Weekly Insight #8 – Markets reach new all-time highs thanks to AI
In this edition of our weekly insight, we dive into last week's market performance, the role of AI as a catalyst, the Fed minutes, and a range of corporate news headlines.
Eventually, both European and U.S. markets ended last week strongly, with these on both continents hitting new all-time highs by the week’s end as investor sentiment remained solid and corporate calendar Q4 results continued to beat estimates. According to data from JPMorgan, U.S. companies saw their earnings grow by 5% in Q4 while 78% beat estimates.
However, the real driver of last week’s gain was enthusiasm for AI after Nvidia reported blowout results on Wednesday, which pushed the shares up by another 16%. This allowed the Nasdaq to advance by over 3% and the S&P500 to add 2.1% on Thursday. Remarkably, this gain was driven by only 60% of stocks on the NYSE advancing – a mismatch that has only occurred three times in over 60 years. Clearly, we shouldn’t underestimate the power of AI.
Meanwhile, we didn’t start the week as strong, with U.S. markets trading roughly flat through Wednesday and technology underperforming somewhat. This was primarily the result of investors still digesting the rate cut expectations reset in the previous week, following higher-than-expected inflation numbers over January. By now, traders have priced in a 73% likelihood of the Fed keeping rates flat in May and a 52% likelihood of a first 25 bps rate cut in June, in line with our expectations.
Nevertheless, by the end of the week, the Dow was up 1.38%, while the S&P500 and Nasdaq were up over 2%, bouncing back strongly from red numbers in the previous week and bringing the YTD total for the S&P500 to an impressive 6.69%.
Meanwhile, European markets also performed well, with the Euro Stoxx 50 advancing by 2.5% and the Stoxx Europe 600 up 1.24%, which meant the latter closed at a new all-time high. All in all, it was another very solid week, with markets putting down new all-time highs at a regular now.
Meanwhile, regarding economic and macroeconomic news and developments, last week was as empty as they get. Therefore, let’s not make this part any longer than it needs to be this week.
The most notable news was the minutes from the January Fed meeting, released last week, even though these did not reveal any real new insights. It once more confirmed that officials are in no hurry to lower rates as long as economic data keeps coming in strong and inflation data remains too hot. At the same time, there was also some optimism to be found in the minutes, with officials being optimistic about the possibility of lowering rates later this year as inflation keeps trending down.
According to Philadelphia Fed President Patrick Harker, the Federal Reserve is on track to cut interest rates later this year. Still, he did warn that this could take longer than the street is anticipating right now. “We can’t go too heavy on the gas too soon, lest we lose control or pass our exit completely and have to reroute,” Harker noted. With this, he confirmed what other officials have been saying in recent weeks, which mainly related to the fact that investors were pricing in too optimistic rate cut expectations.
Federal Reserve Governor Lisa Cook added to this that she “would like to have greater confidence that inflation is converging to 2 percent before beginning to cut the policy rate." She reiterated that the Fed should continue to move carefully and closely monitor incoming economic data to review its decision-making. Overall, the minutes and these recent comments reflected what we have seen and heard over recent weeks: that inflation is trending down, and rate cuts should be possible later this year.
Though, at the same time, these cuts could take longer than expected as inflation remains hot and economic data remains solid. The timing of these cuts will entirely depend on economic data coming out over the next few months, though we continue to expect a first cut in June for now, which is what the market is now pricing in after last week’s reset.
UBS economists have also updated their rate cut estimates after last week’s inflation data and now expect a first rate cut to occur in June as well. Moreover, UBS now expects only 75 bps of rate cuts in 2024, down from a previous 100 bps.
The only real risk to these new estimates UBS economists see is a significant economic downturn, which would force the Fed to lower rates more rapidly. However, UBS believes this is highly unlikely and even positively updated its S&P500 price target for 2024.
The analysts stated that they clearly weren’t bullish enough on stocks at the start of the year and revised their price target to 5400 from 5150, reflecting around 8% of remaining upside. Moreover, the bank also increased its 2024 and 2025 EPS estimates from $235 to $240, and $250 to $255, reflecting growth of 9.1% and 6.3% (against consensus estimates of 10.5% and 13.2%).
However, while this all sounds great and very promising, not all of Wall Street is optimistic. Oliver Bäte, CEO of wealth manager Allianz, which has $1.85 trillion in assets under management, stated to CNBC that it looks “very dangerous out there.” Especially when it comes to the tech sector, the CEO believes valuations are looking extremely tricky, which makes the market extremely sensitive to bad news.
On top of this, there is the general worry that the AI-driven rally is unsustainable. While Nvidia is railing in significant cash flows, revenues, and profits driven by the booming demand for its GPUs, a lot of other AI-related companies are not seeing similar results from AI yet, while their share price is boosted by the AI rally. As a result, we could very well be in for a reality check later this year.
Definitely a fair concern and something that is not limited to just AI-related stocks, as the market looks heated and current highs and market gains are (arguably) not supported by underlying fundamentals (just consider geopolitical tensions, an unclear rate cut trajectory, sticky inflation, and GPD growth projections trending down). Therefore, we once more confirm that we remain cautious and have been closing some positions in recent days, holding a larger cash position.
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In other news…
Weight loss drugs have a significant impact already
It is no real news that GLP-1 weight loss drugs have seen incredible adoption over recent years. I mean, the two largest producers of these drugs, Novo Nordisk and Eli Lily, are up significantly over the last five years (up 400% and 521%, respectively).
This has already led to concerns about major snacks and beverage providers like Coca-Cola, PepsiCo, and Mondelez, and these concerns are now being solidified as research shows that GLP-1 drugs cut grocery bills by 9%. Categories impacted the most include “snacks, pastries, and ice cream, while yogurt, fish, and vegetable snacks are most positively impacted,” according to Morgan Stanley analysts.
For now, only 12.3% of questioned households (92k) stated that they had a member taking GLP-1s, making the overall impact still rather limited for global food and beverage giants. Still, we believe this is now something to monitor more closely when invested in these industry leaders. GLP-1 drugs will continue to see massive adoption over the next few years, and clearly, this could significantly impact food and beverage consumption. This could also impact the likes of Walmart, Target, Kroger, and Albertsons, to name a few.
Bayer cuts dividend by 95%
German giant Bayer announced last week that it plans to lower its dividend by 95% as it looks to reduce debt. The company will cut the dividend from €2.40 to €0.11, making it pretty meaningless but reducing it to the legally required minimum for three years.
The dividend cut does not come as a total surprise for investors, with Bayer having struggled with legal liabilities associated with its Roundup brand, which it acquired through the acquisition of Monsanto. By now, the legal issues have cost the company over €12 billion, significantly worsening its balance sheet, with its net debt now exceeding €30 billion.
Capital One to acquire Discover
Last week's leading news headline was Capital One's announcement that it plans to acquire Discover Financial Services in an all-stock deal worth $35.3 billion, merging two credit card leaders and creating the largest credit card company by loan volume.
The announcement was well received by both Discover and Capital One shareholders, with Capital One shares trading flat after the announcement and Discover shares gaining over 10%. Furthermore, the general opinion among analysts is that the deal definitely makes a lot of sense for both companies. Mizuho USA analysts believe the acquisition could allow the combined company to better compete with leading credit card giants Visa, Mastercard, and American Express.
Crucially, Capital One could migrate its customers to the Discover network, and with it currently being the third largest issuer of Visa and Mastercard credit cards, accounting for around 10% of credit volumes, this could have quite a significant impact and boost the Discover network. Discover now has a global payments network available in over 200 countries and at 70 million merchant points.
Furthermore, Capital One now projects that the deal will generate $2.7B in pretax synergies and add more than 15% to its adjusted EPS in 2027. Also, it believes an ROIC of 16% is achievable by 2027. The deal should also have a positive impact on Capital One’s balance sheet, with the combined company estimated to have a CET1 ratio of around 14%, with 84% of the company’s deposits insured as of 2023.
Overall, it is an interesting deal that could cause a shift in the credit card issuance landscape, although we do not view it as a significant risk to Visa and Mastercard at this point. Also, the deal is expected to face a lot of regulatory scrutiny, and approval will probably take some time.
Mondelez highlights strategic priorities
Mondelez shares gained close to 2% last week after highlighting its strategic priorities at the CAGNY conference. Management noted that the company’s current strategic priorities, mainly focusing on its core categories – chocolate, biscuits, and baked snacks – have been critical in driving success across all its markets.
For reference, over the last two years, the company has been able to drive quite impressive growth far ahead of its consumer goods peers. Critically, this growth was not fueled by just price increases, as volumes remained positive throughout those two years across all categories, which is really impressive!
Moving forward, management is confident that its current strategic priorities should allow it to drive attractive and sustainable growth. The company continues to reshape its portfolio to focus on its core categories, which already account for 90% of revenue. Positively, these are also relatively solid growth categories within the snacks and beverage sector, making Mondelez one of the more promising picks.
We’ll dive deeper into the company’s quarterly results and the CAGNY conference in a separate post later this week. Stay tuned for this!
Intel Foundry has potential, but beating TSMC will be a challenge
While an Intel Foundry event on Wednesday last week revealed several positives, like a new partnership with Microsoft and advancements in AI, analysts are still unsure about whether the segment will be able to challenge TSMC any time soon.
"As Intel aggressively develops its foundry business, it might not be surprising to see additional client/supplier partnerships ahead, yet we see execution, scale, and yield rate to remain as the keys for foundry competition," Bank of America analysts wrote to investors.
The company has made great steps in recent years and remains on track for its five nodes in a four-year roadmap, but even then, the company still has a lot of catching up to do. As pointed out by Bank of America analysts, in terms of scale and quality, the company is still far behind TSMC, which is believed to stay ahead of Intel for the foreseeable future, thanks to its technological leadership and better cost structure.
On a more positive note, Intel stated that Broadcom and MediaTek are already loyal customers of its foundry business.
Next week’s most anticipated earnings
As always, we aim to keep you informed on the most notable earnings releases during the week, so stay tuned for our stock coverage posts and dedicated earnings reviews.
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Disclosure: No recommendation or advice is being given as to whether any investment is suitable for a particular investor. The information provided in this analysis is for educational and informational purposes only. It is not intended as and should not be considered investment advice or a recommendation to buy or sell any security.
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You’ll enjoy this article I have coming out. Heavy focus on AI