Sidekick Money · Market Pulse: Carburetors to C++, the UK economy clings to growth, and US corporate earnings

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Welcome to this week’s Market Pulse, your 5 minute update on key market news and events, with takeaways and insights from the Sidekick Investment Team.

In this week's edition we have:

Carburetors to C++. A radical transformation.
The UK economy clings to growth.
US corporate earnings. This time is different. Or is it?

It’s important to note that the content of this Market Pulse is based on current public information which we consider to be reliable and accurate. It represents Sidekick’s view only and does not represent investment advice - investors should not take decisions to trade based on this information.

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1) Carburetors to C++. A radical transformation.

Tesla is best known for kicking off the electric car revolution. But it also kicked off a battle between big tech and the automotive industry. Who owns the digital user experience in the car of the future?

When Tesla launched the Model S all the way back in 2012 it was one of the first vehicles considered to be software defined. This meant it was constantly connected to the internet and could get software updates on the go. Just like your iPhone.

Tesla delivered this new digital experience via a 17 inch in-car display. The sheer size of the display had people, quite rightly, call it an iPad on wheels. The large display was to be the centrepiece of the driving experience. Tesla was also adamant that it would develop its own fully integrated hardware and software systems and not rely on any external technology partners.

That was more than a decade ago. Today, Tesla is no longer alone in understanding the value of using an in-car display to enhance the driving experience. Other car makers quickly followed as they realised that advanced car infotainment systems provide a way to truly differentiate their product.

McKinsey estimates that in-car data driven products could create as much as $400bn in annual revenues by 2030[1]. Tech titans Apple and Google wanted a piece of this pie and launched Apple Carplay and Android Auto to give users an in-car experience that they’re familiar with.

But car makers are catching on that they’re giving away valuable real estate. Last week GM announced they will no longer offer Apple Carplay in some of their new EVs[2]. They want to own both the hardware and the software so that they can control and optimise the user experience.

GM isn’t the only automaker making some big moves. Auto tech provider ECARX, which serves the likes of Volvo and Mercedes Benz, recently announced they are partnering up with Fortnite maker Epic Games. They want to use their Unreal Engine to develop high resolution 3D visuals to deliver a slick interactive experience[3]. Software defined vehicles are quickly becoming the norm and the car infotainment space is getting increasingly competitive.

This could mean better products for us as consumers and who knows, maybe the slightly boring auto companies of yesterday are the tech titans of tomorrow.

2) UK economy clings to growth

The UK economy eked out 0.1% growth in the first quarter this year. This follows the 0.1% growth in the last quarter of 2022 and this means the UK economy barely avoided a recession[4].

While the growth rate is nothing to write home about it is better than the Bank of England expected back in February. They predicted the UK economy will be in recession for 2023 and only start growing again in 2024.

Thanks to lower than expected energy prices and stronger global growth they now predict UK economic growth will accelerate later in 2023 and won’t have a recession at all[5].

Despite having avoided a recession, the UK is still a growth laggard compared to other G7 countries. The UK economy is only 0.5% bigger than it was pre-Covid while the US is more than 5% bigger and the EU is 2.5% bigger[6].

Despite anaemic economic growth, the Bank of England still decided it was the right thing to hike interest rates at their meeting last week. The UK interest rate is now 4.5% and financial markets expect it could reach as high as 5% later this year[7]. The Bank of England also revised their inflation forecast. They now expect inflation to get to their 2% target later and not before early 2025[8]. This could mean no interest rate cuts, or any much needed respite for borrowers, until 2025.

The BOE warned that most households have not yet felt the full effect of higher interest rates. As many as two thirds of UK households have yet to refinance their fixed rate mortgages[9]. This could lead to a big hit to household consumption over the coming months.

While it’s great news that the UK might completely avoid a recession, the fact that inflation could be above target until 2025 means we all have to live with higher interest rates for a lot longer than we would like.

3) US corporate earnings. This time is different. Or is it?

The US corporate reporting season is drawing to a close and S&P 500 profits are estimated to have dropped by close to 4% year-over-year[10]. This is the second consecutive quarter of profit declines. Data compiled by Bloomberg show analysts expect US corporate profits to fall by more than 7% next quarter. This will be the first time US corporate profits have fallen for 3 consecutive quarters since 2016[11].

But despite falling profits, the S&P 500 is up more than 7% year-to-date. This divergence between the direction of profits and the market has many market participants scratching their heads. One might argue that the stock market has already fully priced in the slowdown in profit growth. After all, the S&P 500 fell more than 19% in 2022. While this might be the case, a cursory look at history is interesting.

There aren’t that many periods over the last few decades where S&P 500 profits fell for 3 or more consecutive quarters. Most notably it happened in 2001, 2008 and then again in 2016. In all those periods the S&P 500 reached its lowest point well into the earnings decline…not before and not during the first or second quarter of profit declines either. This begs the question, will this time be different?

Digging deeper into the 2023 performance data yields interesting insight. An analyst from Socgen suggests that without the key AI stocks, like Nvidia, Microsoft and Alphabet, the S&P 500 would be down 2% for the year[12].

Traditionally, companies buying back their own shares have been a key pillar of support for stock prices. But this pillar is waning. As companies face higher borrowing costs and increasing pressure on profitability they are cutting stock buybacks. Buybacks by S&P 500 companies are down more than 20% compared to last year[13].

Given the US regional banking crisis and a pending debt ceiling showdown it should come as no surprise that a recent survey by Bank of America revealed fund managers have cut their exposure to stocks relative to bonds to the lowest level since 2009[14].

We don’t know for how long corporate buybacks and AI related stocks will be able to support the market but when they run out of steam things could get more difficult.

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