Silicon Valley Sells Off Even as Harris Odds Jump: July 24, 2024 

The new day has brought fresh probabilities for this year’s presidential election, which are strikingly different from yesterday’s prospects, as several polls reflect near coin-flip odds for the two top candidates. At first glance, many would have expected the Harris trade to gain steam, but as big-tech earnings hit the tape, we’re getting quite the opposite. Risk-off sentiments are indeed dominating Wall Street, with investors dumping high-growth tech stocks and almost everything else in favor of Treasury bills, gold bars and Swiss francs. Rates are certainly plunging with weak new home sales stateside and softer-than-expected flash PMIs on both ends of the Atlantic weighing on the economic outlook.

New Home Sales Continue to Tank

This morning’s new home sales data offered the same insight as yesterday’s report on existing housing: fresh year-to-date lows in transaction volumes paired with a new high in inventory. Stretched housing affordability led to a decline in the pace of new homes being snatched up by buyers, with last month’s reading slipping 0.6% month over month (m/m) to 617,000 seasonally adjusted annualized units, beneath projections calling for 640,00 and the previous month’s 621,000. Sharp m/m declines in the Northeast and Midwest of 7.7% and 6.9% overwhelmed the modest 1.4% and 0.3% increases in the West and South. Inventory, indicated by the amount of supply relative to the rate of current monthly sales, rose to a 20-month peak of 9.3, levels consistent with the great financial crisis of 2008. The ratio hit 12.2, an all-time high, in January 2009.

US Service Industry Thrives as Manufacturing Contracts

US economic activity started off strong in the third quarter, according to this morning’s Flash Purchasing Managers’ Indices (PMI) from S&P Global. Services momentum accelerated, with July’s score rising to a 28-month high of 56, above both the anticipated 55 and June’s result of 55.3. Manufacturing dragged down results, however, falling into contraction territory with a score of 49.5, below the median estimate of 51.7 and the prior period’s 51.6. Overall, inflationary pressures slipped during the month, but input costs remained hefty, pointing to firms becoming increasingly unable to pass on loftier costs to consumers. These margin pressures have also become more prevalent on earnings calls, as budget-conscious shoppers trade down amidst erratic purchasing patterns, which are weighing on bottom lines.

Olympic Games Boost Eurozone Services

Conditions were bleak across the Atlantic in the eurozone, with business confidence and a lack of hiring weighing on overall performance. Similarly, though, the services sector expanded while the manufacturing sector contracted. Services and manufacturing PMIs came in at 51.9 and 45.6, missing the estimated 53 and 46.1. In comparison, June’s figures were 52.8 and 45.8. Also weighing on the outlook were rising inflationary pressures, contracting productivity and manufacturing orders. The French Olympics did serve to boost the services sector and offset German sluggishness, however. The combination of rising prices and deteriorating productivity may challenge the European Central Bank’s ability to dish out a rate reduction in September.

Magnificent Seven Off to Lackluster Start

The first two members of the elite Magnificent Seven posted disappointing results, while Visa payment processing volumes grew slower than expected, pointing to weakness in spending by lower-income consumers. Meanwhile, commercial real estate issues weighed on results for Germany’s Deutsche Bank, which tabled a second planned share buyback this morning. Those are a few points from the following earnings highlights:

• Tesla (TSLA) reported its second-consecutive decline in automobile sales, but its revenue surpassed the analyst consensus expectation and grew marginally year over year (y/y) due to sales of the company’s solar energy and battery storage products nearly doubling. The company’s earnings fell approximately 40% y/y and missed expectations with increased sales promotions during the quarter eating away at profits. The drop in automotive revenue occurred despite Tesla’s government credits for emissions reduction tripling from the year-ago period. Tesla’s electric vehicle (EV) auto sales are facing increased competition and decelerating sales industrywide. Chief Executive Officer Elon Musk, who has established a super PAC to support Donald Trump’s bid for the White House, said he has suspended the development of a manufacturing plant in Mexico because the former president has pledged to impose steep tariffs on imports from the country. Musk also pushed back the unveiling of a driverless car from the first week of August to October 10. Tesla’s stock price, which had fallen 1% year to date prior to the earnings release, dropped 8% last night.
• Alphabet’s (GOOG) second-quarter revenue and earnings exceeded analyst consensus expectations, but the revenue beat was considered minimal relative to the company’s past quarters. Additionally, revenue for the company’s YouTube platform fell below expectations. The lackluster results caused shares of Alphabet to decline roughly 4% following the earnings release. On an encouraging note, overall advertising revenue climbed from $58.14 billion to $64.62 billion y/y, pointing to strong business optimism despite the impact of high interest rates and inflation; however, the quarterly results disappointed investors. The company’s search service and cloud computing offering contributed to 14% y/y growth in revenue. During the earnings call, Sundar Pichai, Alphabet’s chief executive, said the company’s artificial intelligence infrastructure and generative AI cloud services have already generated billions of dollars in revenue year to date and are being used by two million developers.
• Visa (V) revenue climbed 10% y/y but fell short of the analyst consensus forecast while earnings only matched expectations as the growth of the company’s payment processing was limited by stratospheric interest rates causing lower-income consumers to curtail their spending. Nevertheless, payment volume, a metric based on the aggregate dollar value of activity processed by the firm, climbed 7% y/y while the number of transactions jumped in the low double digits. Visa experienced stronger growth in cross border transactions, implying that travel volumes were still strong during the period. Visa also experienced weakening payment activity during the first three weeks of this month, a result, in part, of the CrowdStrike software update knocking many computer systems offline. Visa’s share price fell approximately 3.5% after the earnings release last night.
• Deutsche Bank (DB) posted results that underscore troubles with commercial real estate (CRE). The German bank maintained that CRE will continue to pressure its earnings despite conditions potentially stabilizing in the US. It had previously estimated that provisions for credit losses would range from 20 to 30 basis points (bps) of its average loan book value, but this morning, it increased the guidance to more than 30 bps. The bank’s shares dropped approximately 7% after the earnings release. Additionally, revenue from fixed-income and currency trading declined 3% but commissions and fee income jumped as dealmaking increased. In another unfavorable development, the bank tabled plans for a second share buyback, explaining that previously disclosed litigation costs associated with its acquisition of Postbank following the 2008 financial crisis pushed the company into a second-quarter loss. Without the litigation, the bank would have generated a 7.8% return on tangible equity. Despite pressure from real estate loans, the bank’s quarterly loss was smaller than anticipated and overall revenue climbed 2% y/y.

Investors Rush to Safe Haven Assets

Markets are getting punished as investors sell risk assets and pick up safe havens while drifting into hibernation. For stocks, nothing is working, not Harris or Trump, with all major US equity benchmarks in the red. The Nasdaq Composite, S&P 500, Dow Jones Industrial and Russell 2000 baskets are travelling south by 2.6%, 1.6%, 0.8% and 0.3%. Sectoral breadth isn’t as bad as one would think, with 4 out of 11 sectors gaining on the session. Lower interest rates are pushing folks into real estate stocks, loftier oil prices are helping energy, and defensive positioning is motivating purchases of utilities and health care names. But consumer discretionary, technology and communication services are taking a beating; they’re down 3.1%, 2.8% and 2%. Rates are plunging with this morning’s reduction by the Bank of Canada propping up the odds of a Fed cut in September. The 2- and 10-year Treasury maturities are shifting in bull-steepening fashion, changing hands at 4.39% and 4.23%, 11 and 3 bps lighter on the session. The dollar is dancing in lockstep, sinking 25 bps as the greenback depreciates relative to the yen, franc and pound sterling. The US currency is appreciating versus the euro, yuan and Aussie and Canadian dollars, however. Commodities are mixed, with copper and lumber lower by 0.9% and 0.4% on manufacturing and real estate weakness, while gold, crude oil and silver gain alongside volatility protection as market participants hedge against a potential downturn. WTI crude oil is trading at $78.65, benefiting from oversold technical factors as well as dwindling stateside inventories. 

Equity Correction Is Far From Over

Despite recent selling, the S&P 500 is still trading close to 22 times earnings amidst quarterly results that aren’t impressing investors in aggregate. In addition, the benchmark is still up 15% year to date, which is terrific considering it isn’t even August. Yesterday we wrote that a 10% to 15% correction was in the cards this quarter, which is historically the worst period of the year. This quarter, the valuation concerns are being paired with front-loaded gains, irrational exuberance, a high bar for earnings estimates and a presidential election that may very well fundamentally change the technology sector for the worse from an earnings standpoint. Finally, a critical component is found in the narrowing spread between the 2- and 10-year yields, which now stands at 16 bps. When the two instruments have reached rate parity in the past after inversions, violent equity market corrections have occurred. This time isn’t different. 

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