☀️☕ Peaking Interest Rates = Tech heading to the moon? 🚀🌙

Happy Friday!

📝 Focus

• Peaking interest rates = Tech to the moon?

📊 In the Markets

• Zuckerverse gets a rare market hug

• Google's Ads slumping (Alphabet)

• Fluffy clouds are soft, but not as soft as other businesses (Google, Amazon)

📝 Focus

Peaking interest rates = Tech to the moon?

On a day dominated by central bank interest rate policies and the results of ginormous tech companies like Apple, Amazon, Alphabet and Meta, we thought it would be handy to bring the two together. When the conversation turns to interest rates, why does the tech-heavy NASDAQ index, say, swing more wildly than broader market indexes like the S&P500 and Russell 2000?

Tech stocks of various sorts are among the largest in the world by market value. Of the largest ten, only two are not obviously tech: Saudi Aramco (oil) and Berkshire Hathaway (Warren Buffett, though owning a big slug of Apple). Still, some argue that Tesla should be included too.

Tech companies are generally seen as "growth stocks", i.e. having high revenue and earnings growth potential. As a result, they usually have higher prices relative to how things are now regarding this or next year's earnings (or revenues or some other measure) compared to slower-growing companies and industries.

Because more of the current price comes from its growth potential way out into the future rather than what is visibly closer to hand, they also tend to be more volatile to news affecting their future prospects in general.

They also tend to be more sensitive to interest rates because their valuations are often mostly based on future growth prospects. This is because the value as of today (present value) of those prospects in terms of a stream of earnings (or free cash flow) into the future is directly influenced by (indeed, calculated from) interest rates.

However, it's not just current interest rates that matter but also expected interest rates. Investors don't wait for things to have already happened before they take positions, right? So the question is whether most investors have already "priced in" expected lower --or higher-- interest rates into their calculations. (For this, you need to read "What's Priced-In." - see below!)

No subtext about how the Space Shuttle never actually went to the moon - Image credit: NASA via Tenor

Present Values and Interest Rates - a special Nerd section (fanboys need not apply)

• The present value is calculated by discounting future cash flows back to their present value using a discount rate, which is partially determined by the prevailing interest rate.

• An added nerd wrinkle is "the equity risk premium", which is a component of the discount rate above. It's the extra return investors demand for holding risky stocks instead of safer investments like risk-free US government bonds. The ERP changes over time.

• When interest rates rise, the discount rate also increases, reducing the present value of future cash flows and, in turn, lowering the stock value. Conversely, when interest rates fall, the discount rate decreases, increasing the present value of future cash flows and boosting the value of the stock.

• A small change in interest rates can result in a significant change in the present value of future cash flows, causing the stock prices of growth companies to be more volatile.

📊 In the Markets

With the focus on central bankers on both sides of the Atlantic hinting that we are close to the end of the rate hike cycle, markets blasted upwards (ahead of what turned out to be generally weak big tech results announced after the market close.)

Wednesday's entirely expected 0.25% hike in the US was followed on Thursday by equally expected 0.50% hikes in both the UK and Eurozone. The market reaction to the US Federal Reserve chairman's post-hike comments that interest rates would stay high and won't be cut this year was basically, "oh yes, they will."

How market professionals see themselves (despite all evidence to the contrary) - Image credit: Lucas Films/Disney via Tenor.

The Bank of England, importantly, signalled that it has ended the period of automatic rate rises. Traders glommed onto the lack of the word "forcefully" in the statement regarding tackling inflation, even though it remains above 10%. The European Central Bank, on the other hand, took a harder line and said it would "stay the course", but traders chose to be bullish and focused instead on the comment that actions would be "data dependent" (market interpretation: "don't worry, folks, she will cut.")

The volume of after-market results, especially from big tech, was a bit overwhelming.

Apple missed analyst forecasts for the first time since 2016 and broke a 14-quarter streak of revenue growth, though the deafening newsflow about supply chain issues in China over the last few months should have been at least a bit of a hint for Wall Street's Finest. The number of iPhone, iPad and other Apple devices in active use exceeded 2bn, up from 1.8bn the year before, further cementing its place as the top consumer ecosystem. Shares were down 3% in the after-market.

Zuckerverse gets a rare market hug

Markets loved Facebook owner Meta Platforms' (META) fourth-quarter results, announced after Wednesday's close, and added 23% or US$93 billion to its market capitalisation (share price X number of shares), which more than made back the $89bn it lost right after its third-quarter report.

Traders also loved the $40bn stock buyback 🎓 that it announced at the same time - either because of the usual bullish reasons or because it's $40bn not being poured into Mark Zuckerberg's metaverse black hole.

• "Our management theme for 2023 is the 'Year of Efficiency' and we're focused on becoming a stronger and more nimble organization" - Meta Chief Executive Mark Zuckerberg

Meta's market value is now back close to $500bn, putting it back into the global Top Ten, sandwiched between contract chipmaker TSMC and card scheme Visa... and a quarter bigger than oil supermajor ExxonMobil and luxury conglomerate LVMH.)

Enjoying not seeing a sea of red ink after results for the first time in a while - Image credit: Meta Platforms via Tenor

The results themselves showed sales that came in better than expected by Wall Street's Finest, fueled by strong demand for ads in the face of a weak economy, competition from TikTok and the industry-wide business model disruption from Apple's App Tracking Transparency (ATT) from mid-2021, the opt-in privacy framework requiring all iOS apps to ask users for permission to share their data, making it much harder to target users with ads accurately. The iOS changes cost META $10bn in ad revenues in 2022.

But those better-than-expected sales were still down, for the third consecutive time, by 4% in the last quarter. Revenue "guidance" for the current quarter that the market also cheered was also higher than the $27.10bn that analysts were expecting... but only just barely, and only if you really work at it: the midpoint of the range of $26-28.5bn given gets us to $27.25bn.

Google's ads also slumping (Alphabet)

Alphabet saw sales up only 1%, mainly due to generally weaker economic growth, with advertising revenue dropping 4% on Google (only the second time it's seen a quarterly drop) and 8% on YouTube (more exposed to an economic slowdown than the search business.)

Wall Street's Finest were off the mark with their forecasts for Google parent Alphabet's fourth quarter results, which saw earnings per share drop 32%, much wider than the 25% expected.

Unlike META and other social media platforms like SNAP, Google's ads are not much affected by Apple's App Tracking Transparency (ATT) changes since they do not rely on tracking a user's online behaviour and are instead intent-based and targeted via keyword bidding. Google's ad network is much more diversified and less reliant on mobile ad revenue.

Fluffy clouds are soft, but not as soft as other businesses (Google, Amazon)

Though growth at Google Cloud was also much slower than expected again reflecting the generally weaker economy (as did the cloud businesses over at Amazon and Microsoft) at least at 32% it was still growing at a healthy clip.

Meanwhile, AWS, Amazon's dominant cloud business, saw growth fall to 20% in the fourth quarter from 40% a year earlier on budget cuts from its corporate clients, dragging down the after-market share price by 5% even though overall Amazon sales were better than expected.

Amazon's core e-commerce business was never run to optimise profitability, so the AWS business definitely carries earnings at the group level: non-cloud businesses made operating losses of $2.4bn, but Amazon overall had operating income of $2.7bn (a drop from $3.5bn a year earlier.)

Moomin Cloud Services - Image credit: Trove Jansson via Tenor.

There are three "hyper-scalers" dominating the US$200 billion global cloud infrastructure market: Amazon Web Services (AWS), Microsoft Azure, and Google Cloud Platform (GCP), who make up 34%, 21% and 10%, respectively.