Will The Fed Cut Rates?

The U.S. economy keeps throwing curveballs, and the May employment report is the latest example.

Employers added 272,000 jobs last month, well above what economists had expected as hiring gradually slowed.

Most concerning for the Fed, which meets next week and again in July, wages rose 4.1 percent from a year ago—a sign that inflation might not yet be vanquished.

The report also showed the unemployment rate rising for a second straight month.

RATE CUTS:

Wall Street is hoping for at least one cut to the Fed’s benchmark interest rate before the year ends. “To those who are worried about inflation, especially the Fed, the report should raise concerns that wage pressure and sticky inflation is more likely to persist than be transitory,” said Chris Zaccarelli, chief investment officer for Independent Advisor Alliance.

Fed officials are expected to hold interest rates steady at their meeting this week. After the jobs report came out, investors took even more bets off the table that the Fed would cut rates at its July meeting, according to data from CME Group.

WARNING SIGN?

MSFT, NVDA & APPLE—have accounted for 20% of the index for multiple days in the past two weeks. May 28 was the first time on record that the S&P 500’s top three stocks were worth more than 20% since at least 2000, according to Dow Jones Market Data. The closest it came before this was on Sept. 1, 2020, when Apple, MSFT, and AMZN—the top three at the time—made up 19.88% of the S&P 500.

Bear Traps Report founder Larry McDonald argues that it’s even more extraordinary than that: his data show that the index’s largest three stocks have never accounted for a fifth of the S&P 500 before in its history. In fact, in the past 40 years, the top 10 companies’ weight has tended to hover around the 20% mark.

Nvidia will soon be a more affordable stock for individual investors. And if you already own the 3 trillion chip giant, you’re about to have more shares at a lower price.

Nvidia’s big 10-for-1 stock split takes effect Friday after the closing bell. Shareholders of record as of Thursday, June 6, will get nine additional shares of the stock after the close on Friday.

A stock split could eventually pave the way for Nvidia to be added to the Dow Jones Industrial Average.

Nvidia, which is a price-weighted average instead of a market-cap weighted index like the S&P 500 at its current price, would be the largest component in the Dow. But it would be in the middle of the pack following the stock split. Nvidia competitor Intel is struggling and currently has the lowest weighting of any Dow component, with a stock price of just above $30.

Nvidia will begin trading at its lower post-split price Monday morning. So if you own one share, currently trading at about $1,210, you’ll wind up on Monday with 10 shares at a price of around $121.

What happens after that though? Nvidia’s stock has already surged ahead of the split, climbing nearly 30% since the announcement of it was made on May 22. The split isn’t the only reason for Nvidia’s latest bull run. The company also reported strong sales and earnings and a healthy outlook a few weeks ago in addition to the stock split. It also disclosed plans to raise its dividend, which is still tiny, by 150%.

So can Nvidia, which is up more than 150% in 2024, keep heading higher? That will largely depend, of course, on whether the company continues to post above average increases in earnings and revenue. And the artificial intelligence boom seems to be only in its early stages.

But history also shows that companies that split their stock tend to outperform after the split, even though nothing fundamentally changes about the company. It’s incorrect to say the stock is “cheaper” since its market capitalization, price-to-earnings ratio and other valuation metrics don’t decrease following a split.

According to data from BfoA Global Research, average returns for companies announcing stock splits are about 25% during the 12 months after a split is announced versus 12% gains for the S&P 500.

It makes sense. Companies announcing splits in the first place tend to be ones with a rising stock price due to strong earnings momentum. So it stands to reason that a company like Nvidia should continue to do well after a split, especially if the lower share price entices more individual investors who may have been scared off by a quadruple-digit stock price.

It’s also worth pointing out that Nvidia’s stock actually is trading at a lower valuation now than it was earlier this year, despite the stock’s pop. Nvidia has a price-to-earnings ratio of about 45 based on this year’s earnings forecasts. But Nvidia was trading at a P/E of nearly 60 in February. The stock has gotten “cheaper” because earnings estimates have risen sharply over the past few months.

“Nvidia is still going higher but the valuation has been cut,” said Jeff Mills, chief investment strategist at Bessemer Trust. “Stocks can continue to run as long as earnings go up.”

That could very will wind up being the case for Nvidia after its split. Two other high-profile stocks that recently split their shares have maintained their momentum as well. WalMart (WMT -1.89%) is up more than 15% since a 3-1 stock split in February, and Amazon (AMZN -0.38%) has surged 50% since splitting two years ago.

So don’t be surprised to see more blue chip companies joining the stock split parade in the coming months.

Apple’s Stock Is Counting on It.

Apple is expected to use its WWDC keynote address on Monday to provide updates around its AI strategy. Apples shares have been rallying in advance of the event.

Nvidia this past week topped the $3 trillion market value level for the first time, briefly supplanting Apple as the world’s second-most valuable company. (Microsoft still holds the top spot, though not by much).

The contrast between Nvidia and Apple is stark. Nvidia shares have railed 144% this year. Apple is up 1%. Nvidia grew revenue 262% year over year in its most recent quarter, thanks to insatiable demand for artificial intelligence chips. Apple’s latest quarterly revenue was down 4%.

Nvidia sales have nearly quadrupled over five quarters. Apple has suffered year-over-year sales declines in five of its past six quarters.

You get the idea: Nvidia’s business is hot. Apple’s is not.

All of that underlines the importance of CEO Tim Cook’s keynote address at Apple’s 2024 Worldwide Developers Conference, scheduled for Monday at 10 a.m. Pacific.

Forty years ago, Apple used WWDC to highlight its new Mac. This year, the event will be all about AI. And for good reason. The uninspired performance of Apple shared reflects the company’s lack of substantive progress in generative AI, arguably the most important tech development in decades.

To be clear, Apple hasn’t been sitting idle. The company has been including neural processing capability in iPhone and Mac chips since 2017. Apple uses AI for facial recognition to unlock iPhones, for fingerprint scanning on Macs, and to improve iPhone photos. Apple has published papers on large language models, and Cook has made vague promises of AI magic to come.

But now Apple has to deliver. Here are four key themes surrounding this year’s keynote:

Sam I Am: Apple seems unlikely to directly take on OpenAI, Microsoft, Meta Platforms, Alphabet’s Google or Anthropic in large language models. Instead, Apple will likely partner with an LLM provider, not unlike its longstanding search relationship with Google.

The smart speculation is that Apple will join forces with OpenAI and its cloud computing partner Microsoft (Might OpenAI’s Sam Altman show up Monday? Or even Microsoft’s Satya Nadella? Stay tuned).

Just how an Apple-OpenAI relationship would work is murky. Google pays Apple a whopping $20 billion a year to be the default search engine on iPhones and in the Safari web browser; Google in return gets search traffic it monetizes with ads.

In the case of AI, the monetization options are less clear. The cash flows could conceivably reverse, with Apple paying OpenAI—and in turn Microsoft—for the compute time required by users’ generative AI requests. Apple theoretically benefits indirectly from higher iPhone sales and reduced customer churn.

Gene Munster, managing partner at Deepwater Asset Management and a longtime Apple analyst, has mixed feelings about Apple’s likely approach. Aligning with OpenAI, he says, amounts to “outsourcing the fabric of the company.” But he adds that teaming up with OpenAI would effectively accelerate Apple’s AI efforts by five years.

Any AI deal that Apple cuts is likely get close regulatory scrutiny. Remember that a decision is expected later this year in a Department of Justice antitrust suit against Google that could lead to a forced breakup of Apple and Google’s search deal.

Siri Is Dead. Long Live Siri: I recently asked Siri how it compares with ChatGPT, the chatbot from OpenAI. Siri gave me links. ChatGPT answered the same question in prose. While Siri is “optimized for quick tasks,” ChatGPT told me, “I am designed for deeper, more comprehensive conversations, creating writing, and detailed explanations across a wide range of topics.”

With the help of AI, Apple is likely to transform Siri into a digital assistant that adds the full chatbot experience on top its existing weather reports. Analysts expect hooks into Apple’s native applications, such as Mail, Messenger, Music, and Safari.

What could take longer is connecting Siri with third-party apps. Someday, you’ll be able to get Siri to call you an Uberwhen you fly into a new city. Eventually, Siri should simply figure out when you’ve landed and ask if you need an Uber. But not just yet.

Big Models, Small Models: There are obvious issues with relying on cloud-based AI. Queries are expensive, requiring far more computing power than internet search. There are privacy risks. You need a network connection. And there are latency issues—it can take time to get responses.

It seems likely that in addition to a cloud AI partner, Apple will offer AI capabilities that rely on smaller models running locally on iPhones, iPads, and Macs. Imagine AI apps for health and fitness or for suggesting email responses. Expect AI-powered text summarization, new AI-enabled photo editing, AI image creation, and perhaps on-the-fly language translation.

Expectations Risk: Apple shares have been rallying lately in hopes of an AI miracle. “The one thing that will get answered is what Apple’s AI strategy is going to be,” Goldman Sachs hardware analyst Michael Ng says.

But Ng adds that the Gen-AI features coming at WWDC won’t necessarily make a big difference in the company’s near-term financial outlook. The real question is whether it will drive hardware sales over time.

Morgan Stanley analyst Erik Woodring thinks Apple will launch some AI experiences that will only run on iPhone 15 Pros and future models.

Ng expects iPhone unit growth of 4% in fiscal 2025, after a 2% decline in 2023.

Will that be enough for Apple bulls? That’s one question even ChatGPT can’t answer.

Smaller company stock fared much worse. The Russell 2000 fell 1.1 percent and is a source of concern to me because it hasn’t joined the party of record highs, which of course makes the foundation of the market stronger. I would keep a close eye on the Russell 2000.

- Richie

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