BofAML: Apple Grew App Sales In Third Quarter
Elliott Davis
In its third quarter earnings release Tuesday, Apple announced that took in $9.5 billion in services revenue in the three-month period, a new record for the company. The previous record was $9.19 billion put in during the second quarter of this year.
Apple's services category includes a variety of different businesses: Digital Content and Services, Apple Pay, AppleCare, licensing and other services, including iTunes, the App Store, AppleMusic and iCloud. Apple did not break out the exact revenue numbers of each division in its earnings release.
In an earnings conference call, CEO Tim Cook attributed the strong performance to double-digit growth in Apple's overall active install base, and said the company is on track to double its services revenue by 2020.
Cook also said on the earnings call that Apple Music grew 50 percent year over year, while AppleCare grew by its highest rate in 18 quarters. Cloud services also grew more than 50 percent year over year.
"We couldn't be happier with how things are going, but in terms of the next leg-given the momentum that we're seeing across the board, we feel great about our current services, but obviously we feel great about our pipeline, with our new services as well. With the combination of these, we feel good," he said.
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Underlying economic strength and stubborn price pressures are testing the patience of central banks and causing some to question whether financial conditions are restrictive enough. While it is possible that economies are less sensitive to higher interest rates than they were in prior cycles, it is more likely that the headwind from surging interest rates over the past 19 months will hit the economy with a significant lag. Not only will the sharp rise in borrowing costs weigh on consumer spending and business investment, but a variety of other risks have also been added to the mix. In the U.S., large-scale autoworker strikes, the resumption of student-loan repayments and a looming U.S. government shutdown are all factors that are adding to uncertainty and stress in the economy. Furthermore, geopolitical tensions have flared with the recent attacks in the Middle East, a situation that is evolving rapidly and contributing to financial-market volatility. All things considered, the outlook is increasingly murky and we continue to forecast a mild economic recession over the next several quarters. Our forecasts for growth and inflation are below the consensus (exhibits 1 and 2).
Higher borrowing costs, however, are making things more difficult for interest-sensitive segments of the economy. Housing affordability has been severely hindered as mortgage rates have nearly tripled in the past three years and climbed above 8% for the first since early 2000 (Exhibit 6). Against this backdrop, sales of existing homes have fallen to their lowest level since the global financial crisis, weighing on home-builder sentiment (Exhibit 7). Another indication that some consumers could be feeling the pinch from higher rates and rising costs is that credit-card delinquency rates have been rising steadily, especially for customers of smaller banks (Exhibit 8). The softness in these areas is manageable for now, but continued weakness in housing and further increases in consumer defaults could lead to bigger problems for the broader economy.
Financial conditions have tightened significantly over the past few years, but they are perhaps not yet too tight according to Fed Chair Jerome Powell. Corroborating this idea is an index generated by Goldman Sachs that suggests financial conditions are only slightly tighter than normal (Exhibit 12). Recognizing that the tightness of financial conditions is not at an extreme, the Fed has communicated that interest rates could continue to rise further or at the very least remain at elevated levels for an extended period.
The Fed will likely respond based on how the data evolves and, if inflation cools and economic growth contracts as we forecast, the Fed could shift the narrative and reduce rates next year. Pricing in the futures market is in line with this view, suggesting a slim possibility of one more rate hike over the next several months, followed by as many as three 25-basis- point cuts by the end of 2024 (Exhibit 13). The risk to this outlook on rates is that inflation stays hot and the economy remains robust, which would likely push rate cuts further into the future.
Exhibit 22 plots the dollar amount of maturing high-yield debt and leveraged loans over the next several years. The figures increase notably to the hundreds of billions of dollars from 2025 through 2028. Corporate interest expense could balloon over the next several years as increasing amounts of debt reset at higher rates.
The biggest risk to the broader equity markets has to do with the fact that earnings expectations are still too optimistic given our view that the economy is likely headed for recession. The consensus of analyst estimates projects 11% growth in S&P 500 Index profits next year, and that number has increased in recent months (Exhibit 26). Investors are paying a relatively high price-to-earnings multiple at 19 times earnings compared with our modelled equilibrium of 17 times based on current interest rates and inflation (Exhibit 27). In past recessions, earnings have fallen an average of 24% so there is a substantial gap between what analysts are expecting and what could materialize if a recession does take hold. As a result, we think that current earnings estimates will fall and that process appears to have started (Exhibit 28). Further declines in earnings estimates will likely limit stock returns in the near term.
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