$5tn of ‘meh’ earnings

Good morning. It was a remarkable day on Wall Street yesterday. Presumably in response to Wednesday’s Fed meeting, the riskiest stocks staged a huge rally. The tech-heavy Nasdaq was up more than 3 per cent. The ARK Innovation ETF was up 6 per cent, and is now up 50 per cent in a bit over a month.

What is interesting about this is that these so-called “high duration” stocks (with lots of their expected value far in the future) did not move in response to a big change in interest rates. Yes, the yields on 2- and 10-year Treasuries are about 10 basis points lower than they were before Fed chair Jay Powell started talking. But that does not seem like a big enough move to make sense of yesterday’s frivolity. Rather than a big change in expectations for rate levels, what we are seeing is probably a big decline in the expected volatility of future rates. This depresses the risk premium on speculative stocks.

But even that is probably not a sufficient reason for this amazing “flight to shite” (as our vulgar colleague Robin Wigglesworth has called it). The current rally smells strongly of momentum-chasing and fear of missing out. Deep breaths, everyone. And send us your thoughts: robert.armstrong and ethan.wu.

Big tech trifecta

Yesterday afternoon three of the biggest and most important companies in the world reported earnings, all at once. If I was asked to summarise the reports from Apple, Alphabet, and Amazon in a single word, it might be “sober”. There was the usual Big Tech talk of the great opportunities ahead and amazing customer experiences, but the three also sung in unison on challenging economic conditions, decelerating revenue growth, and the need to control costs. A few words on each:

• At Apple, revenue growth, after adjusting for foreign-currency headwinds, grew just 3 per cent from a year ago, an unexpectedly sharp slowdown only partly attributable to supply chain problems with the iPhone. The company expects growth in the current quarter to be similarly meagre. The CFO was careful to point out that expenses came in below the company’s targets.

• Alphabet revenue slowed as well: currency-adjusted sales growth was 7 per cent, down from 11 per cent in the prior quarter. There was a lot of talk about “re-engineering the company’s cost base”.

• Amazon increased revenue a bit more than expected, at 12 per cent, but guidance for the first quarter looked soft (The company has been known to under-promise). Cloud computing revenue growth slowed to 20 per cent in the quarter, that rate slowed to the mid-teens in January. The company expects the cloud business to face economic headwinds for the next couple of quarters. “Efficiency” was mentioned a lot in regard to the retail business.

Alphabet’s comments on its cost-control efforts were of particular interest. Here is Ruth Porat, the CFO:

In the first quarter of 2023, we expect to incur approximately $500mn of costs related to exiting leases to align our office space with our adjusted global headcount . . . This will be reflected in corporate costs. We will continue to optimise our real estate footprint . . . 

We adjusted the estimated useful lives of servers and certain network equipment starting in Q1 ‘23. We expect these changes will favourably impact our 2023 operating results by approximately $3.4bn

That real estate and server accounting are areas that Google is looking to bring costs down is interesting in itself. But it is particularly interesting given that Meta’s CFO said the same thing the day before:

The second component of the lower expense outlook is on cost of revenue . . . depreciation here is impacted by us extending the useful lives of non-AI servers in Q4. And then the third component is our outlook now reflects an estimated $1bn in facilities’ consolidation charges.

Writing recently about Big Tech’s need to cut costs, we have focused on the trade off between productivity and innovation. These companies spend many billions on projects that may or may not become good businesses. It is natural to question whether the more starry-eyed ideas shouldn’t be dumped. But how much might these companies save with belt tightening in pedestrian areas such as real estate that only incidentally touch innovation? I don’t know the answer, but it’s an important issue for investors.

One thing is for sure: the companies won’t find sustainable savings by lengthening the accounting lives of servers, which lowers depreciation expense, a non-cash item.

(Also, the point about “facilities consolidation” has implications for the real estate industry. Office Reits like to brag about Big Tech as premier clients. There may be somewhat less bragging in the months and years to come.)

It is interesting that the market response to these three fundamentally similar reports — significant slowing in revenue growth, lots of promises on costs — was muted. All three stocks fell in after-hours trading, but by less than they had gained in regular trading. Investors appear to be treating the slowing sales as a cyclical rather than a secular change, and are looking though it.

We can’t blame investors for being credulous. All three companies have incredibly strong competitive positions in industries that seem likely to grow faster than the economy for years to come. If single-digit-ish revenue growth is temporary, an artefact of the cycle, the shares in Apple and Alphabet look very fairly priced (it’s not as clear with Amazon). Should the revenue slowdown turn out to be permanent, on the other hand, Big Tech’s relationship with its investors is going to change fundamentally.

One good read

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