“Stocks aren’t the economy, but they are not, not the economy.”
― Neil Dutta, Renaissance Macro
Before diving into Mag 7 earnings, let’s consider the market volatility last week that led to the broken streak. Last Tuesday CPI data was released and came in hotter than expected at 3.9% Core CPI year-over-year vs. 3.7% expected. Inflation is still above target and the Federal Reserve still hasn’t cut rates, so hotter than expected readings are not favorable for near-term rate cuts. Last month I wrote that the biggest risk to the stock market may be disappointment and that seems to have played out last week. The stock market started this year hoping for a rate cut in March, but “hot” economic data has forced markets to reprice expectations around rate cuts. Now the markets are betting on a first cut in June and while that was a disappointment, the cuts are still expected this year. That disappointment wasn’t enough to reverse the momentum of the stock market, but it was enough to cause some volatility. On the day CPI data was released the CBOE S&P 500 Volatility Index (VIX) reached levels last seen in October of last year. The day after the CPI data was released Chicago Fed President Austan Goolsbee commented that the Fed tends to put more weight behind Personal Consumption Expenditures (PCE) for the purposes of policy decisions. PCE data will be released next week. That commentary essentially undercut the importance of that hot CPI print and, coupled with cooler than expected inflation data out of the U.K., reversed the negative sentiment from the CPI data. The S&P 500 reached a new high on Thursday even amid the news that Japan and the U.K. both entered recessions, meaning there have been two consecutive quarters of negative GDP reports from those countries. Additional data on Friday pointed to the possibility of sticky inflation and stocks fell into the long weekend ending the week in the red. Now being down half a point from a record high isn’t big news; however, the price action last week illustrates that while this market has positive momentum, there continue to be mixed signals in the data and market participants are watching closely for any sign of economic weakness that could cause a pullback in stocks. For now, that means more volatility may just be in the cards.
The VIX is trending up slightly, but is still relatively low.
With increased volatility in mind, let’s turn our focus to the performance of the Magnificent 7 stocks year-to-date and how they have fared after earnings reports. The Magnificent 7 is the moniker given to seven of the largest stocks by market cap in the S&P 500 which accounted for a substantial portion of S&P 500 returns last year: Alphabet (GOOG,GOOGL), Amazon (AMZN), Apple (AAPL), Meta Platforms (META), Microsoft (MSFT), Nvidia (NVDA), and Tesla (TSLA).
Tesla was the first to report on January 24 this earnings season and has also fared the worst year-to-date. TSLA was already trending down ahead of earnings, but it fell sharply over -12% upon release of the earnings report and is down -6.19% since reporting. Tesla was the only company of the Magnificent 7 to miss earnings estimates. Although it was a narrow miss with earnings-per-share (EPS) coming in at 71 cents vs. 73 expected, the forward guidance made it clear that the rate of expansion is expected to slow notably in the year ahead and they even opted not to provide targets which was a departure from prior routine and further eroded investor confidence. Tesla is a prime example of the elevated expectations the market has for the companies in the Magnificent 7 and the price of not living up to expectations.
The next reports came on January 30 from Google’s parent company, Alphabet, and Microsoft. Although both companies beat their earnings and revenue expectations, both stocks fell upon the earnings release with GOOG down -7.35% and MSFT down -2.69% that day. GOOG is down -4.94% while MSFT is up 0.43% since releasing earnings. Ultimately, Microsoft’s performance was generally positive with clear signs of AI adding to growth, but the cost of that AI investment and some weak forward guidance was enough to drag the stock price down despite those positive numbers. Alphabet similarly had large costs related to investment in AI and set expectations for costs to rise while also posting disappointing results in advertising revenue. It’s worth noting that earnings also aren’t announced in a vacuum. These earnings were announced after the bell on Tuesday and the news was traded on the same day as the Federal Open Market Committee (FOMC) meeting and an announcement from New York Community Bank of substantial losses which pulled down the financial sector in a short-lived reminder of the regional banking issues of last March. Regardless, the drop on earnings beats for GOOG and MSFT is another example of the price of lofty expectations.
The third round of earnings came on February 1 and included Apple, Amazon, and Facebook’s parent company, Meta Platforms. All three companies beat earnings expectations, but results varied with AAPL trading down -0.54%, Amazon up 7.87%, and Meta jumping an impressive 20.32% that day. Since releasing earnings AAPL is down -2.18% while AMZN is up 9.57% and META is up 23.57% through yesterday’s close. Starting with Apple, although the headline numbers looked good, all business segments other than the iPhone missed expectations and there was significant weakness in Chinese markets. On the other hand, AMZN and META both jumped upon their earnings releases with both companies having broadly positive reports, partly because of cost cutting measures. Meta enjoyed particularly large gains and announced both a stock buyback and a newly instated dividend.
Finally, the Magnificent 7 earnings season closed out with NVDA this Wednesday which had a blowout report that exceeded expectations in most categories. Nvidia stock surged in after-hours trading on Wednesday which carried through to Thursday and managed to drag the entire tech sector and more up with it. This good news from Nvidia and reassurance about the state of the AI-driven rally seemed to erase all negative sentiments the week started with.
Magnificent 7 Stocks Year-to-Date Performance
Magnificent 7 Stocks P/E Ratios
The above chart shows, interestingly, that the price-to-earnings ratios of the Magnificent 7 stocks aren’t outrageously out of proportion to their historical levels. Tesla was left off this chart because of inflated valuations in 2020/2021 which skewed the chart, but the P/E ratio of Tesla has only come down since then and is now in line with the other stocks. In other words, although prices have increased a lot, so have earnings. While that growth in earnings may be supportive of the performance of these seven stocks, the S&P 500 has largely been relying on these seven stocks to “carry the team” as it were. In fact, the Mag 7 stocks are expected to provide roughly 30% of the earnings expected from the S&P 500 in 2024. It is certainly possible that they could pull that off, but if one or more of these stocks begin to disappoint, there could be a sharp pullback in their prices. Investors with highly concentrated investments in these stocks may want to ask themselves if they believe the AI-driven growth will continue at the current pace.
Beyond Nvidia’s earnings, one other important piece of economic data received this week was the release of the January FOMC meeting minutes which showed that the majority of Fed officials are more concerned about cutting rates too early rather than keeping them high for too long. Unfortunately, good news in the form of companies beating earnings expectations is in opposition to good news coming from the Federal Reserve, namely that rate cuts will come soon. The stronger the economy, the more hesitant the Fed is likely to be to ease monetary policy because they fear a bounce back in inflation. Ultimately, it’s the same song and dance from mid-year 2023. So long as we continue to have dueling signals, we should expect periods of volatility. The good news, as we have explored in many newsletters before, is that long-term investors can tune out the noise of short-term volatility and trust in their strategies. That said, knowing what’s driving those fluctuations can make staying the course more palatable.
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