A Google First: Negative Free Cash Flow; Oil Bubbles Higher; Yields Creep Up

Investors are turning wary as we head into the heart of earnings season. Is it the corporate performance? No. Well, maybe a bit, but there are other problems. Overall business performance has been strong, despite the that last night we did learn that Alphabet (GOOGL) had posted a quarterly cash burn for the second quarter.

Due to the company’s aggressive capital expenditure up-spend on the development of its artificial intelligence programs (which has been broadly copied across the hyperscaler space), Alphabet put a negative print (-$5.9 billion) for free cash flow to the tape for the first time since going public in 2004. Investors are focusing on that free cash flow number due to the fact that Alphabet is planning to increase that capital spending and that the cash burn was worse than expected. It mattered not that the firm was also far more profitable and showed far more sales growth than had been expected.

U.S. equity index futures are struggling through the overnight session as I work my way through the zero-dark hours on Thursday morning. Yes, Alphabet is a culprit, as is Tesla (TSLA), which is also trading lower. That said, higher market prices for front month crude oil and lower prices for U.S. Treasury debt securities (higher yields) seem to be what’s bugging the market tonight / this morning. Let us proceed.

Ever Expanding War

Maybe I’m spoiled. Maybe I expect too much. When I was a kid, the Vietnam War seemed to drag on endlessly. The Global War on Terror lasted even longer. This war in and around Iran is still being measured in months, not years, and still has not required the use of ground troops, it is already lasting longer than expected and that is impacting financial markets.

Crude prices popped again overnight. I see WTI Crude trading with an $89 handle (per barrel) on Thursday morning, up from an $86 handle last night and up from a $68 handle earlier this month. The new news? Houthi militants in Yemen are claiming to have attacked two Saudi tankers in the Red Sea on Wednesday evening. For the geographically challenged, the Houthis are Iranian allies, and the Red Sea is on the other side of the Arabian Peninsula from the Persian Gulf. This would mark an expansion of the theater of combat operations into a new neighborhood.

The Red Sea has been a major work-around for Saudi oil exports since the Iranian military started threatening and attacking civilian vessels trying to traverse the Strait of Hormuz, bottling up the Persian Gulf. At least one of the tankers fired upon by the Houthis, after apparently being hit, broadcast a “not under command” message, indicating that it had likely lost its ability to navigate.

In The Meantime…

U.S. forces pounded Iranian targets for a 12th consecutive day. CENTCOM gave little in the way of detail. As we know, the U.S. is doing everything it can to degrade Iran’s offensive capabilities while causing as little as possible collateral damage to the civilian population and while suffering as little in the way of casualties as possible. That’s a very tough way to enforce one’s will on a belligerent enemy.

The Wall Street Journal is reporting that the U.S. is surging more special operations type personnel and fighter aircraft squadrons into the area of operations. In addition, more than 150 additional U.S. military medics have surged into Germany in recent days, which is where we remove our severely wounded to, from the Middle East. That does not necessarily mean that the president is planning to grow from here, the level of U.S. operations. It does mean, however, that he is increasing his flexibility to do exactly that.

Higher oil prices are forcing forward looking estimates for consumer and producer-level inflation upward again. This is having a negative impact on the bond market and on U.S. Treasuries. As the probability of a rate hike in September (as measured by futures markets) has increased to almost 80%, sellers have descended upon U.S. Treasuries.

As I write, the U.S. Ten-Year Note is paying more than 4.68%, up from 4.37% less than a month ago. The Thirty-Year Bond now yields 5.17%, up from 4.86% a month ago and has been paying more than 5% for 11 consecutive trading days. This equals an eleven-day stretch in May. One more day, which is likely, and this will be the longest stretch of 5%+ days for US 30-year paper since a 44-day run in 2007. That ain’t good.

Trading IBM…

IBM (IBM) also officially reported last night after warning last week. The company lowered its constant-currency revenue growth guidance to a range of 4% to 5%, which was better than feared. The company maintained its expectations for annual free cash flow to increase by about $1 billion relative to what the company had experienced in 2025.This was also a relief. The good news? IBM shares are trading higher overnight than where they closed, as the tape shows more red than green. The bad news? The shares are still trading lower than where I was adding earlier this week. Looks like I am going to have to manage this one. That will include another addition at these levels.

Marketplace

Equity markets sort of took a day off on Wednesday. Not completely, but the indexes did not really move all that much and participation was down. The S&P 500 gave up just 0.14% for the day while the Nasdaq Composite gave back 0.57%. Small caps struggled with the Russell 2000 down 0.92%, but the semis rallied again, though moderately, at +0.44%.

Five of the 11 S&P sector SPDR ETFs closed out the regular session on Wednesday in the green led by the utilities (XLU). Though the utilities are defensive in nature, they were alone. There was no clear move into or uniform outperformance by defensive sectors vs. cyclical sectors for the day. That said, despite some support for the semis, defensives and cyclicals both outperformed growth.

Looking at the internals, losers beat winners by a rough five to four at the NYSE and by about five to three at the Nasdaq. Advancing volume, however, still managed to take a 50.9% share of composite NYSE-listed activity. That said, advancing volume accounted for just a 41.8% share of composite Nasdaq-listed trade.

Trading volume was lower across the board, which signals a potentially less than meaningful daily outcome, at least technically. Aggregate trade was down on a day-over-day basis across NYSE-listings, across Nasdaq-listings and across the membership of the S&P 500. In fact, S&P trading volume has now ended the trading day below the 50-day trading volume simple moving average for that index for an incredible 14 consecutive sessions. That takes us back to July 1.

Heads Up

I will be subbing in for our own Doug Kass today at his Daily Diary. Stop in and join us. We’ll talk about the markets. We’ll talk about economics. We’ll try not to talk about politics. We will, however, at some point, talk about baseball. So let it be written.

Economics (All Times Eastern)

08:30 – Initial Jobless Claims (Weekly): Expecting 212K, Last 208K.
08:30 – Continuing Claims (Weekly): Last 1.805M.

10:30 – Natural Gas Inventories (Weekly): Last +41B cf.

The Fed (All Times Eastern)

Fed Blackout Period.

Today’s Earnings Highlights (Consensus EPS Expectations)

Before the Open: CLF (-.21), FCX (.61), HON (1.81), LMT (7.21), ROP (5.29), RTX (1.66), TMUS (2.68), UNP (3.23), URI (11.59)
After the Close: INTC (.22)

At the time of publication, Guilfoyle was long LMT, RTX, INTC, IBM equity.