Job cuts are in motion

Stocks had a mixed close yesterday in the wake of a surprisingly strong GDP figure. Big tech earnings weighed heavy on trading in yesterday’s session.

Shifting wind. With the Fed set to debate the path of key interest rates next week, members are surely digging into their research, and there is plenty to consider from these last several weeks. Let’s start with yesterday's first estimate of Q3 GDP. Don’t ask me why, but Gross Domestic Product / GDP is released throughout the quarter over several revisions, and yesterday’s release was the 1^st cut at it. Generally speaking, the 1^st cut is usually pretty close, so let’s run with it… for now. You can’t avoid hearing discussions about recession these days. After all, the first two quarters of the year had negative GDP growth, technically a recession. You don’t have to be an economist to know that economic conditions have worsened since the beginning of the year – just look at your savings account. So naturally, one would expect yesterday's GDP report to reflect that, and… it didn’t. GDP for Q3 came in showing that the US economy grew by an annualized quarterly rate of +2.6% while economists were only expecting +2.4%. So, does this mean that we are out of the woods? More importantly, does this mean that the Fed will pivot soon?

Let us begin with answering the first question, the one about the woods. Remember that GDP is comprised of 4 key inputs as follows: GDP = C + I + G + NX. The “C” is for consumption. Making up around 2/3 of economic growth, that is driven by you and me, as we consume. That not only drives economic growth, but it is a key driver of inflation. The higher our demand, the more prices go up. The Fed is raising interest rates frantically in hopes that consumers will reduce demand. If we look at the “C” component of yesterday's report, we see that, indeed, consumers may be slowing down. Consumption grew by +1.4% compared to a +2.0% growth in Q2. “I” represents corporate spending, and that component showed a decline of -8.5% after a -14.1% pullback in Q2. Companies are quicker to react to economic conditions than consumers, and higher borrowing costs combined with a slowdown in demand has caused companies to, rationally, pull back on spending. So far, with “C” and “I”, it would appear that things are slowing down. But there is more. “G” represents government spending. That pulled back for the prior 3 quarters but grew by +2.4% in Q3. So, government spending increases were a factor in the last Q3 GDP growth. Finally, we get to “NX”, which stands for net exports. From that we see that exports grew by +14.4% after rising by +13.8 in Q2. It is likely that those were driven by the surge in energy exports used to fill the vacuum caused by Russian sanctions. Regardless of the reason, exports are positive for GDP as they represent inflows to the US economy. The second component of “NX” are imports, which showed a decline of -6.9% in Q3. That number is interesting in that it is an indicator of consumer sentiment. Not surprisingly, we import more foreign goods when the economy is strengthening. So, it would seem that consumers are starting to pull back and companies are already pulling back. Without strong exports and government spending the GDP would be telling us a different story. A story in which Fed rate hikes are beginning to take a toll on the economy.

When looking at GDP, it is important to remember that it is a lagging indicator. It is telling us what happened in the economy in the quarter that started around the 4^th of July! That seems like a lifetime ago. But we have more data to support our thesis. Corporate earnings have been littered with promises of job cuts and pullbacks in the current quarter. Employment remains strong today but, based on earnings, it appears likely that things are about to soften up in the labor market over the next 6 months. Companies are also seeing slowdowns in demand from consumers, which is likely to continue, especially if the employment situation weakens and confidence decays. These are all signs that the Fed’s tight monetary policy is beginning to work. That brings us to question #2 from above – the Fed pivot. This morning we will receive the PCE Deflator, which is the Fed’s favored inflation indicator, and that number is expected to show that inflation ticked up further last month. The Fed has been clear that any pivot would only ensue if inflation was clearly headed back down to its +2.0% target. A recession would be another reason for a Fed pivot, and though the headline GDP number looks solid, we now know that there are underlying signs of weakness.

The Fed’s decision next week will not be an easy one. Inflation is clearly not letting up. The economy appears to be strong with low unemployment and renewed GDP growth, but a trained eye will notice signs of weakness. The futures markets have factored in a 100% chance of a +75 basis-point rate hike next week and the odds favor another +50 basis-point move in December. But, alas, we will hear from the Fed itself next Wednesday. Perhaps the Fed will just tell us what we can expect.

WHAT’S SHAKIN’

Intel Corp (INTC) shares are higher by +5.63% in the premarket after it announced that it beat EPS estimates by +78.27% with a narrow Revenue miss of -0.38%. The stock’s climb is likely due to its promises of aggressive cost cutting, which includes meaningful layoffs. Dividend yield: 5.56%. Potential average analyst target upside: +27.9%.

Chevron Corp (CVX) shares are higher by +2.39% in the premarket after it announced that it beat EPS and Revenue estimates by +12.6% and +9.62% respectively. The gains are due largely, in part, to the global energy crunch. Its competitor Exxon Mobile (XOM) posted its biggest profit in the company’s history (152 years). Dividend yield: 3.18%. Potential average analyst target upside: +0.6%.

Amazon.com Inc (AMZN) shares are lower by -12.94% after it announced an EPS beat of +101.01% while missing Revenue targets by -0.42%. While the quarter was strong on the surface, investors are concerned with a softening in the company’s AWS cloud computing offering. This is consistent with Microsoft’s Azure service, as announced earlier this week. Another concern for investors was Amazon’s admission that it expects a weaker holiday season. Potential average analyst target upside: +27.9%.

Also, this morning: Avantor (AVTR), AllianceBernstein (AB), Church & Dwight (CHD) all beat on EPS and Revenues while DaVita (DVA), LyondellBasell (LYB), and Charter Communications (CHTR) came up short.

YESTERDAY’S MARKETS

Stocks had a mixed close, held back by weak tech earnings and prodded forth by an interest GDP print. The S&P500 slipped by -0.61%, the Dow Jones Industrial Average gained +0.61%, the Nasdaq Composite Index pulled back by -1.63%, and the Russell 2000 Index advanced by +0.11%. Bonds gained and 10-year Treasury Note yields pulled back by -8 basis points to 3.92%. Cryptos broke even and Bitcoin lost -1.70%.

NEXT UP

• Personal Income and Spending (Sept) are expected to have both gained by +0.4% after gaining +0.3% and 0.4% in August.
• PCE Deflator (Sept) may have increased to +6.3% from last month’s +6.2%.
• Pending Home Sales (Sept) are expected to have fallen by -4.0% after pulling back by -2.0% in the prior month.
• University of Michigan Sentiment (October) may have been revised down to 59.6 from the earlier 59.8 estimate.
• Next week: Lots more earnings! Economic releases include regional Fed reports, JOLTS Job Openings, PMIs, the monthly employment situation, and FOMC meeting. It will be a big week, so check back in on Monday for times and details.