Smog 2025
I am happy to be the bearer of good news. The markets continue to move higher as fear of a recession this year recedes, and acceptance of higher interest rates grows. While a large part of the appreciation is coming from companies in the technology sector, and more specifically those involved in artificial intelligence, we are beginning to see a broadening of returns. I continue to expect a pullback at some point this year, perhaps when the Federal Reserve finally does cut interest rates, indicating a need for looser monetary policy, but am pleased that for now that does not appear on the horizon.
JP Morgan reported this week that 78% of S&P 500 companies in the U.S. beat profit estimates in the fourth quarter, representing growth of 5% year-over-year. In terms of revenue, 57% are beating sales estimates with energy, materials, and utilities faring the worst. However, it is worth noting that companies are lowering expectations. JP Morgan mentioned that fewer U.S. companies are raising earnings guidance this quarter, the lowest in a few years. If companies are playing it safe with their guidance, it could mean good things for markets as they beat expectations later this year. On the other hand, it is hard to know if they really do believe earnings and revenue growth will slow down. It is a game they play with investors much to our chagrin.
Perhaps the biggest surprise this week was the announced merger of Capital One Financial and Discover Financial Services in a $35 billion deal. The combined entity would become the sixth largest bank but more importantly, it would provide Capital One with Discover’s payment processing network. This would allow it to shift some of its cards away from the Visa and Mastercard networks. Capital One is the third largest issuer of Visa and Mastercard credit cards, accounting for 10% of U.S. credit volumes. My initial thought is that this will increase competition, and perhaps lower costs for retailers who currently pay between 1.5% and 3.5% of each transaction to the payment processor, i.e. Visa, Mastercard, or American Express. Surprisingly, both Elizabeth Warren and Maxine Waters came out against this merger seemingly in a knee jerk reaction. Lower costs, and more oversight may mean a more stable and competitive marketplace. But I suppose the details are where this could get tricky, and it will likely be some time before regulators give this matchup the green light.
On a different topic, for some years now, gasoline has been blended with 10% ethanol (an alcohol derived from corn) which is generally believed to be more environmentally friendly. In the Midwest, E10 gas is phased out during the summer months because of concerns that it forms smog in hot weather. So, it was a surprise to learn this week that the Biden administration, through the EPA, has approved year-round use of E15 gasoline in eight states. Those states, which produce most of the corn in the U.S. are Illinois, Iowa, Nebraska, Minnesota, Missouri, Ohio, South Dakota, and Wisconsin. The move reflects the importance of ethanol to agriculture. The fuel additive accounts for roughly 40% of the nation’s corn crop. Notable is that support in some of those states could be crucial for President Biden as he seeks reelection this fall. So, what’s the downside? Well, smog for one which plagues the Ohio Valley in the summer. But also, reduced fuel mileage and potential engine issues if your car was manufactured before 2001. This change won’t take effect until 2025.
In closing, I came across a news story that I felt I needed to pass along. The headline certainly caught my attention. The title was as follows, “Magnificent 7 profits now exceed almost every country in the world. Should we be worried?” Deutsche Bank highlighted the Magnificent 7’s combined market cap alone would make it the second-largest country stock exchange in the world. Put another way, these seven companies (in aggregate) now wield greater financial might than almost every other major country in the world. Of the non-U.S. G20 countries, only China and Japan have greater profits when their listed companies are combined. Microsoft and Apple, individually, have similar market caps to all combined listed companies in each of France, Saudi Arabia, and the U.K. One way of looking at this is that the valuation of these companies is too high, and the concern is in comparing them to past peaks, i.e. 2000 and 1929. However, a different way of looking at it, and perhaps a different perspective, is that these U.S. companies are among the most important in the world. Can we live without them? I think some could, but the innovation they bring to market is shaping the future. It’s not popular these days to be proud of the United States and its accomplishments, but I think we can all recognize these seven companies are vital to America’s future. If not for these U.S. companies, the world would look like a very different place. Now you know.
Bruce J. Mason, MBA