Microsoft disappoints with great results

Stocks rose yesterday as optimistic traders added another day in a long streak of gains for the Dow, nearly matching a longstanding record. Consumers are super-confident according to the latest numbers from The Conference Board.

Worth noting. Well, today the FOMC will most likely take the path cleared by the markets. The markets not only cleared the path, but it seems to have lined it with all sorts of fragrant flora. “Go on Fed, we got this,” signals the markets. After a blisteringly rapid rise in rates starting in March of 2022, it is clear that the tightening has had at least some impact on the markets. Namely, inflation, which has unarguably pulled back from its 2022 crest. But there is something unnerving everywhere else.

Raising rates are supposed to cause companies and consumers so much pain, that they literally freeze all spending. Companies, according to theory (and history) will even resort to mass layoffs which would further exacerbate the pullback in consumer spending. That would cause inflation to moderate. AND that’s it, class is over. Not so fast… that has not happened this time. Corporate layoffs have been moderate, and the labor market remains strong. GDP remains healthy with no imminent recession on the near horizon, consumption has not fallen off a cliff (yet - stay tuned for tomorrow’s release), consumer confidence remains strong, and the stock market is enjoying its summer. All this while rates are about to be the highest since 2001!

How can this be? Have high interest rates lost their power over consumption and investment? Not quite. Some interesting data released by Bank of America earlier this year may shed some light on this. It turns out that corporations took full advantage of the low interest rate environment that persisted in the wake of the Global Financial Crisis, piling up on cheap debt. Within the S&P500, only 14% of held debt is floating rate, with nearly 60% of that with longer maturities. That leaves only 6% of the S&P500’s debt subject to the fast-rising short-term rates. What’s more, 76% of those corporations are holding long-term fixed debt. Corporate treasurers have essentially locked in those lower rates for longer periods of time. In other words, companies are not necessarily feeling the burn like they did in the past, due to the long period of near-zero rates that preceded the 2022 hiking regime. According to analysts done by SocGen, corporate debt service actually decreased by -25% during a period where it would have historically risen!

I am not going to get too deeply into consumers, but it is important to recognize that for many folks, home mortgages represent their biggest debt. That is why higher interest rates, in theory, will have the most impact on residential real estate. However, it clearly doesn’t all happen at once. If you locked in a 30-year mortgage when rates were low, unless you were looking to buy a new home, higher rates would not have a material impact on your monthly budget. Therefore, higher rates have really only affected those seeking to buy new homes. Now, to be clear, that has had an impact on home prices as demand is lower, but for many homeowners with existing fixed-rate mortgages, higher rates have not had a material impact on monthly consumption.

So, what does all of this mean? Well, it just means that the Fed is going to have to wait a bit longer to get the damaging results it expects. Some of that fixed-rate corporate debt will eventually mature requiring refinancings, where higher rates will have an impact on corporate spending. With respect to housing, it would seem that basements will remain fully occupied by grown children as long as rents and mortgage rates remain high. There is also an implication that worst is yet to come as the pain of these higher interest rates take their delayed effect. However, if inflation continues to cool down as it has, the Fed may be able to ease rates just in time to avoid all that potential pain. For now, this possibly final rate hike may be harder on the eyes than it is on the wallet.

STOCKS ON THE MOVE BEFORE THE BELL

Microsoft Corp (MSFT) shares are lower by -3.48% in the premarket after it announced that it beat on EPS and Revenues. The reason for the pullback is that the growth of its Azure cloud computing revenue was only +27%! That is down from its prior growth of +31% leaving some disappointed. Dividend yield: 0.77%. Potential average analyst target upside: +9.1%.

Alphabet Inc (GOOG/GOOGL) shares are higher by +5.86/+6.09% in the premarket after it announced that it beat on Revenues with a slight miss on EPS. Despite the EPS miss, analysts and investors were happy to learn that Alphabet’s core advertising business remains stable and strong with slight increases in revenue coming from its YouTube offering. Potential average analyst target upside: +19.9%.

Also, this morning: Lithia Motors, Owens Corning, Hilton Worldwide, Coca-Cola, ADP, Virtu, General Dynamics, Otis Worldwide, Boeing, and Fortive all beat on EPS and Revenues while Thermo Fisher, AT&T, Stifel, Old Dominion Freight, and Union Pacific came up short.

YESTERDAY’S MARKETS

Stocks rallied yesterday on solid economic news and were helped by UPS’s agreement with its Teamsters Union members. The S&P500 Index rose by +0.28%, the Dow Jones Industrial Average added to its epic streak and added +0.08%, the Nasdaq Composite Index advanced by +0.61%, and the Russell 2000 Index inched higher by +0.02%. Bonds slipped and 10-year Treasury Note Yields rose by +1 basis point to 3.88%. Cryptos added +0.16% and Bitcoin climbed by +0.29%. The S&P ESG Index rose by +0.31%.

NEXT UP

• New Home Sales (June) may have pulled back by -5.0% after jumping by +12.2% in May.
• FOMC will announce rate policy at 2:00 PM Wall Street Time. The even more important press conference will follow at 2:30.
• After the closing bell earnings: Align Technology, Mattel, Chipotle, O’Reilly Automotive, VICI Properties, Flex Ltd, ServiceNow, eBay, Lam Research, United Rentals, L3Harris, American Water Works, Meta Platforms, and Seagate.