AMD, SOX: Fed impact could magnify downside to AI names
Movement in Treasury rates following FOMC meetings typically has material impact on tech stocks. The FOMC event today we think could be less about the timing of Treasury rate cuts and more about an acknowledgement by the Fed that the underlying economy is running stronger than expected, and that the odds of a recession have come down. In our view the market reaction to such a take-away would be for investors to shift allocation towards economically sensitive cyclical names, such as industrial and commodity names, and away from high-growth secular names, such as the AI-fueled semis and software names.
The AI-exposed names which reported yesterday, AMD and GOOG but perhaps not MSFT, may be just a tad off in the delivery of good news to investors. This slight roll-back in fundamentals could be compounded by the Fed event today and could result in trimming of recent gains by AI-exposed names.
The significant runup in these names since early Nov, following the Fed’s November meeting has been in no small part due to a significant drop in real rates since Nov (Exhibit 1), in our view. Falling real rates provide tailwinds to equity multiples of secular growth stocks. Could there be a further drop in real rates from current levels? We doubt it. If anything, real rates could move up if the Fed were to lower the odds of a recession. Rising real rates could provide headwinds to multiples, just as they did in the Aug-Oct period of rising real rates. Even if real rates move sideways, as they have been doing of late, the loss of downward momentum in rates could provide loss of upward momentum to equity multiples.
We would look to trim positions in high-growth AI-exposed names and add to cyclical names in the memory/storage and Industrials/Consumer sectors. We would trim position in AMD and look for a 10%-15% pullback from yesterday’s close. SWKS would be a good cyclical name to get behind.
Thoughts on AMD: Into a slightly disappointing AMD report, the stock could have held up well into investor anticipation of upside to MI300X outlook provided yesterday. However, we think the Fed’s stance today may compound the modest earnings disappointment. We would be wary of adding to position at current levels; we would rather wait for a 10%-15% pullback.
We note that excluding the MI300X product, AMD’s 2024 annual outlook implied by management’s qualitative comments points to revenue flat to down slight for the
year, not exactly a ringing endorsement. The company appears to be muddling along entirely on the strength of the MI300X product line.
Macro discussion into Fed event today: There has been a lot of discussion on the Street with regards to the Fed being under pressure to cut nominal rates just so real rates do not spike to the upside in response to falling inflation. We think this is something of a spurious argument. We think the Fed has the luxury of stringing the Street along without having to provide timing of cuts. However, it needs to give a reason as to why they are in no hurry.
We think the critical signal coming out of this meeting is not the timing of rate cuts, but rather an acknowledgement from the Fed that, the surprising strength in the economy, despite high interest rates, reduces the odds of a recession in the medium term. Hourly wages growth, which had been declining most of last year, seem to have stabilized in recent months (Exhibit 2). Consumer confidence metrics show unusual strength. If so, where is the urgency to cut rates?
Real rates have already declined, rather dramatically, in response to dovish Fed Chair comments following the FOMC meetings last November and December. On a 2s, 5s and 10-year basis, real rates have already dialed in rate cuts at some point of time in the future; they may be relatively immune to the exact timing of the cuts.
If anything, there is a case to be made that the Fed may hint at downside to the number of cuts penciled into the SEP at the Dec FOMC meeting. The 1st estimate of Q4 GDP has come in significantly ahead of market expectations prevalent at the time of the Fed’s December meeting. Q1 GDP estimate out of the Atlanta Fed too is running hot, close to the Q4 level. In other words, the economy shows no sign of cooling down. So why would the Fed be anxious to cut rates?
Just as the Fed was loathe to raise rates in the absence of data in the days of high inflation (2022-23), one would think the Fed would be just as loathe to cut rates in the absence of data signaling signs of cooling economy and deteriorating labor markets, neither of which exist today.
That the Fed could indicate rate cuts in anticipation of rising real rates (as inflation cools further) is just not a good enough reason, it seems to us. This argument is especially ill-conceived as real rates have already fallen to a long-running median level (dotted line in Exhibit 1). If on the other hand real rates were running close to where they were back in Oct (prior to the Nov FOMC meeting), we would imagine the Fed might have been a bit more nervous allowing real rates to gallop further. This is not the case today.
If there is something to worry about, however slightly, it would be the nonfarm payroll on a 3-month averaged basis (Exhibit 3). This data has been trending down, as it should. In recent months though, the 3-month moving average has cut below the pre-pandemic average monthly level (dotted line in Exhibit 3). And yet the level (~165k) is still quite a bit away from getting into the negative territory, which would then need a response from the Fed. But the downward trend bears watching as it creeps closer to zero. So, the Fed will wait for more data from the labor markets before making a move.
Net/Net: We think the Fed is likely to acknowledge the surprising strength in the economy even as inflation metrics trend closer to the Fed’s target. In such an environment, standing pat and letting fed rates stay where they are, may be the best strategy.
If the downward movement in real rates is behind us (i.e. no further gains in the multiples of high-growth names) and if the odds of a recession have come down, then it seems to us that a good portfolio strategy would be to trim high-growth AI names into their recent outperformance and then allocate capital to cyclical names, which have underperformed the indexes over the past three months.
