Earnings misses and fallout from the UK inflation report

The main story as we move towards the end of the week is the 6.3% decline in Tesla shares, and the more than 8% decline in Netflix shares after their earnings reports for Q2 missed expectations. The market is once again punishing companies if they do not meet or exceed earnings expectations, they punish them even more so if the stock looks over valued. For example, Tesla, even with Thursday’s sharp decline, is still up 134% so far this year, while Netflix is up 47.8% YTD, so there could be further downside to come. The selloff post their earnings reports will hardly make a dent into these stellar 2023 performances, but the question for investors now is whether this is the high point for some over-valued tech stocks for this year? If the answer is yes, then there could be better opportunities elsewhere.

Tesla: when the market tires of growth stocks

Looking at Tesla first, the future does not look bright. It announced that profitability could take another hit later this year, and that it will have to continue to cut prices to attract customers, which is hurting its gross margin, which fell to a 4-year low in Q2. As well as having to cut prices, it is also increasing costs to create a cybertruck, it is planning to spend $1bn this year on the Dojo, an in-house supercomputer, and upgrades to its factories could lead to a dip in car production, which has reached 1.8 million so far in 2023. Two things are hurting Tesla right now: 1, discounting is necessary during weak economic times when interest rates are high, but it hurts margins and 2, AI spend is expensive. High spend and low profitability is a hallmark of a super growth stock, however, while the market was happy to buy Tesla stock earlier this year as the sale of vehicles expanded, they are now not happy that profits aren’t following suit. Thus, investors are part of the problem for tech stocks right now: they like growth, but they also love profits, so they should probably look for a growth-value stock hybrid. Since few of these exist, the answer for investors is to broaden out their exposure to stocks, especially US stocks, beyond tech. Therefore, the selloff in Netflix and Tesla hasn’t been too detrimental on the overall S&P 500, which is down a mere 0.24% on Thursday.

Netflix: on the cusp of a negative turnaround?  

Netflix’s share price is experiencing its biggest decline so far this year on Thursday. Even though it grew its subscriber base by 8%, sales rose by 2.7%, less than analyst expectations, and it generated less revenue per customer in Q2, because of foreign exchange effects and cutting prices in some markets. This suggests that Netflix’s crackdown on password sharing is not doing enough to boost the bottom line. After a strong stock market performance in the last 6 months, the market isn’t willing to accept a sales miss of this magnitude and Netflix is getting punished. In terms of its long-term outlook, that will depend on how it can monetise its content through ads. It recently scrapped its cheapest AD-free plan, which has not gone down well. Added to the writers’ strike, which is likely to boost Netflix’s free cash flow for the rest of this year by $1.5bn to $5bn, there are lots of unknowns when it comes to Netflix’s outlook for the next 6 months, which is why investors are ditching the stock on Thursday. Netflix is traditionally a volatile stock, while we still consider it to be a fantastic streaming platform, it has challenges, which is why profit-taking is taking place. If we continue to see declines in the stock price into next week, then it could signal a deeper downturn.

Market expects a slow pivot from the Fed

Elsewhere, the stock market rally is broadening out as the narrative shifts to lower inflation and the potential for a Fed pivot later this year. The Federal Reserve is in a quiet period now ahead of their meeting next week. The market is fully expecting the Federal Reserve to hike rates next week, and there is a 99.8% chance of this happening. The market expects next week’s move to 5.25-5.5% to be the peak for US rates this cycle, and for rates to start to fall from Q1 2024. Thus, rates are expected to remain elevated for most of this year before a slow pivot lower later this year.

The fallout from the UK inflation figures

In the UK, expectations for interest rates seem to depend on monthly data releases, which is a bit stupid, if you think about it. There is a good argument to be had that UK inflation has been overstated in recent months. Food prices, which make up nearly a quarter of the CPI basket, do not consider selective discounts that are given to loyalty card holders, for example Tesco Club Card or Sainsbury’s Nectar Cards. In the US they do take account of selective discounts, so their food price inflation is both lower than the UK’s and more accurate. However, Wednesday’s large decline in price pressure, and the drop in core prices, has had a big impact on UK financial markets. The 2-year UK government bond yield has fallen more than 20 basis points this week, and GBP/USD is lower by 1% so far. The decline in UK inflation is allowing the dollar to catch a bid, which is giving the buck some much needed respite. The dollar upswing is also impacting the euro, which has backed away from $1.12 this week. USD/JPY is higher this week, as the lack of yield continues to hold JPY back.

Is the UK at risk from deflation?

Overall, this week has shown us a few things: 1, earnings matter but the stock market rally is broadening out beyond tech. 2, The market is obsessed by UK inflation figures, and this impacts the real economy, after stronger inflation data for May that sent mortgage rates surging, the weaker figures for June have reversed some of this increase. Thus, inflation data matters, albeit for all of the wrong reasons. The market is paying far too much attention to inflation data, and as former BOE governor Mervyn King said on Thursday, the BOE needs to be wary of over-tightening, as the UK money supply shrinks rapidly. Going forward, it is worth noting that UK M1 data has fallen back to 2022 levels, if this continues then it could be a sign that 1, the UK is at risk of deflation, and 2, recession for the UK is on the cards.