Apple Rallies - Small Caps Outperform Sharply
On the day before the Fed’s rate decision and the trading session before Apple Rallies reported, stocks mostly fell. Although small caps rallied. On Tuesday S&P 500 fell 0.26%, Nasdaq fell 0.24%, and Russell 2000 rose 1.06%.
VIX increased 8.65%. It’s interesting to see that the KBW regional bank index rallied 1.17% ahead of the Fed’s rate cut. Maybe investors already priced in the cut and this is a relief rally. That’s why you sometimes see a stock or market rally on highly anticipated bad news.
1 Rate Cut Incoming
Apple Rallies - If you would have asked me a month ago, I would have said this rate decision is huge, but now I think it is overhyped. Fed probably won’t shock the market with its statement as it will be neutral.
As you can see from the chart below, this will be the first rate cut in 3,878 days which is the longest streak without a cut since 1954. While that’s interesting, it doesn’t matter now because this cut has been priced in for weeks.
As of Tuesday, there is still a 100% chance of a cut. There is a 21.9% chance it is a double cut.
This chart is slightly misleading in the sense that it’s not like rates were too high for too long. Rates were at zero for years. So the Fed couldn’t cut them unless it wanted to experiment with negative interest rates. It’s debatable if the Fed ever had hawkish policy.
Only analysis that shows the Fed got hawkish is the shadow Fed funds rate. I say it’s debatable because the exact impact of the expansion and contraction in the Fed’s balance sheet is uncertain.
Apple Rallies - 3 Options For Fed Guidance
Language in the statement will impact the Fed funds futures market along with all other markets. TD Ameritrade slide below perfectly previews the Fed decision.
As you can see, a hawkish bias, which has a 15% chance of occurring, would be if the Fed excludes the part of the statement where it says it will act appropriately to sustain the expansion. I don’t see that part being removed. Entire point of this rate cut is to sustain this expansion.
Fed would need to see the global economy improve and the trade war end to stop cutting rates. There is no way anyone can look at the recent global economic data and say a turnaround is underway. There are only trade negotiations ongoing, just like in May.
I know it’s boring, but I see the base case scenario occurring (it has 60% odds).
In this situation the Fed leaves the statement about sustaining the expansion. And Powell leaves the door open for more rate cuts.
Apple Rallies - In the base case, the 10 year yield rises 3 basis points and the 5s 30s falls 2 basis points. There shouldn’t be much of a reaction to policy meeting expectations.
Finally, the dovish case is the Fed hinting more cuts are coming regardless of future data and Powell showing he’s willing to overshoot the inflation target. I can’t see Powell going with that narrative with core PCE only at 1.6%. Fed is a few months away from core inflation getting close to 2%.
Apple Rallies - Stock Nears Record High On Earnings Beat
Apple was the last major tech firm to report earnings. With its earnings beat, there were 4 good reports (Facebook, Apple, Alphabet, & Microsoft) and 2 bad ones (Netflix & Amazon). Apple beat EPS estimates of $2.10 by 8 cents.
Revenues of $53.8 billion beat estimates for $53.39 billion. As a result of this beat, Apple stock rose 4.48% after-hours which means it is very close to its record closing high of $232.07.
It’s interesting that Apple beat revenue estimates. Yet services and iPhone revenues both missed estimates. iPhone revenues were $25.99 billion which missed estimates for $26.31 billion. Services revenues were $11.46 billion which missed estimates for $11.61 billion.
As you can see from the chart below, yearly revenue growth was only 1%. Trailing 12 month product revenue growth was -0.63% on a quarter over quarter basis. By the same metric, services revenue growth was 4.56%.
Two best parts of this report were the rebound in greater China revenue growth and guidance.
Apple Rallies - Greater China revenue growth improved from -22% to -4%. In describing this improvement, Cook stated, “The VAT reduced from 16% to 13%, that’s clearly a big help. We took some price action, that’s a big help. We introduced trade-in and financing, that’s a big help. The more subjective thing is, when the countries are meeting and talking, that’s better than not.”
Q4 revenue guidance was for $61 billion to $64 billion which beat estimates for $60.98 billion.
As you can see from the chart below, iPhone sales fell. They were down 12% from last year. iPhone sales can’t keep falling if Apple wants to grow services revenues. Importance of services makes it even more important for Apple to improve its offerings in the mid-priced smartphone market.
Apple Rallies - Apple is becoming less of an iPhone company
Services and wearables are growing quickly and because iPhone is declining.
As you can see from the chart below, iPhone was 48.3% of the business, wearables was 10.3%, and services was 21.3%. The wearables segment, which includes Watch, AirPods, and Beats, had 50% revenue growth.
AirPods will never be the next iPhone, but it has been a wildly successful product. Services revenues were up 13%; they increased 18% when you ignore forex and lawsuit payments. This division has margins of 64%.
Conclusion
Apple Rallies - The stock market will probably pop mildly on the first rate cut of the cycle. Fed will put forth neutral guidance. It is ready to cut rates again, but it won’t guarantee further cuts.
Rate cuts depend on the global economy, trade negotiations, and inflation. Apple reported a solid quarter as its greater China business showed less of a decline.
Apple’s results were led by growth in the wearables segment. Even though Apple is focused on services, its new devices later this year will determine its level of success starting in Q1. This has been a solid earnings season for the big tech names.