🎙️ Big Tech

Happy Fed Day!

The financial world eagerly awaited the Federal Reserve’s latest decision on interest rates, and as expected, it announced another 0.25% increase, raising rates to their highest level in 22 years 📈

Chairman Jerome Powell noted that investors shouldn’t rule out another rate hike at the Fed’s next meeting in September.

💭 While the Fed has already made much progress against inflation, Powell suggested it might not cool down to its 2% target until 2025.

Here’s Powell: “We think we’re going to need to hold, certainly, policy at restrictive levels for some time.”

— Shawn, Matthew & Weronika

Here’s the rundown:

Today, we'll discuss the three biggest stories in markets:

• Big tech earnings

• UPS’ strike-free summer

• Post-crisis regional bank mergers

All this, and more, in just 5 minutes to read.

CHART OF THE DAY

IN THE NEWS

📈 Microsoft and Alphabet Beat Estimates, Tout AI (CNBC)

Pro tip: If you find yourself hosting a quarterly earnings call anytime soon, mention “AI” as much as possible. You can’t go wrong, right? Last quarter, Bloomberg found that Alphabet, Microsoft, and Meta said the abbreviation at least 200 times in their calls.

Microsoft and Alphabet opened Big Tech earnings season Tuesday after the bell, with plenty more AI talk.

• Both showcased more resilience in their core businesses, though their share prices reacted differently: Alphabet rose sharply while Microsoft fell. (Both have risen roughly 40% in 2023.)

In sum: Google’s core advertising business returned to growth, and Microsoft’s cloud business beat Wall Street expectations.

• Alphabet's cloud revenue grew 28% year-over-year. Microsoft's cloud (Azure) revenue growth dipped slightly to 26% from the previous quarter's 27%, concerning investors that Microsoft cloud services are losing steam.
  

• Both companies are increasing their capex and betting heavily on artificial intelligence for the next decade.

Consider: Both have done an estimated $30 billion in capital expenditures (spending on fixed assets like buildings or technology) in the past year, more than the annual revenue of three-quarters of the companies in the S&P 500.

Google search ad sales grew to a better-than-expected $42.6 billion as people continue to use Google search even with options like ChatGPT.

• Also of note: 25 years ago, Google started with a $100,000 investment. Today, it makes about $100,000 every 18 seconds from ads.
  

• And Microsoft's cloud business reached a remarkable $111 billion and reflected over 50% of the company’s revenue for the first time. The 48-year-old tech behemoth is chugging along just fine.

Why it matters:

Yes, other parts of the market are kicking into gear this summer, but 2023 has mostly been the year of Big Tech’s resurgence. All the heavyweights that dominate so many of our portfolios, such as Microsoft, Apple, Amazon, and Nvidia, have soared after a brutal 2022.

Last year, Alphabet declared a “code red” as rivals like ChatGPT burst onto the scene. But its CEO, Sundar Pichai, said it’s been an “AI-first” company for nearly a decade. Google continues to invest heavily in AI, and investors have continued to reward it by playing the long game.

• Pichai noted that Google search will soon be more ChatGPT-esque, saying: “You will see us continue to bring it to more and more users. Over time, this will just be how search works.”

Meanwhile, Google’s YouTube posted its first jump in ad sales since early 2022, an encouraging sign for one of its growth businesses amid a global advertising slump.

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📦 UPS Averts Strike and Cuts Five-Year Labor Deal (WSJ)

Phew! A widely feared strike has been avoided.

On Tuesday, UPS inked a tentative deal with its (mostly) Teamster delivery drivers, avoiding what would’ve been one of the costliest strikes in recent U.S. history. The largest collective bargaining agreement involving a private employer in North American history comes amid numerous labor negotiations nationwide, including in Hollywood.

• “This contract sets a new standard in the labor movement and raises the bar for all workers,” Teamsters’ President said.

According to some forecasts, roughly 340,000 drivers were prepared to go on strike, costing the U.S. economy about $7 billion in its first 10 days. UPS customers might have lost $4 billion, drivers might have lost $1.1 billion in wages, and the company itself might have lost nearly $1 billion.

Old faithful: While Amazon has become a household name, UPS still delivers more packages per day: Nearly 25 million a day, or about 25% of all U.S. shipments.

• The new five-year labor deal delivers drivers about $30 billion in new money. It includes concessions from management, including guaranteed air conditioning in new vehicles following the heat-related hospitalization of more than 100 drivers in recent years.
  

• Part-time drivers also will get a long sought-after pay raise: The Teamsters were seeking an hourly wage for part-time workers north of $20. (Veteran full-time drivers can make up to $100,000 annually, plus benefits and a pension plan.)

UPS moves about 5% of the nation’s gross domestic product—or roughly $3.8 billion of goods daily, per the U.S. Chamber of Commerce. President Biden congratulated the union and company on working out their differences.

Why it matters:

For weeks, UPS and the union accused each other of walking away from contract talks, which have been underway since May.

• “This agreement continues to reward UPS’s full- and part-time employees with industry-leading pay and benefits while retaining the flexibility we need to stay competitive, serve our customers and keep our business strong,” noted UPS CEO Carol Tomé.

Shippers monitored the progress of negotiations to see if they needed to make other plans should UPS workers go on strike. The Retail Industry Leaders Association said the agreement was “an enormous relief to retailers, who have been navigating the possibility of a strike and the associated uncertainty for weeks.”

• In other words: The ripple effects of a UPS driver strike could have been enormous, and everyone’s just glad all the fuss is over with.
   

• “We encourage a quick ratification and adoption of the agreement to ensure this chapter of uncertainty is closed,” the group added.

UPS shares have gained about 5% this year vs. 19% for the S&P 500.

MORE HEADLINES

🗺️ Meta, Microsoft, and Amazon team up on maps project to crack Apple-Google duopoly

🥤 Coca-Cola says it’s done raising prices in the U.S. and Europe this year

👮🏽‍♀️ British billionaire Joe Lewis indicted on insider trading charges

💼 PacWest to be Sold to Banc of California (Bloomberg)

The bank failures of early 2023 may feel like a distant memory, but the fallout is still unfolding.

Once eyed as the next to potentially fail after the implosion of First Republic and Silicon Valley Bank, PacWest Bancorp scraped through the crisis, but it won’t survive unscathed.

• Instead, the bank is being bought by its smaller rival, Banc of California.
  

• The deal includes a combined $400 million investment from two private equity firms, which will control about 20% of the combined company.

It’s been a year to forget for the Beverly Hills-based PacWest, whose stock is down some 62% in the past six months. Much of those losses came in early March when many other regional banks sold off on worries that the panic surrounding Silicon Valley Bank would spread.

Relieved investors: Rather than being zeroed out like the shareholders in the U.S. banks that did fail, PacWest’s stockholders will receive 0.66 shares of Banc of California stock for each share in PacWest they hold. That news sent PacWest’s stock up over 28%.

• The banking consolidation illustrates that confidence remains fickle in the industry, especially for regional banks not large enough to join the elite club of megabanks deemed “too big to fail.”
  

• And rather than risk it alone, the two banks determined that merging assets and welcoming new investment from private-equity backers is the best way to restore faith in their long-term operations, hopefully slowing and reversing the exodus of customer deposits.

The combined bank will have about $36 billion of assets, though that’s less than PacWest alone had at the end of March.

The bank has since sold off assets as large swathes of its customers fled — it lost about 18% of its deposits — presumably to bigger banks perceived to be safer.

• And the two banks expect to sell off even more assets like mortgages to pay down debt as part of the combination deal.

Why it matters:

Amid a crisis, external investors may be incentivized to simply wait for banks to fail to buy up their assets at a steep discount.

With the worst of the storm seemingly behind us, the $400 million private equity investment in this deal was on far more generous terms than would’ve been imaginable a few months ago, highlighting how investor sentiment towards regional banks has shifted.

• It also provides a playbook for other small banks to follow.

What brought down Silicon Valley Bank, in particular, was its extremely concentrated depositor base of mostly venture capital-backed startups.

When those companies drew down their cash balances over the same period, that triggered a bank run. Banks like PacWest faced similar deposit concentration issues, and merging with Banc of California, which had a fraction of the deposit outflows, helps diversify its customer base.

• As Telis Demos of the Wall Street Journal writes, “bank crises can’t be resolved in one big step. Only many small ones.” And this is one of those many small ones.
  

See you next time!

That's it for today on We Study Markets!

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