Weekly Investment Update (10/27/2023)

This Week’s Views and Positioning

Third quarter gross domestic product (GDP) data supports the notion that economic growth in the United States continues to surpass expectations. For investors, however, lagging indicators like GDP are less important, as markets typically focus on data that may provide clues about the future. Looking ahead, we expect clearer confirmation that economic activity is cooling, giving equity investors some assurance that the Fed rate-hiking cycle is over. Interest rates have climbed in recent weeks, fueling concerns about tighter financial conditions, which have further pressured stock valuations.

Worth watching:

• – U.S. personal income increased 0.3% in September. At the same time, personal spending surged 0.7%, supported by a decrease in the personal savings rate from 5.2% to 3.8%.
• – Consumer confidence measures are moving lower after increasing for most of the year. The University of Michigan Consumer Sentiment measure fell over four points to 63.8 from over 70 a few months ago.

We are watching the consumer closely, as continued demand is now being supported by falling savings. Any deterioration in the labor market may impact the consumer quickly, as confidence is under renewed pressure. Confirmation of slowing economic activity should further support the notion that inflation is trending lower. As a result, we maintain our equity overweight with a preference for less cyclically oriented sectors.

U.S. Economic Growth Reaches Highest Rate Since 2021

What is happening: Economic growth for the third quarter came in ahead of estimates, with GDP accelerating to a 4.9% annualized rate, more than doubling the 2.1% pace seen in the second quarter. The economy was driven by robust consumer spending within goods and in particular services, while government spending was also strong. One quarter of the growth came from a build in inventories, a trend that may not be as durable in future quarters. Notably, auto purchases were robust, which is normally an interest rate sensitive area of spending. There have been signs that the balance of consumer spending is normalizing between goods and services, a shift from the surge in services spending seen following the post-pandemic reopening. For example, a strong retail sales report beat expectations, and this week, U.S. S&P Global Purchasing Managers’ Index (PMI) also saw a narrowing divergence between services and manufacturing with both measures modestly in expansion.

Why it matters: Economic resilience in the U.S. has, in part, pushed Treasury yields higher this year, although the latest move higher has been driven in large part by technical factors and a rising term premium. Although consumer excess savings are diminishing, a strong labor market and positive real wages have continued to fuel consumer spending. Thus far, the Federal Reserve has been able to slow inflation and cool job growth while the economy has been able to grow at a rate above trend. It is important to note that GDP is a lagging indicator, and commentary from this earnings season, with more forward-looking information, has pointed to some emerging macroeconomic challenges ahead. We believe earnings commentary supports our view that growth will more clearly slow in the coming months. Headwinds such as student loan payment resumptions and an overall tightening in financial conditions are additional pressures to consider. We do not believe the GDP report will cause the Federal Reserve to hike rates at next week’s meeting, especially since the core inflation measure slowed more than estimated. With slower growth likely to eventually push yields lower, Bessemer’s fixed income portfolio managers have favored positioning that is longer in duration relative to the benchmarks.

Technology Companies’ Earnings Beat Expectations, Though Cloud Business Sees Mixed Results

What is happening: Many of the largest technology companies in the S&P 500 index, including Microsoft, Alphabet, and Meta reported earnings this week. Microsoft and Alphabet both reported stronger than expected earnings results, although results diverged on their cloud computing businesses. Microsoft saw a boost from customers utilizing its generative artificial intelligence (AI) products on its cloud product (Azure), while Alphabet’s cloud unit (Google Cloud) saw slowing growth. Investors were highly focused on cloud performance given its expected contribution to future earnings growth, despite other parts of these companies’ businesses outperforming expectations and, as a result, Microsoft’s shares rose while Alphabet’s shares declined after reporting results. Meta similarly posted strong sales and earnings growth above expectations, although the company did not provide a 2024 revenue outlook given expectations for a volatile macro environment that may impact the advertising market next year.

Why it matters: Investors are closely monitoring the earnings of the so-called Magnificent Seven group of companies given they are largely responsible for the majority of the S&P 500’s gains this year. Cloud computing remains a growth tailwind for Alphabet and Microsoft, although the industry has started to mature after expanding rapidly over the past decade. While Microsoft has recently begun to monetize its AI projects on the cloud, Alphabet’s near-term monetization of AI looks less clear. Both companies are investing heavily in their AI capabilities and believe it will be a new secular driver of earnings in the future. However, the technology is still in the preliminary stages of its development and will take time to become a meaningful driver of earnings.

While technology companies’ earnings have generally beat consensus expectations thus far, Meta warned of a softer and more challenging economic backdrop going forward, echoing commentary from several other companies that are pointing to a mixed economic environment ahead. Bessemer’s All Equity Model Portfolio maintains an overweight to the technology sector, including the companies mentioned above, as Bessemer’s portfolio managers continue to focus on capitalizing on the opportunities offered by AI and other secular growth trends that continue to support these businesses.