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Market Outlook

 Earnings season for Q2-2024

As usual, the first to report were the big banks. I always look at credit provisioning and charge offs as indicators of economic weakness. 

JP Morgan (JPM) confirmed guidance for the rest of the year for earnings and revenue; earnings growth will be less than 1%, while revenues will grow at a modest 5%. JPM did increase credit loss provisioning to $3.05Bn, higher than 2.8Bn earlier, this is also higher than 1.88Bn in Q1, and 2.9Bn in Q2. Charge offs (mainly on credit card delinquencies) were also higher by $820Mn at $2.2Bn. Jamie Dimon, CEO of JP Morgan, was cautious as usual, JPM tends to over-provide for losses and has been doing it for years.

Wells Fargo (WFC) didn’t need to increase provisioning, but its charge offs were also higher – net loan charge-offs, as a percentage of average total loans, increased to 0.57% from 0.50% in Q1 and 0.32% in Q2 2023.  WFC’s bigger problem is net interest income, it now expects full-year 2024 net interest income to fall 8%-9% from 2023’s $52.4B, compared with its prior guidance of down 7%-9%.

Citi (C) was mixed with higher charge offs but lower provisioning, and also commentary from the CEO, that lower FICO score customers are pulling back on spending. In addition, he’s seeing signs that delinquencies may be bending back down.

These don’t set off any alarm bells but does confirm what we’ve been hearing for most of the year, that outside of tech, the economy is lackluster, and that inflation is stunting growth, especially for lower and middle income groups.

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Market Outlook

Inflation Cools: June CPI Drops, Core Rate Eases to 3.3% Year-over-Year

CPI continues to cool in June, with core Y/Y rate easing to +3.3%

  • June Consumer Price Index: -0.1% M/M vs. +0.1% expected and 0.0% in May.
  • +3.0% Y/Y vs. +3.1% expected and +3.3% prior.
  • Core CPI (excludes food and energy): +0.1% M/M vs. +0.2% expected and +0.2% prior.
  • +3.3% Y/Y vs. 3.5% expected and +3.4% prior.

The 10-year yield has dropped to 4.27% and S&P 500 futures are up 0.3%.

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Pharmaceuticals Stocks

Galapagos Faces Uncertain Future Amidst CAR-T Therapy Pivot

Galapagos (GLPG) $27 pivots to CAR-T therapy, divesting Jyseleca; faces clinical, market risks amidst investor skepticism. Divestiture of its Jyseleca business reflects a significant shift in its business strategy. There are dissenting opinions on whether this was a good move.

Revenue up 9% YOY; operating losses reduced; strong cash reserve at $4.2B; 

  • Negative enterprise value and underperforming stock; high short interest and bearish investor sentiment.
  • A lot of uncertainties in CAR-T strategy, competitive landscape, and market skepticism. The CAR-T therapy landscape is intensely competitive, and the success of Galapagos’ key candidates, GLPG5101 and GLPG5201, is imperative.
    • Pipeline and R&D Success Rate: Concentrating on CAR-T therapies, particularly GLPG5101 and GLPG5201, presents significant risks. Nevertheless, the EUPLAGIA-1 study’s preliminary data reveals encouraging results. In the study, 75% of CLL patients (12 out of 16) who received GLPG5101 achieved Complete Response with no report of serious adverse effects. In contrast, the GLPG5201 treatment group faced more severe outcomes, with 2 out of 14 patients encountering fatal (Grade 5) events, and a few others experiencing life-threatening or disabling (Grade 4) complications.

This is from a biotech analyst, he’s bearish but a couple of other biotech specialists were bullish in 2023, but haven’t published any updates.

Wall Street has a hold rating.

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Market Outlook

Title: PCE for May 2024

Headline, core PCE inflation ease in May, as expected

Headline – May PCE Price Index: +0.0% M/M vs. +0.0% consensus and +0.3% in April.

+2.6% Y/Y vs. +2.6% expected and +2.7% prior.

Core – PCE Price Index: +0.1% vs. +0.1% expected and +0.3% prior (revised from +0.2%).

+2.6% Y/Y vs. +2.6% expected and +2.8% prior.

10-year treasury yield lower at 4.276%

S&P 500 Futures up 0.4%

Breadth in the market was better the past few days, hopefully with these inflation numbers the broader rally should continue.

Categories
Market Outlook

Savita Subramanian on the state of the markets

A Summary of Barron ’s interview with Savita Subramanian – head of U.S. equity and quantitative strategies at BofA Securities

Definitely one of the smarter strategists on Wall Street with a lot of prescient calls, especially being one of the first to raise the S&P 500 2024 target to 5,400, a level we passed yesterday.

https://www.barrons.com/articles/large-companies-value-stocks-market-rally-subramanian-21f7c4c2?mod=hp_LEADSUPP_1

“If I were going to buy one kind of investment for the next 12 to 24 months, it would be large-cap value. That’s where you’re going to get the most bang for your buck. That’s what will lead over the next few years, given the macro environment.” 

“At the beginning of the year, it was much easier to be bullish because there were a lot more bears. And at this point, I feel like a lot of the bears have capitulated.”

“I’m not worried about equities from a valuation perspective because these multiples are sustainable.”  “Inflation volatility has subsided. This is where clients probably disagree with me the most, but I feel that what the Fed does now is less important because it has already done the extreme process of hiking.”

I agree with this to a great extent – interest rate cuts, higher for longer, neutral interest rates have a marginal impact. Directionally, the 10 year is moving lower, and except for shelter inflation, which has a variable called “notional rent” (A computed number based on what you would pay if you were renting your home today), a majority of other indicators have been moving lower.

​​” Until we get to that moment where the Fed says we’re at peak rates, inflation is coming down, and we can be more accommodative, you want to hold inflation-protected sectors such as energy, materials, and financials. These are more cyclical than defensive sectors.”

“When we were in more of an inflationary environment, we wrote about how the best environment for equities was 2% to 4% inflation. That’s where we are right now. The best environment for equities is when real wage growth is positive and nominal sales growth is at reasonable levels.”

A somewhat Goldilocks scenario…

“But I am surprised by how narrow the market has become. I would have expected a broadening out to have happened earlier.” “The earnings of the mega cap tech cohort are so high that we are more likely to see a deceleration than an acceleration. Another reason to expect a broadening out is that we got positive guidance across the board, and not just from tech companies, during first-quarter earnings season.”

“I like a mix of companies that are generating strong free cash flow and enjoying the benefits of this tech revolution, but also companies that are potentially becoming more labor light. If you think about the areas that could benefit from generative artificial intelligence, it’s banks, legal services, and IT [information technology] services.”

“And if you think about cash flow, it isn’t just tech but also utilities, power, infrastructure, and energy companies that are generating substantial amounts of cash. Some are exciting, and some are boring. But they are mostly big. That’s where I differ from a lot of other bulls. I don’t think you want to buy all small-caps, because while some of them are economically sensitive and will benefit from better gross-domestic-product growth in the U.S., others are morphing into smaller-cap companies because they used to be large.”

So be selective, the devil is in the details – cash flow, operational performance are paramount regardless of small, big, value, boring, tech – BUY THE BUSINESS, Buffet style..

When asked about the election – “The fact that both candidates agree that they want to bring back manufacturing from China and other regions of the world to the U.S. has created more jobs. While these policies are protectionist and inflationary, they are also pro-growth.”

“Right now is the most interesting time to be a market strategist, in my opinion. We’re back to a more rational market. When we were in a zero-interest-rate, massive-stimulus-driven market, it was hard to forecast what would happen next. Events were in the hands of central bankers.” “The outlook depends less on central bankers, and more on corporations and consumers.”

Its a very practical approach, and its folks like Savita, who are instrumental in allocating investment capital – this is not a theoretical, economists top down approach, which at the end of day is much less influential/meaningful for investors.

Categories
Market Outlook

May’s CPI cools more than expected, with core CPI rising 3.4% Y/Y

  • May Consumer Price Index: 0.0% vs. +0.1% expected and +0.3% in April.
  • +3.3% Y/Y vs. +3.4% expected and +3.4% prior.
  • Core CPI: +0.2% vs. +0.3% expected and +0.3% prior.
  • +3.4% Y/Y vs. +3.5% expected and +3.6% in April.

These are better than expected numbers and Futures are up 0.7% and the 10 year treasury is down 14 basis points to 4.3%

Categories
Market Outlook

 Fed Officials Dial Back Rate Forecasts, Signal Just One ’24 Cut

Officials acknowledge ‘modest further progress’ on prices

Fed boosts estimate of long-run neutral rate further

Federal Reserve officials penciled in just one interest-rate cut this year and forecast more cuts for 2025, reinforcing policymakers’ calls to keep borrowing costs high for longer to suppress inflation.

They now see four cuts in 2025, more than the three previously outlined.

The Federal Open Market Committee adjusted language in its post-meeting statement released Wednesday, noting there has been “modest further progress toward the committee’s 2% inflation objective” in recent months. Previously, the statement pointed to a “lack” of further progress.

The S&P is still up 0.96% and the 10 year is at 4.29% – no major reaction.

Categories
AI Stocks

The Apple AI event (AAPL) $195

Apple started its Developers Conference with its long awaited, long overdue AI development announcements yesterday. 

These were the key points

Emphasis on privacy – Majority usage of AI on device but cloud available as well for more computing power, they would be using their own cloud service instead of Google or Microsoft. Apple will be hosting its own Cloud AI services on its own Apple Silicon servers to counter Microsoft’s cloud AI.

Strategy was integration and not an add on – To show AI integrated into the apps and products you already use—rather than powering a tacked-on perk or stand-alone chatbot. 

Partnering with Sam Altman’s OpenAI – Not developing their own artificial intelligence from scratch, instead partnering with Sam Altman’s AI, but crucially it will be integrated. Using a third party for AI could be a smarter move (cheaper, less Capex, fewer failures) – or simply they were too far behind.

Integration Apple’s strongest differentiation was and remains integrated hardware and software product, “System on chip” – basically Apple created and designed silicon with its own operating system and hardware, it’ll be interesting to see how well it is integrated.

The adoption is companywide and includes iOS 18, iPadOS 18 and MacOS Sequoia, Siri, 

Some new features, and a lot of catching up – – several features are in Google and Samsung. 

Playing Catch Up – Writing tools, Voice transcription, Image generation and Notifications, these all exist, and are now available from Apple Intelligence.

Differentiators

The key differentiator here is that Apple Intelligence will also make it easier to search through our existing data – for example, What’s exciting here is the blending of AI with the photos we’ve already taken, and prioritize our notifications. Like other chatbots, you can now text with Siri. But unlike other chatbots, Siri has access to all your Apple stuff. When all the promised updates arrive, it will be able to see what’s on your screen and work across apps. “Add this address to his contact card.” “Text yesterday’s picnic photos to my mom.” Things like this make total sense to a human but up until now have been out of Siri’s reach. The thing that really elevates Siri is its new friend, ChatGPT. When you ask Siri to do some things it doesn’t know how to—say, come up with dinner ideas based on your recent grocery haul—it asks your permission to check with an integrated version of OpenAI’s bot. However, If Apple can pull off what it showed and convince people that Siri is no longer painfully stupid, it might be a tech miracle. That’s a big if. The company has a decade long history of underwhelming Siri improvements.

If you get a chance watch Joanna Stern’s video in the Wall Street Journal.

https://www.wsj.com/tech/personal-tech/apple-intelligence-ios-18-macos-sequoia-ai-b08bb299?mod=hp_lead_pos7

Apple AI analysis: Impact on the company’s business and stock.

Much needed, frankly regardless of much this helps Apple, if they hadn’t done this it would have hurt them really badly.

Apple’s widest moat has been its integration unlike its competitors, for example you have Windows operating, Intel Silicon and Dell hardware – the Wintel systems for the mass market competing on price. Or the Samsung phones with the Android operating system. Apple’s was always designed to be one seamless product from scratch and that’s how they got their premium pricing and loyal customers. 

They continue to emphasize integration and privacy with AI, a big plus.

I think overall, this will help and Apple is going add on features with each new iPhone or Mac version and increase sales, which were stalling for the past three years.

For a lot of people, yes may be underwhelming and just catching up for the regular Apple user, it would be a convincing argument to at least stay with Apple and possibly upgrade.

A core holding: I’ve bought and held Apple for several years now, and usually buy on declines, the last buy call I had made was around $170, and will add if there are unusual or large dips, this will remain a core holding for at least another 5 years. Apple is not a big mover but I’m very, very confident of at least 10-12% a year, plus it works well as a defensive stock too in bad times.

Categories
Healthcare Industry Stocks

Tempus (TEM) IPO Analysis: Cautious Outlook Amid Slowing Growth and Competitive Landscape

Tempus (TEM) IPO at $36 

Key Risks 

Revenue growth has slowed to 26% from 65% and likely to end the year at $650Mn. 

The valuation is about $6Bn almost 10x sales with negative operating margins of 37%. 

Gross margins are also lower this year than last year, which is a bad sign. 

I won’t reject paying 10x sales if the growth is extremely strong, say over 40% but only 26% growth pre-IPO doesn’t inspire much confidence, especially when they’re so far from profitability. 

Dilution Risk – in the first few years post IPO, cash will needed to fund losses and there will more dilution. 

Very competitive industry – there are several large companies doing a combination of diagnostic revenue, data sales and getting paid for drug discovery milestones. 

The AI product line is nascent – less than $3Mn in revenues in Q1-24. 

Major investors – Softbank, Baillie Gifford, Google is a convertible note holder. Eric Lefkofsky – Founder, also co-founded Groupon and Mediaocean. 

Positives 

They do have major pharmaceutical clients – the roster is pretty impressive, and the pipeline is also strong. Some areas of promise – revenue from data has picked up, which can be more stable and sustainable. 

To be sure, this is a very interesting and promising space and has a genuine need for AI related solutions. For now, I would be a little careful, there doesn’t seem to be enough growth, differentiation, or compelling reasons to invest, unless the price is really low. Wouldn’t want to get caught up in the first day euphoria. I’ll keep a lookout, there will be more research coming down the pike.

Categories
Cloud Service Providers Stocks

 A Cloud Storage Titan Struggling to Stay Relevant

Dropbox (DBX) $21.25 – I’m Neutral On This Company

Dropbox has been quite the underperformer, in the last 5 years the stock has lost 7%, and 8% in the past year.

Sales growth has really slowed down from 8-10% to only 3-4% expected for the next 3 years and that’s why there’s no appreciation for the stock. Its a fairly profitable company 15-16% operating margins and cash flow of 30+% because of the high stock-based compensation. Earnings growth is also tepid with just 6-8% expected for the next three years. These are two big reasons why there isn’t much scope for Dropbox to grow.

Dropbox is proving to be less sticky than originally thought. As churn rates have increased over the past year, many investors are re-evaluating the stickiness and value of Dropbox’s subscription revenue base.

Deep competition- Dropbox has always been in an eternal tug-of-war with competitors Google Drive (which has an advantage in pricing and integration with consumer email accounts) and Box, Inc. (BOX), which is better known for its enterprise-grade features and security.

Confidence in Dropbox faltered even more after the company reported rather dismal Q1 results – Analysts have an average hold rating.

Box (BOX), which is about 40% the size of Dropbox, not surprisingly, has a better growth profile with 6-7% revenue growth and 11-12% earnings growth expected in the next 3-4 years. It has a similar valuation multiple, so it’s not like that the markets have given it too much of a premium. 

The main thing is that growth will likely be in the low to mid-single digits in this industry, so can’t expect too much in terms of return from either. 

The one thing Dropbox/Box could do is to put their cash to better use (both generate in excess of 30% cash margins) and buyback shares, the valuations are low enough, which would help them and also help investors. For now, its neutral – don’t see much scope for expansion.