Weekly Investment Update (07/28/2023)

This Week’s Positioning and Views

In our view, inflation is likely to slow further as employment gains trend lower, developments that should satisfy Chair Powell’s conditions for not hiking again. While we expect the consumer to continue to underpin growth, we also expect a slowing from the robust levels we have seen in previous quarters. Service consumption should continue to support the economy until there is a meaningful loosening within the labor market. Though the capabilities of generative AI are fascinating and rapidly growing, the technology is still in the preliminary stages of its development and will take time to become a meaningful driver of earnings. Bessemer’s portfolio managers are focused on capitalizing on the opportunities offered by this disruptive technology. We discuss several of our holdings related to this theme below.

Fed Raises Rates While Maintaining Data-Dependent Approach

As was widely expected, the Fed raised interest rates 25 basis points (bps) to 5.25%-5.50% at this week’s Federal Open Market Committee meeting, a move that brought the fed funds rate to a 22-year high. Notably, the statement updated the characterization of current growth from “modest” to “moderate” with the Fed staff no longer forecasting a recession, an acknowledgment of how resilient underlying growth has been this year. In the press conference, Fed Chair Powell highlighted that the labor market remains tight with labor demand still exceeding labor supply, though some progress in rebalancing the labor market has been made . He emphasized that the committee plans to take a data-dependent approach when evaluating whether an additional increase in rates will be warranted.

While Fed officials appear to be seeking maximum flexibility for future rate decisions by keeping the possibility of further tightening on the table, the interest rate futures market indicates investors largely believe the cycle peak has been reached; the market is pricing in a near 20% chance of another 25 bp hike in September. Several inflation and labor market data points are set to be released before the Fed’s next meeting, which is nearly two months away. In our view, the incremental data is likely to reveal further signs of easing inflation as employment gains trend lower, developments that should satisfy Chair Powell’s conditions for a pause. For additional commentary on the economy and the Fed, please see our recent Market Update Video.

U.S. Economic Data Shows Resilience

The economy and markets have displayed stronger-than-expected growth thus far this year. The relative resilience in economic data compared to the dire expectations at the start of the year has led, in part, to the strong equity performance seen thus far in 2023. The Federal Reserve echoed this sentiment this week, which is discussed in more detail above. Positive sentiment was coupled with a second quarter GDP reading that exceeded expectations; the economy increased at a 2.4% annual rate, topping the first quarter’s 2.0% annual rate.

Second quarter GDP growth reflects an economy that has been able to withstand aggressive interest rate hikes, supported in part by a resilient consumer. Growth this quarter was driven by continued albeit slowing consumer spending and stronger business investment relative to the first quarter. Consumption accelerated more than estimates, boosted by strong service demand. Although goods consumption modestly increased, it weakened significantly compared to the prior quarter’s levels. While we expect the consumer to continue to underpin growth, we also expect a slowing from the robust levels we have seen in previous quarters. Service consumption should continue to support the economy until there is a meaningful loosening within the labor market. For more detail on our outlook for consumers, please see our recent Investment Insights on the consumer.

Technology Companies Emphasize Cloud Computing and Artificial Intelligence in Second Quarter Earnings

Alphabet and Microsoft reported earnings this week with the two technology companies highlighting their cloud computing offerings and plans to further incorporate generative artificial intelligence (AI) across their platforms. Alphabet beat both revenue and earnings estimates as search spending reaccelerated, Google Cloud maintained growth momentum, and a recent focus on cost controls led to improved margins. Similarly, Microsoft beat both revenue and earnings estimates though it guided toward softer revenue in the following quarter. The company saw decelerating growth for its cloud computing product, Azure, and indicated that further deceleration for Azure in the following quarter is likely. Cloud computing remains a growth tailwind for these companies though the industry has started to mature after expanding rapidly over the past decade.

Microsoft and Alphabet also emphasized AI during their earnings calls and noted plans to increasingly incorporate the technology into their businesses. Alphabet’s management highlighted how incorporating the technology into its products would better serve both advertisers and users. While Microsoft also discussed “infusing AI across every layer of the tech stack,” it also emphasized that growth from its AI services will be gradual as the technology scales. Though the capabilities of generative AI are fascinating and rapidly growing, the technology is still in the preliminary stages of its development and will take time to become a meaningful driver of earnings. Bessemer’s All Equity Model Portfolio maintains overweight positions in the companies mentioned above, and Bessemer’s portfolio managers are focused on capitalizing on the opportunities offered by this disruptive technology.