Reality check for markets: US economic data weakness and big tech misses
As we move to the end of the week the market tone is starting to shift. This month it has felt like nothing could hit sentiment or sour risk appetite, yet three events on Thursday could be hard for the market to square with this relentlessly positive attitude. Firstly, US GDP for Q3 disappointed estimates, then Apple and Amazon both reported earnings that missed estimates to varying degrees. With a key Fed meeting coming up next week, along with a much-anticipated jobs report, investors may get an uncomfortable feeling as we reach the end of this week, and although the Nasdaq and the S&P 500 both closed at record highs on Thursday, after posting decent gains of 1.4% and 1% respectively, this could trigger some profit-taking as traders ponder the next direction for key asset markets.
Is the US GDP data really that bad?
US economic data was significantly weaker than expected, the US economy grew at a 2% annualised rate last quarter, weaker than the 2.7% expected and the slowest pace since the end of 2020’s recession. Drags on growth included supply chain issues and a sharp slowdown in consumer spending caused by the outbreak of the Delta variant across the US in the summer months. The BEA said that a resurgence of Covid 19 cases resulted in new restrictions and delays to re-openings in the three months to September. Added to this, government assistance payments in the forms of forgivable loans to businesses, grants to state and local governments and social benefits to households also decreased. When you see what the US economy was up against last quarter, the 2% annualised growth rate does not seem that bad. Added to this, even though the decline in growth was partly down to the sharp decline in consumer spending, which grew by 1.6% in Q3, vs. 12% in Q2, we think that consumption could bounce back in Q4, even with the current backdrop of supply chain problems.
There are some strong reasons why we think the US economy is stronger than the headline growth rate of 2% suggests: personal income increased by some $47.8bn in the third quarter, in contrast to a decrease in Q2. This increase was driven by a rise in compensation (wages). The personal savings rate fell slightly in Q3, but this remains high at 8.9%, and although disposable income fell in Q3, the pace of decrease has been falling compared with recent quarters, as inflation growth has started to fall. This tells us a few things: 1, the US labour market is strong, 2, workers have pricing power, which should be good for consumption down the line, and 3, covid has retreated significantly in the US, thus a big dampening effect on Q3 growth should be avoided in Q4 and beyond. Overall, the US economy is strong, which is why US stocks shrugged off this “bad” news and is also why US 10-year Treasury yields rose to 1.57% on Thursday, up from 1.54% on Wednesday.
US GDP and the dollar
From a financial market perspective, this GDP news will most likely be forgotten by the end of the week as the data is extremely backward- looking and it may also be forgotten about as the market focusses on next week’s Fed meeting. However, it did cause the dollar to slump on Thursday. EUR/USD attempted to trade above $1.17, however, it was rebuffed at this level, possibly on the back of a fairly dovish ECB. Instead, GBP/USD could try to make further gains as we move to the end of the week. While $1.38 was a step too far for GBP/USD on Thursday, short-term momentum for this pair remains to the upside, and it could make another attempt to break above this level on Friday.
Market reaction ahead of the Fed
On the stock market front, we still think that there could be a bias towards taking profit in US indices as we reach the end of the week, and this is mostly down to some major earnings misses from Apple and Amazon. Amazon’s Q3 EPS came in at $6.12 vs. $8.92 expected, while revenue came in at $110.8bn vs. $111.6bn expected. The stock initially fell 4% in after-hours trading and there may be some further downside to come in the short term, as the market has treated companies that fail to deliver the goods this earnings season in a very rational way: they have sold their shares, whilst favouring stocks that have beaten earnings expectations. From a sectoral point of view, the news from Amazon confirms that it has been a shaky earnings season for tech compared with the stellar earnings season for US financials. Tech stocks are also burdened with the prospect of longer duration (higher rates), which is negative for their discounted future cash flows and makes their future profits look weaker. Thus, we may continue to see financials flourish in favour of tech in the coming weeks.
Amazon in trouble, as Apple makes small mistake, but is likely to bounce back
Turning back to earnings, Amazon also detailed decelerating sales growth as consumers go back to bricks and mortar stores and said that costs would rise significantly in Q4 due to rising wage costs and tighter labour markets, increased freight and shipping costs and supply chain concerns. Amazon executives said that tighter labour markets and inflation could add $4bn to its cost base. There was some good news about Amazon services, which saw its revenue surpass retail sales for the first time in its history, net product sales were $54.9bn for Q3 vs. $55.9bn for Amazon services including its prime business. Apple’s results were not as bad as Amazon’s, it managed to achieve higher net profits than expected, even though a components shortage cost it $6bn in Q3. Revenues slightly missed forecasts, coming in at $83.4bn vs. $84.3bn. However, Apple said that demand for its products remains very strong and it expects record revenues for the holiday season in Q4. Added to this, all five of Apple’s business divisions grew from a year ago. If you are going to miss revenue estimates, this is the way to do it – deliver a stunning message about the excellent prospects for the company’s future. In our view, there is no stopping Apple. Its stock price was up 2.5% on Thursday, and we believe that fresh record highs could be on the menu as the market is likely to forgive Apple’s small revenue miss for Q3.