Huge sums spent on the AI race raise a few red flags, as the good times roll

This article originally appeared in The Post

ANALYSIS: It was another buoyant week for the global indices. All three benchmarks in the US made record highs. The S&P 500 gained 0.7% for the week and 3.8% for the month of October. The broad benchmark has risen for six consecutive months and is now up 16.3% for the year. While there has not been much data to speak of, with the US Federal Government in shutdown mode, a strong start to the earnings season has underpinned positive sentiment, boosted further by another rate cut by the Fed last week.

Last week saw the Fed cut interest rates by 0.25%, leaving the Fed Funds rate range at 3.75–4.00% - the lowest since 2022 and 1.5% below the 2023/24 peak. The central bank has also decided to end its balance sheet runoff, which means it is going to stop reducing the pile of bonds (mainly U.S. Treasury bonds and mortgage-backed securities) it owns. The cessation of “quantitative tightening” highlights the easing mode that the Fed is now in.

Some Fed members want to ease at a faster pace. Stephen Miran, Donald Trump’s recent appointee, unsurprisingly voted for a larger 50-basis-point cut. At the press conference afterwards, Fed Chair Jerome Powell remarked that the jobs market was cooling but that tariffs presented a key risk to inflation, which remains elevated relative to the Fed’s 2% longer-run goal. Powell said that it was all a “risk-management exercise,” with risks to inflation tilted to the upside, while risks to employment are to the downside.

The Fed Chair said there was no guarantee of a rate cut in December, with policy not on a pre-set course. This is an understandable conservative positioning, given the central bank is not receiving as much official data as it normally would due to the shutdown. Markets are anticipating the Fed will err on the side of caution in terms of risks to the labour market and are pricing in a 70% chance of a rate cut in December.

It was a big week in terms of results, especially for the super-cap technology names. There was some concern with the reactions to how much companies are spending on the AI race. Microsoft and Meta both fell in the wake of what were strong results. There was far less concern with the spending of Alphabet, with the shares up over 8% last week. The cloud computing and YouTube businesses are doing well - as is Search. Contrary to concerns about AI eating into Google’s revenues, it is actually providing a tailwind. AI-driven ad products were a major reason for the strong growth in Search and YouTube ad revenue. Google Ads now uses AI-driven bidding and creative tools to automatically adjust how and where ads appear, optimising performance and returns from ads.

Amazon also delivered a strong result from advertising, which provides further positive takeaways for the strength of the economy. The shares soared 10% on Friday. The cloud business (which rents out computer power to other companies) is doing well, with revenues up 20% from a year earlier to US$33 billion. The unit generated operating income of $11.4 billion, accounting for roughly two-thirds of Amazon’s total operating profit even though it contributes only a fraction of total sales. Management said that demand for AI tools is so strong that Amazon is planning to spend even more this year (around $125 billion) building data centres and technology to keep up. Amazon’s advertising arm is also booming. Revenues rose 24% to $17.7 billion - Amazon is now one of the biggest ad companies on earth.

Apple is also performing strongly. The shares didn’t have the same reaction, easing slightly, but they are up over 30% over the past six months. CEO Tim Cook says he expects revenue to grow 10–12% in the final three months of the year, helped by “red-hot” demand for the new iPhone 17, which he says has been “off the chart.”

Quarterly sales were up 8% to $102 billion, with around half of this attributable to iPhones. Net income nearly doubled to $27.5 billion. Apple’s newest phones went on sale on September 19, so there is just over a week of sales in this quarter. Cook also said the company was dealing with supply constraints and could have sold even more.

Apple’s services business is also quickly becoming the quiet superstar. That includes subscriptions, iCloud, Apple Music, and App Store fees - and it jumped 15% to almost US$25 billion. Macs are also cool again, with sales up 13%, helped by cheaper MacBook Air models. The humble laptop is back in style.

On tariffs meanwhile, Apple is eating the extra $1 billion-plus cost but still managed to hit record profit margins near 47%. Management said that Apple stores were buzzing again, with traffic up significantly from last year, and Cook is confident this December quarter will be Apple’s best ever. Apple is predicting sales of $137 billion in the final quarter — more than the entire annual GDP of many countries.

In the week ahead there are plenty of results due, with tech darling Palantir, AMD, McDonald’s and Novo Nordisk among those reporting.

In Asia, the Nikkei also hit a record high, moving above 50,000 for the first time ever with a 6% gain for the week. This was driven by the narrative that monetary policy could be normalising as the economy finally escapes decades of stagflation. The Bank of Japan kept rates on hold at 0.5% but officials reiterated they could raise rates if economic and inflation conditions evolve in line with forecasts.

The Australian market eased 1.5% last week. There was a hotter-than-expected inflation print, which has effectively ruled out a rate cut by the RBA tomorrow. Trimmed mean annual inflation was 3.0% to the September quarter, up from 2.7% in the June quarter. This is the first time trimmed mean annual inflation has increased since December 2022. Core inflation rose 1% against the RBA’s own forecast of 0.6%.

We have the race which stops a nation tomorrow, but there will also be plenty else to occupy investors this week. Results are due from NAB, Breville, Amcor and Macquarie. Today Westpac reported a 1% fall in full-year net profit to $6.92 billion. This was ahead of expectations, with margins improving in the second half. Business loans grew by 15% to $115 billion, with loans to the agriculture and health sectors up 22% and 24% respectively.

The NZX 50 rose 1.2% in a shortened week. There were some noises around economic green shoots. The ANZ Business Confidence Outlook (titled“Retail Renaissance?” ) jumped from 50 to 58 in October — the highest level since February. Expected own activity lifted 2 points to net 45%, the strongest since April. Past own activity was little changed at +5 (but surged 11 points for the retail sector). The same optimism wasn’t forthcoming from the consumer confidence survey (titled“Stalled”), with a net -14% seeing it as a good time to buy a major household item. Consumers are, though, more optimistic about the future outlook, with sentiment helped by a lower interest rate environment.

Inflation indicators were little changed: the net percentage of firms expecting to raise prices in the next three months eased from 46% to 44%. One-year-ahead inflation expectations were little changed at 2.75%. In terms of consumers, inflation expectations lifted from 4.8% to 5.1%. With CPI at 3%, consumers may be more focused on what food prices (5.1% inflation) have been doing.

The narrative around a budding economic recovery was helped by Freightways, which updated that “the NZ economy is no longer a headwind.” The company added that the Aussie economy (where it has a significant operation) is slowing but remains buoyant for its business. Freightways shares rose last week.

The agriculture sector has been a bright spot for the economy, and a notable event last week was Fonterra farmers approving the sale of the global Consumer and associated businesses, Mainland Group, to Lactalis for $4.22 billion. It was a comprehensive vote, with 88.47% of total farmer votes cast in support of the divestment.

Fonterra will reinvest around $1 billion into existing businesses as it looks to get earnings back to current levels within three years. Farmers will receive around $3.2 billion once the sale is complete. The tax-free distribution means each dairy farmer could get nearly $400,000 each, with some positive trickle-down effects for the broader economy. The transaction is expected to complete in the first half of the 2026 calendar year.

This week we have another dairy auction (ironically, the last few have been soft), along with the RBNZ stability report and September-quarter labour market data. The unemployment rate is expected to tick up to 5.3%, providing another reason for the RBNZ to cut rates by another 0.25% (if not 0.5%) at the end of the month.