Margin Pressures and Higher Interest Rates Offset Good Earnings Reports
The market remains under pressure as it awaits significant employment news.
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The market is under modest pressure early Thursday with bonds as the central issue. The 10-year Treasury is crossing back and forth around 4.8% and sits at its highest level since October 2023.
Bonds tried to bounce and faded, and oil is higher again Thursday morning with the United States Oil Fund (USO) up 1.7%. Crude is at its highest level since July and it has been whipsawing around $95 for two days on renewed military action in Iran.
President Trump said Wednesday that he does not expect the latest round of fighting to last too long and that oil prices will come down. He also said he could not care less whether Iran signs an agreement to reopen the Strait of Hormuz, and that the U.S. is prepared for another attack anytime. That is not the language of someone expecting a quick resolution, and the oil market has not priced one. There are even reports that Trump may just declare that the war is over and continue with current policies.
Good Earnings Are Not Generating Momentum
After earnings reports Wednesday night, the pattern in the AI sector has become clear and it is about margins rather than demand. Hewlett Packard Enterprise (HPE) beat expectations and lifted its long-term forecasts, but then it said margins are normalizing, and the stock fell around 4% ahead of the bell. “Normalizing” is corporate language for coming down.
Broadcom (AVGO) grew AI chip revenue 221% and the shares slipped on fourth-quarter margin guidance. Nvidia (NVDA) guided its own margins lower last week on memory costs and faded within days.
Dell Technologies (DELL) is the exception, having raised prices and passed the memory cost through to customers with margins up rather than down. It is one of four, and even Dell is struggling to build on its blowout report.
Demand for AI-related infrastructure is not the issue. Every one of these companies delivered revenue that would have produced a sustained move a few months ago. What changed is that memory and component costs are rising faster than most of them can pass through. Investors are focused on future profitability and that means margins rather than just pure revenue growth.
Snowflake (SNOW) surged more than 20% on a narrower loss with AI driving the business. Snowflake is a software company that buys compute rather than building it, which means it benefits from the pressures that others in the AI space are dealing with.
The Rate Picture Keeps Getting Worse
Markets are now pricing about a 66% chance of a quarter-point hike at the Fed meeting later this month, up from roughly 40% a week ago. The odds of at least one hike by the end of the year are around 88%.
One of the main drivers of the likelihood of higher interest rates is that there are now estimates that AI company debt issuance this year will hit $1.5 trillion. That is a big pile of bonds and it limits the capacity of the market to absorb all the government debt that is out there. The AI buildout is competing with the U.S. Treasury for the same buyers, and both are forced to offer higher interest rates to attract buyers.
What Determines the Next Move
The market’s short-term direction will be set by economic data over the next two days rather than by anything corporate. Weekly jobless claims and the ISM services index are out this morning.
Wednesday the ADP numbers indicated a further slowdown in private-sector employment growth in August. On Friday the payroll report carries more weight than usual because in July payrolls declined by 23,000 with another 103,000 of downward revisions.
The trade that worked all summer was that weak employment was good news because it removed the pressure for a rate hike. That isn’t happening now because there are inflation pressures.
Oil is at a two-month high, European inflation hit a three-year high this week, and three central banks are leaning hawkish. A soft jobs number Friday raises the stagflation question rather than helping to alleviate the interest rate problem.
Game Plan
I notice a number of readers complaining about the bearishness of writers on TheStreet Pro. It is important to be clear about time frames. I’m cautious about the market in the short term but I’m optimistic about it longer term. I’m reacting to the weakness that is in front of me and trying to position so that I can benefit as we work through a tough patch and set up for more positive seasonality after the mid-term elections.
If you are a long-term buy-and-hold investor then you can probably ignore most of the talk about what is going on in the market right now, but if you are an active investor trying to produce some shorter-term gains then you better pay attention to the bears because it looks like they may finally be right about a few things after being wrong for a long time.
At the time of publication, Rev Shark was long HPE.
