AI’s success went unrewarded, oil bounced back
What happened to Alphabet’s share price?
Alphabet delivered; revenue rose by 24% to $119.8 billion, ads beat expectations, and cloud accelerated to 82% growth from 63% last quarter. Yet the stock fell anyway, quite hard.
The reason for this was found in the fine print: capital expenditure forecasts rose again, to as much as $205 billion this year, the second increase this year. Free cash flow went negative, and AI investment is being funded in part by nearly $50 billion of stock sold in June, plus $20 billion of debt securities. We asked in June what would finance the AI buildout. Alphabet answered: with more of everything, including your shares.
One irony deserves a mention: headline earnings tripled to $9.11 per share, but that includes $99 billion of paper gains, largely through stakes in Anthropic and SpaceX. Strip those out, and profit slightly missed its target. Alphabet’s AI bets are paying off on paper, in other people's companies, while the core business burns cash building its own. Nobody doubts the growth anymore, they doubt the bill.
How is the microchip sector performing?
The microchip sector entered the week in an official bear market, down 20% from its June record, after giving back a third of a gain that had reached almost 97% this year. Second-quarter semiconductor earnings are forecast to grow 131%. Of the S&P companies to report earnings so far, nearly 88% have beaten their forecasts.
ASML (a Dutch company that builds equipment to manufacture the most powerful AI microchips) and Taiwan Semiconductor Manufacturing Company both topped their earnings estimates this month and both saw their shares dip. Demand is not the question; price is. A sector that’s still 53 points ahead of the index after a 20% decrease leaves room for valuations to compress without a single order being cancelled.
The flow of money in and out of the market tells us what kind of correction this is. Money is rotating toward value and energy stocks; it’s not leaving the market. The market is deciding, name by name, what perfection should cost.
Why is the price of oil bouncing back up?
The conflict in Iran kept escalating: eleven straight nights of U.S. strikes, a Houthi embargo on Saudi shipping, risk spreading to the Red Sea, and Washington declaring Iran not serious about talks. Brent oil settled at a six-week high, at more than $20 above its early July low.
The inflation math is simple. June's encouraging lower U.S. Consumer Price Index (which moved the odds of the U.S. Federal Reserve [the Fed] holding its interest rate to 85%), was built on a 10% drop in the price of gasoline. That drop no longer exists. The disinflation that markets celebrated last week is being deleted barrel by barrel, and the bond market never bought it. The 30-year yield stayed pinned above 5.1% through all of it.
Both U.S. and Canadian central banks are exposed. The Fed will meet next Wednesday with a rate hold still expected, but it's getting closer to a coin toss by the minute. And Bank of Canada governor Tiff Macklem's forecast last week rested on one condition: that oil continues to decline from elevated levels. A week later, it's not looking that way.
What key market data is due next week?
The Fed will make its rate-cut decision next Wednesday, something that can’t be taken for granted. The heaviest stretch of mega-cap earning reports will follow, and Personal Consumption Expenditure data for June (outlining how much U.S. households spent on goods and services) will close out the month. Last week, we asked which was the blip; June's cooling or July's barrels. The barrels answered. The question now is how long the Fed can call an oil shock temporary when it’s so persistent.
Listen to the latest podcast from the IG Investment Strategy Team for further insights.
