Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
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Is the market blind to inflation and can Adobe finally deliver on AI?
Peter Garnry
Chief Investment Strategist
Summary: Yesterday's US inflation report did nothing to stop the strong sentiment in equities setting markets up for a potential disappointment at tonight's FOMC press conference. US core services inflation has accelerated the past three months which might have spooked the Fed into doubling down on its message of higher for longer. If this is the case then equities will be great disappointed. After the US market close, Adobe will report earnings and investors are likely demanding that the company's generative AI product Firefly begin to move the needle on growth. If not, then it will be increasingly difficult to justify the current valuation.
The market feels dangerous
Yesterday’s US November inflation report showed that headline inflation fell as estimated to 3.1% y/y from 3.2% y/y in October driven by lower energy and food prices. On the surface, the inflation report delivered on the market’s narrative of policy rate cuts coming sooner rather than later. However, US services inflation less energy services rose 0.4% m/m with the 6-month annualised rate rising to 4.9% which is the third straight month with rising core services inflation which bottom at 4.5% in August. This suggests that overall inflation is sensitive to a change in energy cost and that inflation might be more entrenched than expected. Surprisingly, the market has not paid attention to this fact and equities continue to push higher.
As we alluded to in our FX update Fed has a final chance to push back on rate cut expectations the core services inflation might have spooked the Fed into a position of pushing back on market expectations. This would align with the supposed Fed strategy of rather be too late than too early on rate cuts in order to avoid repeating the mistakes done by the Fed back in the 1970s. With sentiment in equities remaining strong tonight’s FOMC decision at 1900 GMT and subsequent press conference could turn out to be far more interesting than initially thought.
Adobe earnings: Is AI a productivity booster, cost reduction technology, or a growth enhancer?
So far this year the AI hype has mostly generated a lot of growth for the early stages of the AI value chain with Nvidia being the biggest winner. On the application side, Microsoft is so far the company that has gained the most from AI seen in the previous earnings release with the cloud business Azure delivering the upside surprise on growth as customers are venturing into AI products and services from Microsoft. The software maker’s revenue growth rose to 12.8% y/y in the previous quarter up from 2% y/y in the last quarter of 2022.
In the content creation industry, many thought Adobe would benefit a lot from AI, but so far the revenue growth rate has not shifted gear but remained stable around 10% y/y. Adobe’s price gains this year of 85.5% has been driven by slowly expanding profit margin due to cost cutting and revenue growth that stabilised. As tonight’s earnings release is the last quarter of the fiscal year (ending 30 November) it will naturally be a springboard for Adobe to post its outlook for the current fiscal year ending 30 November 2024. Analysts expect revenue growth of 12% y/y which is not bad in an economy growing around 6-7% in nominal terms but with the valuation hitting 3% on the free cash flow yield investors will likely demand more than 12%.
As the market is expecting AI to be a growth enhancer for many of these companies investors will focus a lot on Adobe’s generative AI product Firefly on the earnings call tonight. For all those interested in AI technology, then tonight’s earnings from Adobe are worth watching.
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