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Easing Up: Fed Expected To Cut Rates, But Apple's Strong Results Front And Center Early

JJ Kinahan

If there’s a “third rail” for Wall Street, it’s anyone mentioning 2008. That was the year stocks crashed, and also the last time the Fed cut rates. 

Things couldn’t be more different now, with major indices at record highs and the U.S. economy showing plenty of resilience. Today, however, the Fed is expected to cut interest rates for the first time since that infamous year.

Futures trading suggests a 77% chance that the Fed will deliver a quarter-point easing, and those kind of odds the day of a decision historically tend to be on target. We’ll be back later today with post-Fed analysis.

Digesting Apple’s Better-Than-Expected Quarter

Before the Fed announcement at 2 p.m. ET, people could spend the morning digesting Apple Inc’s (NASDAQ: AAPL) mostly better-than-expected earnings that bowed after Tuesday’s close. AAPL’s results seemed to put a charge into the morning, with major indices up in pre-market trading after weakness in Asia and some European indices overnight.

AAPL beat analysts’ earnings per share and revenue estimates, and also gave a guidance range for fiscal Q4 of $61 billion to $64 billion vs. the consensus Wall Street estimate of $60.98 billion. That compares to revenue of $62.9 billion in the same quarter of 2018, and many analysts seemed impressed. The guidance might be a key factor behind AAPL shares’ 4% rise in pre-market trading Wednesday.

What stands out when you look at AAPL’s June quarter is how it managed to beat expectations despite two key segments—iPhones and Services—coming up a bit short on revenue vs. what third-party consensus had projected. The company overcame this with better performance from areas like wearables (which includes watches and ear buds), and the Mac business.

For the iPhone, there was some improvement in sales quarter-to-quarter, but revenue was down 12% from a year ago. Services, which include subscriptions, App Store fees, and other online services, grew 13% year-over-year. It’s also a higher-margin business than some of AAPL’s others, which potentially helps on the bottom line.

The iPhone is still AAPL’s biggest product by far, but it now represents a little under half of its revenue for the first time since 2012. If there’s a key takeaway, it’s that AAPL was able to grow revenue by 1% year-over-year to $53.8 billion even with the continued losses in iPhones, and this could bode well for the company going forward. It’s a sign that investments in its ecosystem might be starting to pay off for the company and it won’t be so heavily reliant on a product where demand is falling. 

By 2020, AAPL is expected to offer 5G capacity on its iPhones, so that could give the company’s core asset a potential boost. Another psychological boost in the June quarter came from Greater China, where revenue fell only 4% compared to a 20% drop the previous quarter. Trade-in and financing programs in that region appeared to help sales, the company said, along with government economic stimulus and lower taxes. 

Rate Cut Anticipated Today

With today’s Fed decision straight ahead, a 25-basis point rate cut is pretty much built in, according to the futures market.

Wild cards include the low probability of a deeper 50-basis point cut, and also what sort of dissent level we might see among voters at the Federal Open Market Committee (FOMC). If there’s a rate cut but the post-meeting statement shows high levels of opposition, that could potentially make people rethink the likelihood of additional rate cuts later this year. Right now, futures prices put high odds on the chance of one or two more cuts before 2020. 

Fed Chair Jerome Powell is arguably in a truly terrible situation. As we noted yesterday, there’s hardly anything he can say to please people. His path has been more of “Let’s wait, see what happens and go from there.” But the market is saying ‘you’re going to do it.’ 

We noted recently that the 12 level has been hard for the Cboe Volatility Index (VIX) to break through, and that looks true again this week. The VIX dipped below 12 for a bit last week, but it’s bounced back to well over 13, helped in part by nerves apparently triggered on trade when President Trump posted negative tweets about China early Tuesday. 

There’s more going on here than that. It appears some investors are putting money into VIX options as a hedge in case turbulence returns, especially with the Fed meeting concluding today and markets still near all-time highs. 

Dollar Defies Tradition

When a Fed rate cut comes into play, it often weighs on the dollar. That isn’t the case this time, as the dollar index climbed above 98 this week for the first time since late May. Strong U.S. economic and consumer data seems to be propping up the greenback, with Tuesday’s July consumer confidence number the latest firm reading. U.S. consumer confidence surged 11.4 points to 135.7 in July, much better than expected, after falling 7.0 points to 124.3 in June (revised up from 121.5). This is the best since November’s 136.4, and higher than the 127.90 level a year ago.

Keep in mind that consumer spending represents 65% to 70% of gross domestic product (GDP). So for anyone looking to see economic growth improve, this latest confidence data looks positive and also reinforces the consumer strength seen from many reporting companies so far this earnings season.

One company that could maybe have used a bit more consumer confidence in Q2 was Under Armour Inc (NYSE: UAA), where apparel sales fell more than 1%. Shares of UAA got smacked down 13% on Tuesday. Looking more closely at the numbers, UAA actually looks like one of the most interesting earnings reports so far this quarter. Their domestic sales didn’t look good, but they’re doing well overseas. That’s the opposite theme we’ve heard from almost every other company. 

Home builder D.R. Horton Inc’s (NYSE: DHI) stock got a nearly 6% boost Tuesday from earnings. What’s a little concerning is to see orders come up a bit short. Generally, though, the company blew away estimates with earnings and revenue. The housing market has been a concern for a long time, but we’re starting to see some encouraging numbers come out.

The numbers didn’t seem as encouraging for Advanced Micro Devices, Inc. (NASDAQ: AMD), which came up short of Street expectations with its revenue forecast outlook yesterday. Shares fell 3.6% in pre-market trading. 

Things looked better over at General Electric Company (NYSE: GE) and Amgen, Inc. (NASDAQ: AMGN), both of whose earnings got a nice reception from market participants in the early going Wednesday.

FIGURE 1: FED BALANCE SHEET HISTORY. Much of the "Fed talk" ahead of this week's meeting has focused on the Fed funds rate, and much less about the assets on its balance sheet, which currently stands at about $3.8 trillion. The balance sheet expansion continued for years after the end of the last recession, and the central bank has only recently begun inching it back toward pre-financial crisis levels. Data source: Federal Reserve's FRED database. Chart source: The thinkorswim® platform from TD Ameritrade. FRED® is a registered trademark of the Federal Reserve Bank of St. Louis. The Federal Reserve Bank of St. Louis does not sponsor or endorse and is not affiliated with TD Ameritrade. For illustrative purposes only.

On Balance (Sheet): As the Fed meeting commences this afternoon, it seems all eyes are on the Fed funds rate. Will they cut, and if so, will it be by 25 or 50 basis points? With so much focus on the front end of the yield curve, it's tempting to ignore the Fed's other major policy initiative—the paring down of its balance sheet, currently $3.8 trillion. While that's down a bit from the $4.5 trillion or so that it held from 2014 to 2018, it's still well above pre-crisis levels, when it typically held about $800 billion in assets (see figure 1 above). 

Thus far, the wind-down has consisted of buying fewer securities to replace those that have matured ("balance sheet roll-off"), rather than actually selling securities. So aside from the 2013 "Taper Tantrum" in which the market got spooked by the possibility the Fed would pare down too quickly, its effect on interest rates appears to have been muted. But the speed at which the Fed turned from hawk to dove this year begs the question: Might $3.8 trillion be about as low as the balance sheet gets this cycle? And if the global economy is indeed slowing down, might the central bank be discussing a return to balance sheet expansion? This is certainly something to keep an eye on, perhaps as much as the Fed funds target. 

Jet Lag for Multinationals: While consumer-oriented companies continue to report mostly decent earnings, companies with big international businesses are getting punished in the market. That got reinforced with data from FactSet this week showing that S&P 500 companies with less than 50% of their revenue in the U.S. have seen earnings fall more than 13% year-over-year so far this quarter, while companies with more than 50% of their revenue in the domestic market posting earnings growth at an average of 3.2%. Revenue growth has also been much better for companies with more than half of their sales in the U.S.

This backs up ideas that trade concerns could be hurting U.S. companies, especially multinationals like Caterpillar Inc (NYSE: CAT) and Ford Motor Company (NYSE: F), both of which reported disappointing results. It also calls into question how the Semiconductor sector might hold up, because it’s heavily exposed to China. The PHLX Semiconductor Index reached all-time highs this week. The other worry for multinationals is exposure to Europe’s flagging economy.

Don’t Forget Crude: The Fed is probably front and center, along with digesting Apple Inc’s (NASDAQ: AAPL) earnings. However, if you have the chance, it might be worth checking today’s weekly crude supply report from the Energy Information Administration (EIA). Last Wednesday, the EIA reported a huge draw of more than 10 million barrels, but at the time analysts said that might have been due to the Gulf hurricane that slowed production and imports. Crude has been rallying since the data.

Even with the big draw last week, crude oil inventories of 445 million barrels are 2% above the five-year average for this time of year, the EIA said last week. Continued heavy drawdowns, however, could put supplies in a place where strong demand could have a bigger impact on crude prices. That could help boost Energy stocks but might be a drag on some Transportation stocks.

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