Budget rally goes into reverse, Microsoft hit by AI spending concerns, Shell beats forecasts and unveils buyback, quartet of Halloween profit warnings includes Smith & Nephew

“Yesterday’s relief rally after the Budget didn’t last long,” says Russ Mould, Investment Director at AJ Bell.

“Gilt yields jumped after the market cottoned on to a big increase in government borrowing over the next five fiscal years and that extra tax income from changes announced in the Budget won’t appear overnight. That means interest rates could stay higher for longer which is not good for housebuilders and retailers hoping for reduced pressures on household finances, hence why those sectors were in the red today. It also explains why banks were among the select few risers on the FTSE 100 as they stand to benefit from a stronger interest rate environment as they can charge more for lending.

“The idea of rates staying higher for longer was also relevant to the US market after GDP figures pointed to a robust economy. That might encourage the Fed to be less aggressive with rate cuts.

“Many investors were hoping big rate cuts would create another tailwind for equities, particularly tech stocks, so add in a slight setback on this front with a negative response to Meta and Microsoft’s latest figures and you’ve got the potential for a gloomy day on Wall Street. Futures prices point to a 1% drop in the Nasdaq when US markets open today.”

Microsoft

“It’s clear from the reaction to Microsoft’s latest quarterly numbers that the market’s tolerance for big spending on AI without immediate signs of a return is waning.

“While third-quarter earnings and revenue were a touch ahead of expectations, the market was always likely to focus on the outlook and here the massive investment in the ChatGPT spawning OpenAI venture and other AI developments is expected to deliver a hit to income. Softening revenue in its Azure cloud business – in contrast to the more positive cloud outlook at Alphabet – also gave investors pause for thought.

“Microsoft faces a significant challenge as it looks to build the infrastructure required to service the massive computing power involved in AI. This includes building and populating countless data centres but also addressing the huge associated energy demands. Hence the recent deal to revive the mothballed US nuclear plant at Three Mile Island to support its energy needs.

“Investors know there is significant potential in AI but they increasingly want to see that the money being invested in its development is being allocated sensibly and that, at some point in the not-too-distant future, it will deliver tangible rewards.”

Shell

“Shell has managed to beat some gloomy forecasts in the third quarter despite the weak oil price. The addition of a new share buyback has helped drive a positive response from the market.

“The company’s long-term strategy of focusing on natural gas appears to be paying off with the integrated gas division proving the real engine of growth.

“Shell has invested heavily in this area in the last decade or so, including through the blockbuster acquisition of BG in 2016, betting that gas could have a role to play as the world transitions away from more polluting fuels like coal or oil. The strength in liquefied natural gas helped make up from weak refining margins which had been flagged by the company in a teaser ahead of the results.

“The focus under CEO Wael Sawan has been on streamlining and simplifying the business and taking a more hard-nosed approach to the energy transition. While the aspiration of keeping up with US peers is still to be met, Shell has at least outperformed its direct UK rival BP.”

Profit Warnings: Smith & Nephew, Spectris, Kainos, Nexteq

“The Halloween effect sent shivers down the spines of investors as four UK-listed companies issued profit warnings on a day normally associated with scares of a different nature.

“Smith & Nephew led the charge, with its shares crashing 13% after cutting its revenue growth guidance amid issues in China.

“The medical equipment group has walked a rocky path since the pandemic led to elective surgeries being cancelled. Many planned hip and knee replacements were pushed back, reducing demand for Smith & Nephew’s orthopaedic products, while its supply chain was also disrupted.

“Smith & Nephew’s comeback post-pandemic has been uneven and the share price has spluttered. That attracted activist investor Cevian Capital onto the shareholder register in search of an opportunity. Cevian knew a lot of work was needed to fix Smith & Nephew but it will still be furious at the latest setback, no doubt prompting it to be more vocal in how the business should be run.

“Chinese weakness was also behind a warning from scientific instruments group Spectris, whose shares fell after cutting its annual profit forecast. In July, Spectris lamented softer market conditions in the first half of the year but was optimistic about the second half. Sadly, the recovery hasn’t been as expected, with markets continuing to be weak in China, pharma and academia, and it says this could remain the case for a while.

“Software company Kainos slumped 14% after saying full-year revenue won’t meet market expectations. Clients are dithering about spending in an uncertain macroeconomic environment, which implies that fewer companies are signing up to Kainos’ services than expected.

“Among small caps, industrial tech firm Nexteq fell 17% after experiencing a nasty cocktail of problems. Industry destocking has slowed new orders and customers are delaying agreed project spend into the new year, leading to Nexteq saying full-year revenue will be up to 12% below previous market estimates.

“All these warnings point to a tough trading environment, even for companies with specialist expertise.”

These articles are for information purposes only and are not a personal recommendation or advice.