Centerfin Collective Weekly

Weekly Update April 26, 2024

Economy slows more than expected, Inflation and bond yields rise, The capex cycle in full swing

Economy slows more than expected

Gross Domestic Product (GDP) for Q1 2024 came in way lighter than expectations of 2.2% at 1.6%.   This is a significant slowdown from the 3.4% rate in Q4 of last year. Under the surface, however, were some important highlights. Personal and disposable income both grew at a faster rate than the prior quarter, while the savings rate declined. On a “current dollar” basis, which is not inflation-adjusted, the economy grew at 4.8% versus 5.1% in the prior quarter. The big difference was inflation was significantly higher than the prior quarter at 3.4%. Since GDP is a real number, which means it's adjusted for inflation, the headline number came in low.

  • Lots of commentators have pointed to this report as impending stagflation
  • Stagflation is when we experience a recession, and inflation is too high
  • This is not what this report indicated
  • The consumer is almost 70% of the economy and seems to continue to be strong
  • However, inflation was higher than expected, which is what really hurt the real number
  • While stocks initially sold-off and bond yields surged, we think it was more associated with the inflation read through than the actual GDP reading
  • This, to us, continues to be the main issue to focus on

Inflation and bond yields rise

Relatedly, the Fed’s preferred measure of inflation, PCE, came in higher than expected at 2.8% for core. This was higher than the prior month’s reading of 2.5%. The trend is now clearly upwards, which doesn't bode well for rate cuts this year. The market is now pricing in only 2 cuts by year end, down from 6-7 expected at the beginning of the year. What is more concerning is long-term bond yields have continued to rise, with the 10-yr bond trading through 4.7% for the first time since late last year.

  • The most concerning part of the report was the trend is clearly up
  • The 3-month annualized PCE is now 4.4%, which is up from 2% a quarter ago
  • The probability of rate cuts continues to decline
  • Long-end bond yields, however are the more concerning trend
  • Long-dated debt (including mortgages) is priced off the long end of the interest rate curve
  • The recent spike in long yields has corresponded to a similar spike in mortgage rates
  • This makes housing less affordable, and in the absence of being able to buy homes, people will continue to rent, putting upward pressure on prices
  • Just as concerning is the interest cost of the US government
  • The US treasury finances the federal government through a mix of short and long-term debt
  • The higher the long end of the bond market trades, the more expensive it is to issue new debt
  • With interest costs already out of control, this exacerbates our fiscal situation

The capex cycle is in full swing

Earnings continued this week, with 30% of the S&P 500 companies reporting.  Four of the MAG 7: MSFT, META, GOOGL, and TSLA reported this week.  A clear trend from META, GOOGL, and MSFT is that capex is growing significantly.  META guided to $30-40bn of capex this year. MSFT had $14bn of capex in the last quarter, this is more than an entire year of capex just 5 yrs ago. GOOGL reported $12bn, double the prior quarter.  

  • Most of this spend is on GPUs and other infrastructure that these companies need to continue to develop their generative AI models
  • This is obviously bullish for companies like NVDA
  • However, this also has downstream implications on energy companies, utilities, and industrials as the infrastructure needs to be built and powered
  • This is marginally negative for consulting businesses and certain SAAS companies as the new technology allows for some of these functions to be built in-house
  • While the bears point to no data around the ROIC of this spend, the trend remains firmly in place for now

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