An un-inverted yield curve, a lousy jobs report, and mind boggling consumer debt walk into a bar…what do they order?
If you guessed the recession special, you might be onto something. Here’s what we’re watching:
- Japanese markets crashed 20% over the past few days, driving our recession odds way up. Because Japan historically keeps low interest rates, many borrow Yen and invest in higher yield currencies, like the USD. However, Japan just raised rates and the carry trade is now unwinding.
- The stock market also took a hit over last Friday’s jobs report. Unemployment jumped to 4.3 percent in July from 4.1 percent in June, the highest level since October 2021. The report showed 114,000 added jobs in July, well below expectations of around 175,000.
- In the world of consumer debt, credit card write-offs at Citibank reached 6.5%, the highest we’ve seen since Q2 2022. Net charge-offs from Wells Fargo and JP Morgan’s credit card businesses increased 60% in Q2 2024.
The nationwide manufacturing sector has contracted in 19 out of the last 20 months, the second longest downturn in recorded history. The Richmond Fed Manufacturing index fell 17 points in July, the lowest point since the pandemic. The Mag 7 experienced some wild volatility, losing trillions of dollars in a matter of days. It lost the equivalent of double Tesla’s market cap in 48 hours.
In this edition of our newsletter, we’re diving deeper into what could ultimately burst big tech’s bubble.
We’ll also touch on how the present yield curve behavior signals a potential recession and how we’ll get through this one step at a time.
Hate to Burst Your Bubble
Does big tech have a cash flow problem? If you take a peek behind the curtain, it certainly seems like it.
Even though Google reported double digit earnings growth, their shares sold off by 5%. This caused a bit of a domino effect and was a major contributor to big tech’s trillion dollar losses over the last week or so.
Additionally, Google’s free cash flow dipped 40% to $13.5B. That’s significantly below its reported net income of $24.3B.
What kind of accounting shenanigans are happening behind the scenes? Two words: data centers.
Four out of the seven companies that make up the Mag 7 spend $200B a year on data center infrastructure, including Google.
In 2021, big tech started revising their depreciation methodology for data center servers and networking equipment. These are their two largest sources of capex spending.
Google first extended the “estimated useful life” of their servers from three years to five years. That led to operating results experiencing a “favorable impact” to the tune of $2.1B in 2021.
In 2023, they did this again, extending the depreciation schedule from five years to six. The favorable impact there? Approximately $3.4B.
These changes allowed Google to cut annualized depreciation expenses by a whopping $5.5B. But here’s where it gets tricky.
Big tech giants have massively increased their capex spending since 2020. Google doubled theirs from $22B to $44B. What’s left is a huge gap between what’s spent on capex and depreciation expenses.
This mismatch increases the risk of some major investor backlash. Pouring billions into these data centers without the cash flow to show for it could spell disaster.
We could be looking at the pin that pops the bubble.
Throwing a Yield Curve Ball
Moving on to yield curve news, after over 700 consecutive inversion days (the longest inversion period since 1929), it’s officially un-inverted.
When the yield curve stays inverted for a long period, jobless claims start to increase, the job market suffers, and risk of a stock market correction increases. When jobless claims hit 260,000, warning bells go off.
From there, investors may begin reducing long stock market exposure and add in recession bets.
In the un-inversion, there’s often a flight to safety trades in the treasury market. People buy bonds and rates go down.
Until now, we had an inverted yield curve, meaning the yields for 2 years are higher than the yields for 10 years. That’s now back to normal, with 2 year yields back below the 10 years.
If we check the history books, we know what ultimately comes from this ain’t exactly good.
This kind of trend has always pointed to an economic downturn. It’s always been a signal for a recession.
One Step at a Time
In The Zen and Art of Motorcycle Maintenance, the author reminds readers that the reality of your own nature should determine your speed. With that mindset, each footstep becomes a unique event itself, not just a means to an end.
We all have our predictions for how things will come to pass, but as The Zen points out, living only for some future goal is shallow. Life is sustained on the sides of the mountains we climb, not the top. Magic happens in the mundane.
A hero becomes a master of his world one step at a time. Sure, slaying enemies and discovering gold are what we write home about, but it wouldn’t be possible without time spent sharpening our swords and studying maps.
Wherever you are in this ever-evolving journey, you’ll make it through by simply putting one foot in front of the other.
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Until next time,