Handwringing Over Inflation, Fed Could Use More QT, How I'm Trading Microsoft
One tiny speck of sand after another. Fall. Fall. Fall... The allotted time has elapsed.
This afternoon, the Federal Open Market Committee is once again making decisions about the future of US monetary policy. There has been little doubt about what the Fed plans to do in this FOMC meeting. Last time the committee met on policy, on June 14, the central bank decided not to make any changes, keeping the fed funds rate within the range of 5% to 5.25%. Fed Chairman Jerome Powell and his team were clear that this decision was simply a temporary pause and should not be misinterpreted as something more significant, like a longer break.
The reasons for the slowdown in the pace of this tightening cycle are clear. It is believed that the effects of monetary policy on everyday people take about six to nine months to fully materialize. This means that the actual economic activity was still adjusting to the changes made by the FOMC to short-term interest rates and the money supply over a period of around 18 months, which included a streak of 10 policy decisions resulting in rate hikes. This streak ended in June. In that same month, the Consumer Price Index showed a year-over-year growth of 3%, which was a decrease from the peak inflation of 9.1% in June 2022 and the slowest annual rate since March 2021. The core CPI growth for June also showed its slowest pace since late 2021.
The focus here is on the battle between consumer inflation, which has decreased quickly due to the easing of post-pandemic shortages, and the possibility that this success in controlling consumer prices may be coming to an end. As we mentioned earlier, June 2022 is the peak of inflation, so it will be more challenging to compare year-over-year data. There are certain factors that are likely to contribute to inflation, but they haven't had an impact yet. One factor is the potential for increased demand from China due to fiscal measures. Another factor is Russia's withdrawal from the deal that allowed Ukrainian grain to be sold internationally. Lastly, the weakening of the US dollar compared to other major currencies may also contribute to inflation as markets anticipate the end of the Federal Reserve's tightening policy.
After understanding all of that, there is another conflicting situation that involves the battle between inflationary forces and their opposite, but it is much bigger than that. The bigger conflict is and will be between economists who believe that the Fed has done enough to reduce inflation and that the economy can handle the situation on its own, and economists who believe that the Fed will need to significantly slow down the US economy, or even worse, in order to prevent a likely increase in consumer prices. This would require the FOMC to further restrict credit markets, to the extent that it visibly harms the job market, thus causing a decline in economic activity. Recently, wage growth has been higher than the growth in consumer prices. These economists view the idea of a potential "smooth landing" for the US economy as unproductive in the long term.
These economists, who definitely have a valid argument, believe that there is still too much money circulating in the economy. Despite the Federal Reserve's efforts to reduce this through quantitative tightening, the progress that has been made is quite small compared to the expansion of the Fed's balance sheet during the pandemic and the period after the Great Financial Crisis. Currently, the Fed's balance sheet is at $8.275 trillion, down from its peak of $8.965 trillion in April 2022. In February 2020, the Fed's balance sheet had assets worth $4.158 trillion. This means that there has been a growth of 116% over a little more than two years, followed by a decrease of less than 8% over almost a year and a half. Even considering factors like population growth, it is clear that there are strong reasons to be cautious and take a careful approach when it comes to the possibility or probability of prices for goods and services increasing again.
As someone who specializes in economics and trading, it's important to note that these two aspects of my profession often clash when it comes to future policies. If I were in the shoes of Jerome Powell, head of the Federal Reserve, and had just increased the fed funds rate target to a range of 5.25% to 5.5%, I would still consider signaling a more substantial pause in rate hikes at the upcoming Jackson Hole conference. However, during the press conference following the rate hike announcement, I would try to portray the central bank as more inclined towards raising rates in the future than what the futures markets currently believe. Furthermore, I believe that the Federal Reserve could potentially speed up its process of reducing its balance sheet through quantitative tightening. However, it would be best to implement this adjustment in a way that goes unnoticed, rather than forcefully prolonging the inverted slope of the Treasury yield curve.
Microsoft's (MSFT) performance was strong, as it typically is. In the fiscal fourth quarter that ended on June 30, Microsoft reported GAAP earnings per share of $2.69 on revenue of $56.865 billion. Microsoft, a company held by Action Alerts PLUS, exceeded Wall Street's predictions for both revenue and profit. The revenue increased by 8.3% compared to last year, while gross income rose by 11.2% due to the improvement in Microsoft's gross margin from 68.32% to 70.11%. This surpassed the general opinion of market experts.
Sales outperformed predictions in all of Microsoft's reporting divisions. The segments of Productivity and Business Processes, Intelligent Cloud, and More Personal Computing all surpassed their expected figures. However, in terms of operating income, both Productivity and Business Processes and Intelligent Cloud exceeded expectations, while More Personal Computing fell short.
Underneath the exterior, the primary aspect that individuals typically seek when Microsoft provides updates is the expansion of Azure cloud services. Azure experienced a 26% increase in revenue compared to the previous year (27% in constant currency). Although this aligns with expectations, it shows a decrease from the 45% growth recorded last year.
Microsoft continues to generate a significant amount of free cash flow. The company's operating cash flow increased by 16.8% to $28.77 billion, while spending on capital expenditures, particularly in the field of artificial intelligence, rose by 30.2% to $8.943 billion. As a result, Microsoft's free cash flow reached $19.827 billion, representing an 11.7% increase compared to the previous year. From this amount, $9.7 billion was distributed to shareholders, leaving the company with a cash position of $111.3 billion. Despite a slight decrease from three months ago, Microsoft maintains a robust current ratio of 1.77. Additionally, the current unearned revenue, which is not considered a significant financial liability, stands at $50.901 billion, making up 48.9% of current liabilities. Excluding this item, the current ratio increases to 3.46, aligning with Microsoft's previous three-month standing and indicating no significant decline in its financial position.
The instructions were somewhat challenging. They had to be that way. I believe, or at least I do, comprehend that. The projected earnings were slightly lower for More Personal Computing. The forecasted earnings for cloud services were also modest. Microsoft still anticipates a 25% to 26% increase in sales for Azure, considering currency fluctuations. Profitability may experience some strain.
The company has entered a phase of investment and plans to remain in this state for the upcoming year. Why? In order for Microsoft to maintain its competitiveness, or even surpass it, in meeting the future demand for cloud services and its initiatives in generative artificial intelligence (AI), it is essential to invest before reaping the benefits.
This strategy will maintain the same level of profitability as Microsoft continues to invest, thus avoiding any immediate growth in the short to medium term. It may seem like this could potentially put at risk the significant amount of money generated through free cash flow in recent months. Nevertheless, Microsoft has managed to accumulate a substantial amount of cash reserves, and this trend has persisted in the most recent quarter.
Dedicated followers are well aware that Microsoft has consistently held the most significant position in my portfolio. Although this may result in some unfavorable consequences on my financial statement this morning, the company's performance has been commendable. (Had I not utilized Nvidia (NVDA) as a means to generate immediate cash this year, that particular stock would hold the top spot. Nevertheless, one must prioritize sustenance, and I can only secure it by achieving success. Hence, I must strive to succeed.)
Those who read or watched my interview on TD Network with Nicole Petallides last week are aware that the stock failed to reach the $370 mark, which is crucial for me as a reference point. This lack of progress caused me concern, especially considering that the shares had previously reached their highest point in late 2021 and early June this year. Moving forward, let's delve deeper into this issue...
Readers will notice that MSFT concluded on Tuesday at around $351. The Relative Strength had recently decreased, as the daily moving average convergence divergence (MACD) had prepared for a second instance this month where the 12-day EMA fell below the 26-day exponential moving average, signifying a bearish trend. Currently, the shares are being traded at approximately $337 overnight, experiencing a decrease of nearly 4%.
Currently, there are two important aspects affecting the decline in share prices. Investors who hold this company's stock wish for it to maintain its 50-day simple moving average (SMA) of $333, and they also hope that the lower trend line of our Pitchfork model, currently at $320, remains intact. If the stock breaks below this lower boundary, it may result in a decline towards the 200-day line, which is not a desirable outcome.
Desired cost: $425 (restatement)
Turning point: $370 (until the trend shifts, the goal will also shift)
New: Reduced: From $333 to $320 (presently)
Fear: Violation of Pitchfork's lower trend line (by fear, I mean gradually decrease, not leave)
Due to the numerous inquiries I received and promptly addressed, it is likely that there are more individuals who are curious. Yes, I did increase my investment in Raytheon RTX yesterday, and I intend to persist with this strategy if the stock price dips below $82 once again in the near future.
Economics: Eastern Time All Day
07:00 - Weekly Update on MBA's 30-Year Mortgage Interest Rate: Previously recorded at 6.87%.
7 AM - Weekly MBA Mortgage Applications: Previous week's change was a decrease of 1.1%.
At 10:00, there will be an update on the number of new homes sold in June. It is predicted that around 724,000 homes will be sold, compared to the previous month's figure of 763,000 on a seasonally adjusted annual rate.
10:30 - Weekly Oil Stockpiles: Previously decreased by 708,000 units.
10:30 - Inventory of Petrol (Weekly): Previous -1.066 million.
The Fed's Schedule
2:00 pm - FOMC Policy Announcement.
2:30 PM - FOMC Briefing.
Earnings Report: EPS Expectations Unveiled
Prior to the market open, the stock of company T gained 0.61 points, while company BA experienced a decrease of 0.89 points. Company KO saw a rise of 0.72 points, GD gained 2.60 points, TMO skyrocketed with a 5.43 point increase, and UNP witnessed a rise of 2.75 points.
End of Day: (CMG) (12.28), (LHX) (2.95), (LRCX) (5.13), (NOW) (2.05), (URI) (8.94)
(MSFT, CMG, and URI are part of the stocks owned in TheStreet's Action Alerts PLUS investment portfolio. Do you want to receive alerts before the portfolio purchases or sells these stocks? Find out more today.)
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