation scare earlier in the year, the rate of price growth continues to move slowly towards the Fed's 2% annual target, allowing the central bank to keep its federal-funds rate target in the range of 5.25% to 5.50%, where it has been since July 2023. The Fed's policy stance is higher for longer than anticipated, as the U.S. economy has been stronger for longer than anticipated. Investors were banking on at least six interest-rate cuts totaling 1.5 percentage points over the next 12 months, based on pricing in the interest-rates futures market. However, the data has not complied with either forecast, and inflation remains uncomfortably stuck at nearly 3%, above the Fed's annual target.
Interview:
-The Eurozone economy is improving, inflation is cooling, and the European Central Bank is expected to cut interest rates by a quarter of a percentage point this month, beating the Federal Reserve. James Rossiter, head of global macro strategy at TD Securities, believes that the economy has diversified its growth drivers and is expected to have a soft landing. Rossiter, who has worked at the Bank of Canada, the Bank of England, and the ECB, contributed the opening essay in TD Cowen's annual European Best Ideas report, highlighting four themes likely to play out in Europe for the rest of the year: macroeconomics will remain a key driver of markets, growth is likely to rebound, integration has made the region more robust to external shocks, and US elections are a bigger issue for Europe than the electoral contests in its own backyard. TD's top 26 stocks include ASML Holding, Booking Holdings, LVMH Moët Hennessey Louis Vuitton, Novo Nordisk, and Universal Music Group, all either listed in Europe, headquartered there, or heavily dependent on the region as an end market.
Tech Trader:
-China has launched a $48B fund to build a world-beating semiconductor industry, surrounded Taiwan in a military war game. Semiconductor investor Paul "Chip" Schorr warns that if China were to take over Taiwan, advanced servers based on Nvidia chips would not be as popular. Schorr has secured $120M from the US Commerce Department to expand Polar Semiconductor's factory in Minnesota, which makes power management chips for auto and aerospace customers. The federal contribution is part of the $53B aimed at returning chip production to American shores under the Biden Administration's Chips and Science Act. The Chips Act money helps US factories match China's cost profile. More than 90% of leading-edge processor chips are made in Taiwan by firms like Taiwan Semiconductor Manufacturing, and nearly all memory and logic chips that accelerate artificial intelligence are fabricated there, in Korea, or Japan.
The Trader:
-Travel stocks experienced turbulence this week, with American Airlines Group lowering earnings guidance, causing shares of other airlines to slide. Airbnb, however, remained relatively unscathed, falling 0.2%. Shares are down 8% since May 8, when the company reported first-quarter earnings. The problem was that the stock had already risen double digits for the year coming into earnings, reflecting heavy optimism as the company guided for a second-quarter deceleration of sales growth to 9%, or $2.71B. The fact that Airbnb shares barely moved could be a sign that its recent troubles have passed. Wedbush Securities analyst Scott Devitt upgraded the stock to Outperform from Neutral, predicting sales growth to reaccelerate during the third quarter and a strong consumer spending backlog that should materialize over the summer.
-Investors have been overly optimistic about the stock market, with bulls outnumbering bears and Wall Street strategists raising price targets. The S&P 500 index has gained 26% since October's bottoming. However, Renaissance Macro Research's Jeff deGraaf suggests that markets can become too optimistic, with a recent survey putting the number of bulls at 60%, even though the S&P 500 had risen about 5% over the previous 13 weeks. This could lead to returns being below average when bulls are excessive to historical returns. Fund managers, who have just 4% of their portfolios in cash, are of particular concern, as anything below 4% is a sell signal. This hesitation could leave stocks with a dearth of buyers and put them in a vulnerable spot. Weakness is already creeping in, with the S&P 500 on pace to drop 1.2% this past week.
Features:
- US retailers have experienced a volatile season of earnings reports, with investors giving outsized stock gains to companies that beat expectations and pummeling the shares of others that disappointed. This volatility is partly due to a broader shift in investor strategy, which was successful in the years following the Covid-19 pandemic. However, now that consumer trends have normalized, chasing specific trends isn't enough to give stocks a lift. The industry's fiscal first-quarter earnings season highlights that it's a stock picker's market, and company execution matters. For example, Abercrombie & Fitch's shares soared 24% after reporting earnings, while American Eagle Outfitters fell close to 8%. Consumers are being more selective about what and where they buy, and companies with strong brand momentum have kept shoppers engaged and saw stock gains after reporting results. The macroeconomic environment played a role in crowning the season's winners, with big-box retailers such as Walmart and Costco Wholesale showing signs of gaining more market share in the latest quarter.
-Trump Media & Technology Group stock closed lower on Friday after former President Donald Trump was found guilty in a hush-money trial. Trump criticized the verdict earlier in the day, stating that it should never happen to other presidents and that there was nothing illegal. Trump was convicted of falsifying New York business records and attempting to influence the 2016 presidential election by paying off actress Stormy Daniels, who alleged an affair with Trump. The 12-person jury convicted Trump on all 34 counts after deliberating for two days. Trump's nearly 115M shares in Trump Media were valued at around $5.9B, with a net loss of $58.2M in 2023. Trump Media's trading is largely disconnected from the company's fundamentals, with its Truth Social platform being a niche player in social media. The stock is seen as a bet on Trump himself rather than a company with significant revenue and profits.
Europe:
-European telecommunications providers are merging and acquiring to consolidate their way out of competition. Swisscom recently agreed to buy Vodafone's Italian business for EUR 8B ($8.7B), French champion Orange merged its Spanish operations with local operator Masmovil at a EUR 19B valuation, and Telecom Italia sold its fixed-line assets to private-equity giant KKR for EUR 22B. Companies are trying to consolidate their way out of ruinous competition, with growth in core cellular and broadband services slowing down and too many players keeping prices down. Overcapacity makes connectivity a commodity, and debt from building 5G networks has risen with interest rates. Stocks reflect these concurrent calamities, with returns on most companies being negative over the past 10 years. The Holy Grail for telecom dealmakers is a "four to three" transaction, with regulators generally favoring competition.
Emerging Markets:
- -Mexico is set to elect its first female president in a historic election, with two women competing for the top spot. Claudia Sheinbaum, the protégé of outgoing President Andres Manuel Lopez Obrador and former mayor of Mexico City, is widely expected to win the race against conservative opposition candidate Xóchitl Gálvez. This could boost investors' interest in Mexico, which is well-positioned to benefit from the U.S.-China rivalry. The iShares Mexico exchange-traded fund has returned an average 13% over the past three years, but higher-for-longer interest rates in the US and uncertainty around elections have contributed to a pullback of about 4% so far this year. The Goldilocks outcome for the stock market is a solid win by Sheinbaum by a wide enough margin to avoid contested elections and prevent disruptive agendas.The risk to markets in the short-term comes from a loss for Sheinbaum or a narrow win that leads to a contested election. However, past selloffs on domestic politics have been relatively short-lived and shouldn't significantly change economic fundamentals, according to Laura Geritz, founder of investment firm Rondure Global. She favors consumer-oriented stocks like Coca-Cola Femsa and tequila maker Becle, which gets 80% of its sales from the US, Mexico, and Canada. JP Morgan strategist Adrian Huerta expects the Mexican stock market to rise closer to its bull-case target of 63,000, representing over a 10% increase from current levels.
Commodities:
-ConocoPhillips has acquired Marathon Oil for $22.5B, marking the latest consolidation deal in the oil industry. The deal follows Exxon Mobil's $60B acquisition of Pioneer Natural Resources and Chevron's $53B purchase of Hess, part of $250B in oil and gas mergers-and-acquisitions activity in 2023. Standard Oil, once controlling 90% of the US market, faced accusations of monopoly and was broken up into 34 smaller companies in 1911. The company's ruthlessness frightened competitors and spurred attacks from politicians and journalists. Standard Oil was controlled by a "trust" comprising nine men controlling 41 companies, owning everything from pipelines and tankers to railroads. The company has been trying to get back together ever since.
Streetwise:
-Homeowner's insurance premiums have risen 70% over the past three years, with 18 states experiencing unprofitable insurance industries. Car coverage costs have also increased by 48% over the same period. Inflation and litigation are key factors contributing to this increase. Insurance can be a lucrative business, but insurers must keep their combined ratio below 100% and put customer money to profitable use between collecting premiums and paying out claims. Volatility in earnings can occur due to insurers having to ask state regulators for permission to raise prices, which can take time. Allstate experienced a 41% increase in earnings per share in 2020, but it is expected to approach $15 a share in earnings in the coming years. The term "social inflation" refers to liability judgments that have gone wild, with the median size of nuclear verdicts increasing by 35% from 2015 to 2020. This is due to the public's numbness to the numbers, declining sentiment towards big companies, and a shift in tort reform.