Sometimes the macroeconomic outlook changes like the weather, and investors find themselves sailing in a crosswind of uncertainty.
The Reserve Bank of Australia (RBA) is ensnared in a catch-22 dilemma: whether to raise rates to tame inflation and risk plunging the economy into recession, maintaining the current status with the hope that inflation will abate and the economy will grow; or yield to calls for cuts due to cost of living crisis. The delicate balance between addressing inflationary pressures and safeguarding against economic downturns underscores the RBA’s reluctance to adjust interest rates, especially given the alarming rate of growing national household debt. In the broader global context, despite speculation surrounding the US Federal Reserve’s potential influence by election cycles, historical data reveal a consistent pattern.
Since 1980, the Fed has both hiked and cut rates in every election year except 2012, when rates remained at zero amid post-financial crisis recovery.
Often we see media speculation around interest rate movements which can tend to be overblown in either direction. Headlines calling for multiple rate rises could signify that we’re closing in on peak interest rates. Furthermore it wasn’t long ago that there was discussion around multiple rate cuts occurring during the 2024 calendar year.
Predicting inflation rates often hinges on the relationship with unemployment figures.
Logically, when more individuals find employment, increased disposable income propels consumer spending, thus stimulating economic activity. This interplay underscores the pivotal role of interest rates, which central banks manipulate as a lever to regulate economic growth and inflation. During periods of economic overheating, central banks may raise interest rates to mitigate inflationary pressures, while lowering rates during downturns stimulates borrowing and spending, bolstering economic activity.
Meanwhile, inflation, the measure of price increases for goods and services, exerts its gravitational pull on interest rates. High inflation erodes purchasing power, prompting investors to demand higher interest rates to offset the loss in value. Conversely, low inflation or deflationary pressures may warrant lower interest rates to stimulate consumption and investment, thereby fostering economic growth.
Given the fluid nature of interest rates and inflation, investors must adopt a strategic approach to prepare for varying scenarios.
Rising Interest Rates and Inflation
In this scenario, central banks hike interest rates to rein in inflationary pressures.
Investors typically face headwinds as higher borrowing costs dampen consumer spending and corporate earnings. Industries sensitive to interest rates, such as financials, growth stocks and utilities, may experience heightened volatility. In an environment like this, sectors such as healthcare act as a safe haven and are widely regarded as a reliable and defensive investment which tend to fare better during periods of economic tightening.
Falling Interest Rates and Rising Inflation
Central banks may respond to sluggish growth by slashing interest rates despite mounting inflationary risks.
Equity markets may experience a temporary boost as lower borrowing costs stimulate economic activity. However, sustained inflationary pressures could erode purchasing power over time, especially for fixed-income investments. Investors will often see strength in inflation-resistant assets such as commodities which can act as hedges against rising prices.
Stagflation
Stagflation is characterised by stagnant economic growth coupled with high inflation.
It poses a unique challenge for investors where traditional asset classes may struggle to generate meaningful returns in such an environment, prompting investors to explore alternative strategies. Historically, investing in dividend-paying stocks with strong cash flows and pricing power can provide a buffer against inflationary pressures. Additionally, allocating a portion of the portfolio to gold or inflation-linked bonds can serve as a hedge against the erosion of purchasing power.
Higher For Longer
A narrative that is being pushed lately is the likelihood that we see extended periods of higher interest rates.
This can impact investors in several ways. Firstly, stocks become less attractive relative to fixed-income investments like bonds, leading to a potential decrease in stock prices. Secondly, companies face higher borrowing costs, reducing profitability and potentially dampening stock prices. Additionally, the present value of future cash flows from stocks decreases due to higher discount rates, exerting downward pressure on prices. Prolonged higher rates can also slow economic growth, negatively affecting corporate earnings and overall market performance. Sectoral effects may vary, with interest-rate-sensitive sectors experiencing more significant declines compared to others.
What Action Should Investors Take?
Feeling anxious about macroeconomic developments is natural, but making investment decisions based on emotions is detrimental.
Reflecting on Howard Marks’ insights from his 2022 memo, “What Really Matters in Investing,” we’re reminded of the lesser relevance of macroeconomic news in daily investment decisions. Despite the media’s focus on fluctuating interest rates and economic forecasts, Marks argues that these elements are often unpredictable and inaccurately assessed in terms of their market impact. He emphasises the importance of adopting a long-term investment perspective, avoiding the pitfalls of speculative trading, and prioritising the intrinsic value of businesses. This aligns with the time-tested investment philosophy of Warren Buffett, who champions long-term ownership over short-term gains, suggesting that consistent, thoughtful investment outweighs the erratic nature of economic cycles and media hype.
In other words, the titans of the investment world advise we tune out market noise, concentrate on company fundamentals, and maintain a rational, disciplined approach to investing.
The TAMIM Takeaway
The tug of war between interest rates and inflation presents both challenges and opportunities for investors.
By understanding the dynamics of this relationship and preparing for various scenarios, investors can position their portfolios to weather market fluctuations and capitalise on emerging trends. Flexibility, diversification, and a keen awareness of macroeconomic indicators are essential tools for navigating the ever-shifting landscape of global finance.
As the battle between interest rates and inflation rages on, savvy investors stand ready to seize the moment and unlock the potential for long-term wealth creation.
Few entities wield as much influence as tech behemoths Microsoft (NASDAQ: MSFT) and Alphabet (NASDAQ: GOOG).
These tech titans’ quarterly performances serve as litmus tests for market sentiment and economic health. As stalwarts in their respective domains, Microsoft’s innovative software solutions and Alphabet’s pervasive online presence not only shape industry standards but also hold the power to sway investor confidence and dictate market trends. The quarterly results are eagerly awaited by analysts and investors alike, as their outcomes often reverberate far beyond their individual stock prices. Indeed, the ripple effects of Microsoft and Alphabet’s performance can be felt across major indexes, with the S&P 500 and NASDAQ Composite often hanging in the balance of their success or failure.
Both key members of the ‘Magnificent Seven’, Microsoft and Google picked up where they left off last quarter delivering strong results in March. We take a closer look below:
Microsoft
Back in March we wrote why we own Microsoft and with the release of recent results our conviction remains.
Microsoft’s March 2024 quarterly performance showcased impressive growth across key financial metrics. Revenue grew to $61.9 billion, marking a 17% increase compared to the previous year, while operating income rose by 23%, driven by growth in Artificial Intelligence (AI). In the Productivity and Business Processes segment, revenue reached $19.6 billion, climbing 12%, with strong performances from Office Commercial products and cloud services, Office Consumer products, LinkedIn, and Dynamics products and cloud services.
The Intelligent Cloud segment saw revenue of $26.7 billion, representing a strong 21% increase, driven primarily by growth in server products and cloud services, particularly Azure which itself grew by 31%.
Revenue in the More Personal Computing segment reached $15.6 billion, rising 17%, fueled by increased Windows revenue, Xbox content and services revenue driven by the Activision acquisition, and growth in search and news advertising revenue. Additionally, Microsoft returned $8.4 billion to shareholders through share repurchases and dividends during the third quarter.
Microsoft anticipates solid performance in the following quarter, with revenue projected between $63.5 billion to $64.5 billion, which was slightly below consensus estimates.
For fiscal 2025, double-digit revenue growth is expected, albeit with operating margins declining marginally. The company remains a leader in AI, driven by its partnership with OpenAI, with demand exceeding capacity, indicating future growth. Capital expenditures are set to increase notably, primarily due to cloud and AI infrastructure investments, reflecting Microsoft’s commitment to scaling its operations in response to growing demand. Azure revenue growth in Q4 is forecasted at 30% to 31%, propelled by Azure consumption and AI contributions.
Alphabet
Alphabet witnessed a remarkable 10% share price increase following the release of its quarterly results sending the shares to all time highs. The move marked its sharpest rally since July 2015.
The tech giant reported stellar financial performance, with revenue reaching US$80.54 billion, a significant beat of analyst expectations of $78.59 billion and a 15% increase from the previous year. The growth reflects its fastest increase since early 2022. Earnings per share stood at US$1.89, again surpassing analyst expectations of US$1.51 per share. The impressive performance above those expectations was reflected in the market’s enthusiasm. Alphabet outperformed predictions for both YouTube advertising revenue and Google Cloud revenue, further solidifying its market dominance.
A further catalyst to the share price move, Alphabet announced its inaugural dividend of US$0.20 per share. The company intends to pay quarterly cash dividends in the future while also unveiling a US$70 billion buyback program, reflecting its confidence in its financial position and growth prospects. Alphabet’s market capitalisation is closing in on $2.1 trillion at the time of writing.
Alphabet’s balance sheet showcased impressive strength, boasting over US$108 billion in cash and equivalents, while maintaining US$13.2 billion in long-term debt. The company also generated an operating cash flow of US$23.5 billion for the quarter, underlining its financial resilience and operational strength.
Sundar Pichai, CEO, said:
“Our results in the first quarter reflect strong performance from Search, YouTube and Cloud. We are well under way with our Gemini era and there’s great momentum across the company. Our leadership in AI research and infrastructure, and our global product footprint, position us well for the next wave of AI innovation.”
Alphabet’s outlook emphasises efforts to moderate expense growth to accommodate increased investment in artificial intelligence, aiming for full-year 2024 operating margin expansion. Despite taking Google over 15 years to reach $100 billion in annual revenue, the company has achieved over $300 billion in just six years, driven by Search, YouTube, and Cloud. Expectations include YouTube and Cloud exiting 2024 with a combined annual run rate exceeding $100 billion. With reported capital expenditure of $12 billion in Q1, investment focuses on technical infrastructure, particularly in servers and data centres, reflecting confidence in AI’s potential. Quarterly CapEx is projected to remain robust throughout the year.
The TAMIM Takeaway
With another successful quarter in the books, Microsoft and Alphabet continue to stand as pillars of innovation and market influence. As the AI story unfolds these two market giants will continue to have enormous influence on the path forward. As they navigate the digital frontier, their strategic investments and operational strengths reaffirm their status as industry leaders, driving investor confidence and shaping the future of technology.
Disclaimer: Microsoft (NASDAQ: MSFT) and Alphabet (NASDAQ: GOOG) are held in TAMIM Portfolios as at date of article publication. Holdings can change substantially at any given time.
This week’s reading and viewing list covers How Not to Invest in the Bond Market, Secrets of Family Empires and Generative A.I. Arrives in the Gene Editing World of CRISPR.
In the early days of the internet, scepticism swirled around the notion of a global network connecting computers.
People questioned its reliability, its security, and even its purpose. Yet, as history unfolded, the internet proved to be a transformative force beyond anyone’s wildest dreams. It democratised information, revolutionised communication, and reshaped entire industries. Fast forward to the present, where another technological marvel, artificial intelligence (AI), stands poised at the frontier of innovation.
Much like the internet before it, AI is being met with uncertainty and speculation. Will it surpass human intelligence? Could it fundamentally alter the fabric of society? Today, AI permeates every aspect of our lives, from personalised recommendations on streaming platforms to autonomous vehicles navigating our streets.
But what fuels the astonishing capabilities of AI?
The answer lies in the vast infrastructure of data centres, where immense amounts of data are stored, processed, and analysed with unprecedented speed and efficiency. As we delve deeper into the realms of AI, it becomes increasingly clear that data centres are the silent engines shaping the future and powering this technological revolution.
What is a Data Centre?
Data centres serve as the backbone of modern computing infrastructure, providing a physical space for organisations to store critical applications and data.
Evolving from traditional on-premises servers to virtual networks and multi cloud environments, data centres now span multiple sites, including the edge and public and private clouds. As data proliferates across these diverse environments, effective communication between data centres becomes paramount. The rise of artificial intelligence (AI) further amplifies the demands on data centres. We have previously discussed the side effects of power-intensive deep learning models requiring substantial computational resources.
GPU’s and TPU’s are specialised hardware for accelerating AI workloads, driving up power density, necessitating the construction of more energy-efficient and high-capacity data centres.
Legacy and on-premises data centres face challenges in adapting to these changes, requiring optimisation of interconnection, compute, and storage solutions to keep pace with AI advancements. Additionally, managing the heat generated by energy-intensive hardware presents both technical and environmental considerations, driving the adoption of enhanced cooling solutions like liquid cooling. As AI continues to reshape industries and drive innovation, the role of data centres in supporting its growth becomes increasingly vital.
Who are the Data Centre Players on the ASX?
NEXTDC
NEXTDC (ASX: NXT), an ASX 100-listed technology company, is a leading Data Centre-as-a-Service provider in Asia.
They focus on building infrastructure for the digital economy, providing power, security, and connectivity for global cloud computing providers, enterprises, and governments.
Running a data centre isn’t easy and requires significant capital investment. NEXTDC recently announced a capital raise with the intention to develop its infrastructure platform in both Sydney & Melbourne to meet client demand. Commenting on that demand, NEXTDC Chief Executive Officer and Managing Director, Craig Scroggie said:
“NEXTDC continues to see significant growth in demand for its data centre services underpinned by powerful structural tailwinds. Amid this backdrop, we have decided to bring forward the development and fitout of key assets in Sydney and Melbourne to ensure we are able to meet this growth in demand, continue to support our customers, and ensure the Company is well positioned to take advantage of the diverse range of opportunities expected to present over the medium term.”
The entitlement offer aims to raise an extraordinary $1.3 billion and comprises a 1 for 6 pro-rata accelerated non-renounceable entitlement. The deal offers holders a price of $15.40 per new share, which represents a discount of 6.8% to the share price prior to the announcement of $16.52.
At the time of the announcement, NEXTDC reaffirmed its previously announced guidance with total revenue in the range of $400 million to $415 million and net revenue in the range of $296 million to $304 million. The company expects underlying operating earnings (EBITDA) in the range of $190 million to $200 million. Capital expenditure remains a significant factor and is expected to be in the range of $850 million to $900 million, more than double the expected revenue!
AirTrunk
Strike while the iron is hot? That iron is AI and AirTrunk is looking for over $15 billion for its business.
AirTrunk is a hyperscale data centre specialist creating a platform for cloud, content and large enterprise customers across the Asia-Pacific & Japan (APJ) region. It develops and operates data centre campuses with leading technology and innovation while using unique capabilities as part of the designs and construction to provide its customers with a scalable and sustainable data centre solution at a significantly lower build and operating cost than the market.
Global Data Centre Group (ASX: GDC) is an Australian fund that provides holders with the ability to gain exposure to digital infrastructure assets. That exposure includes a stake in AirTrunk acquired through its investment into the Macquarie led consortium that acquired an 88% stake in AirTrunk.
As AI continues its meteoric rise, reshaping industries and driving innovation, the critical role of data centres in supporting this growth becomes increasingly evident.
From the early days of scepticism surrounding the internet to the present, where AI permeates every aspect of our lives, data centres have evolved into the silent engines powering technological revolutions. As power-intensive AI applications demand more computational resources, data centres face the challenge of adapting to meet these demands. Companies operating within this sector are poised to be pivotal in supporting the forthcoming wave of technological advancements. However, prudent investors must exercise vigilance in assessing the enduring quality of these investments, despite their importance.
As the world embraces the transformative potential of AI, the significance of robust and efficient data centres cannot be overstated, positioning them as indispensable players in shaping the future of technology and society.
Disclaimer: Global Data Centre Group (ASX: GDC) is held in TAMIM Portfolios as at date of article publication. Holdings can change substantially at any given time.
We first highlighted the importance of semiconductors back in April 2023 when we introduced the concept of megatrends. Back then, we used the example of the automotive industry and the increasing adoption of electric vehicles (EVs), and highlighted how investing in the “picks and shovels” of an industry can often lead to substantially higher returns for investors.
Semiconductors Primer
As we discussed, semiconductors are a unique substance that can operate as both an insulator (it prevents the flow of electrical charge) and a conductor (it can carry electrical charge). Semiconductors are produced from pure elements like silicon or germanium, or compounds such as gallium arsenide, and then treated through a chemical process known as “doping” that enhances conductivity. These chips perch on wafer-thin stages where their properties of conduction (like metals) and insulation (like rubber), let them steer electrical signals to lay the cornerstones of today’s technological evolution.
By combining semiconductors with insulators and other materials, engineers can precisely control the movement of electricity. They are therefore invaluable components in a host of electronic equipment such as computers and other consumer electronics, telecommunication devices, and automobiles. There are semiconductor manufacturers that focus on niche industries or even specific products, there are more diversified semiconductor producers, and there are also a range of companies that provide associated technologies.
A New Wave of Innovation
The evolution of semiconductors over the last fifty years has been truly transformative. They have evolved with and enabled personal computing in the 1990s, the Internet in the 2000s, smartphones in the 2010s, and now, are a key in the emerging “Internet of Things” (IoT) megatrend. This involves embedding everyday devices (air conditioners, washing machines, etc.) with sensors, software and other technologies to enable them to send and receive data (that is, interact with the Internet).
Breakthrough technologies such as 5G networks, EVs, and artificial intelligence (AI) have only accelerated these trends and led to a new era of progress for the semiconductor industry. In fact, consulting agency McKinsey foresees only continued growth in semiconductor demand, with it poised to become a US$1 trillion industry by the end of the decade.
America on the Fringe
Unfortunately for where this all began, the United States is no longer at the forefront of this wave of innovation. According to the U.S. Department of Commerce, the U.S. today is only responsible for the production of just 12% of the world’s semiconductors–down from 37% in the 1990s. This is believed to be largely a result of a decline in government investment, with research and development spending on semiconductors holding largely flat relative to GDP while other countries have significantly ramped up their investments.
Taiwan is the undisputed leader of semiconductor manufacturing as a direct result of the aptly named Taiwan Semiconductor Manufacturing Co. (NYSE: TSM), which is believed to produce up to 50% of the world’s total semiconductors. It operates a foundry business model, where it produces chips for a number of other companies such as Apple, AMD, Qualcomm, and as we have previously mentioned, NVIDIA.
South Korea is also another semiconductor powerhouse, largely owing to Samsung Electronics Co (KRX: 005930), which contributes a staggering 20% of the country’s gross domestic product (GDP). Samsung also operates a foundry producing semiconductors for other companies, as well as operating as an integrated device manufacturer (IDM), producing semiconductors to use in its own range of products, such as home appliances.
Other major countries involved in semiconductors are Japan, which is home to more than 100 semiconductor fabrication plants, and of course, China. China is the world’s largest market for semiconductors thanks to its manufacturing prowess, and the Chinese government has stated its intentions to expand the country’s capabilities with the intention of eventually becoming self-reliant (that is, producing all the semiconductors it requires within China and not requiring any imports). This could lead to China producing up to one-quarter of the world’s semiconductors by 2030.
Enter the CHIPS Act
The U.S. has increasingly pursued an America-first agenda, most notably since the Trump administration when Donald Trump used a more aggressive stance towards China, resulting in a so-called trade war (this included, among other things, the alleged theft of intellectual property). Since this time, geopolitical tensions with China have only deteriorated, partly as a result of China’s stronger commentary towards Taiwan.
This increased geopolitical tension, combined with severe supply chain disruptions during the pandemic and the economic potential of a growing semiconductor industry led to the Creating Helpful Incentives to Produce Semiconductors and Science Act of 2022 (CHIPS Act).
Passed into law in August 2022, the CHIPS Act is designed to strengthen the domestic U.S. semiconductor industry (research, design and manufacturing) as well as enhancing national security.
Specifically, the CHIPS Act provides approximately US$278 billion in total funding between 2022 and 2026. This includes a range of different programs, the most notable of which are STEM (science, technology, engineering and mathematics), R&D, and workforce and development program authorisations for the National Science Foundation, U.S. Department of Energy and U.S. Department of Commerce, and advanced manufacturing tax credits and loan programs.
The Act is already having an effect. Micron Technology (NASDAQ: MU) has announced a US$40 billion investment in memory chip manufacturing (critical for computers and electronic devices), which is expected to create up to 40,000 new jobs in construction and manufacturing. This investment alone is expected to increase U.S. memory chip production from less than 2% today to more than 10% over the next decade.
Taiwan Semiconductor Manufacturing, too, recently announced it had received US$6.6 billion in grants and US$5 billion in loans to boost U.S. production of advanced semiconductors in Arizona, while Intel (NASDAQ: INTC) inked a deal for US$20 billion in combined grants and loans, and Samsung a further US$6 billion.
The TAMIM Takeaway
Identifying companies that are poised to benefit from megatrends is a great strategy for finding long-term investment winners on the share market. There is no doubt that increased demand for semiconductors is one such megatrend as the world moves into a new era fuelled by EVs, 5G, cloud computing and AI. For U.S.-focused investors, the CHIPS Act looks only set to compound this trend, providing enormous incentives for companies to increase their development and production of advanced semiconductors in America. While some may have reservations about the level of the U.S. government deficit and growing debt level, the US$278 billion of funding for the CHIPS Act certainly provides an opportunity for investors.
