The
US stock markets sure feel inflectiony, at a major juncture. After
achieving new all-time record highs, sentiment was euphoric heading
into this week. But those latest heights could be a massive triple
top that formed over 15 months. Then heavy selling erupted in
recent days as the US-China trade war suddenly went hostile. The
big US stocks’ just-reported Q1’19 fundamentals will help determine
where markets go next.
Four
times a year publicly-traded companies release treasure troves of
valuable information in the form of quarterly reports. Required by
the US Securities and Exchange Commission, these 10-Qs and 10-Ks
contain the best fundamental data available to traders. They dispel
all the sentiment distortions inevitably surrounding prevailing
stock-price levels, revealing corporations’ underlying hard
fundamental realities.
The
deadline for filing 10-Qs for “large accelerated filers” is 40 days
after fiscal quarter-ends. The SEC defines this as companies with
market capitalizations over $700m. That currently includes every
stock in the flagship S&P 500 stock index (SPX), which contains the
biggest and best American companies. The middle of this week marked
38 days since the end of Q1, so almost all the big US stocks have
reported.
The
SPX is the world’s most-important stock index by far, with its
components commanding a staggering collective market cap of $24.9t
at the end of Q1! The vast majority of investors own the big US
stocks of the SPX, as some combination of them are usually the top
holdings of nearly every investment fund. That includes retirement
capital, so the fortunes of the big US stocks are crucial for
Americans’ overall wealth.
The
major ETFs that track the S&P 500 dominate the increasingly-popular
passive-investment strategies as well. The SPY SPDR S&P 500 ETF,
IVV iShares Core S&P 500 ETF, and VOO Vanguard S&P 500 ETF are among
the largest in the world. This week they reported colossal net
assets running $271.9b, $175.1b, and $111.5b respectively! The big
SPX companies overwhelmingly drive the entire stock markets.
Q1’19 proved extraordinary, the SPX soaring 13.1% higher in a
massive rebound rally after suffering a severe correction largely in
Q4. That pummeled this key benchmark stock index 19.8% lower in
just 3.1 months, right on the verge of entering a new bear market at
-20%. By the end of Q1, fully 5/6ths of those deep losses had been
reversed. Did the big US stocks’ fundamental performances support
such huge gains?
Corporate-earnings growth was expected to slow dramatically in Q1,
stalling out after soaring 20.5% last year. 2018’s four quarters
straddled the Tax Cuts and Jobs Act, which became law right when
that year dawned. Its centerpiece was slashing the US corporate tax
rate from 35% to 21%, which naturally greatly boosted profits from
pre-TCJA levels. Q1’19 would be the first quarter with post-TCJA
year-over-year comparisons.
Big
US stocks’ valuations, where their stock prices are trading relative
to their underlying earnings, offer critical clues on what is likely
coming next. By late April the epic stock-market bull as measured
by the SPX extended to huge 335.4% gains over 10.1 years! That
clocked in as the second-largest and first-longest bull in US
stock-market history. With the inevitable subsequent bear overdue,
valuations really matter.
Every quarter I analyze the top 34 SPX/SPY component stocks ranked
by market cap. This is just an arbitrary number that fits neatly
into the tables below, but a dominant sample of the SPX. As Q1
waned, these American giants alone commanded fully 43.7% of
the SPX’s total weighting! Their $10.9t collective market cap
exceeded that of the bottom 437 SPX companies. Big US stocks’
importance cannot be overstated.
I
wade through the 10-Q or 10-K SEC filings of these top SPX companies
for a ton of fundamental data I feed into a spreadsheet for
analysis. The highlights make it into these tables below. They
start with each company’s symbol, weighting in the SPX and SPY, and
market cap as of the final trading day of Q1’19. That’s followed by
the year-over-year change in each company’s market capitalization,
an important metric.
Major US corporations have been engaged in a wildly-unprecedented
stock-buyback binge ever since the
Fed forced
interest rates to deep artificial lows during 2008’s stock
panic. Thus the appreciation in their share prices also reflects
shrinking shares outstanding. Looking at market-cap changes
instead of just underlying share-price changes effectively
normalizes out stock buybacks, offering purer views of value.
That’s followed by quarterly sales along with their YoY change.
Top-line revenues are one of the best indicators of businesses’
health. While profits can be easily manipulated quarter to quarter
by playing with all kinds of accounting estimates, sales are tougher
to artificially inflate. Ultimately sales growth is necessary for
companies to expand, as bottom-line profits growth driven by
cost-cutting is inherently limited.
Operating cash flows are also important, showing how much capital
companies’ businesses are actually generating. Companies must be
cash-flow-positive to survive and thrive, using their existing
capital to make more cash. Unfortunately many companies now obscure
quarterly OCFs by reporting them in year-to-date terms, lumping
multiple quarters together. So if necessary to get Q1’s OCFs, I
subtracted prior quarters’.
Next
are the actual hard quarterly earnings that must be reported to the
SEC under Generally Accepted Accounting Principles. Lamentably
companies now tend to use fake pro-forma earnings to downplay
real GAAP results. These are derided as EBS profits, Everything but
the Bad Stuff! Certain expenses are simply ignored on a pro-forma
basis to artificially inflate reported corporate profits, often
misleading traders.
While we’re also collecting the earnings-per-share data Wall Street
loves, it’s more important to consider total profits. Stock
buybacks are executed to manipulate EPS higher, because the
shares-outstanding denominator of its calculation shrinks as shares
are repurchased. Raw profits are a cleaner measure, again
effectively neutralizing the impacts of stock buybacks. They better
reflect underlying business performance.
Finally the trailing-twelve-month price-to-earnings ratios as
of the end of Q1’19 are noted. TTM P/Es look at the last four
reported quarters of actual GAAP profits compared to prevailing
stock prices. They are the gold-standard metric for valuations.
Wall Street often intentionally conceals these real P/Es by using
the fictional forward P/Es instead, which are literally mere guesses
about future profits that often prove far too optimistic.
These are mostly calendar-Q1 results, but some big US stocks use
fiscal quarters offset from normal ones. Walmart, Home
Depot, and Cisco have lagging quarters ending one month after
calendar ones, so their results here are current to the end of
January instead of March. Oracle uses quarters that end one month
before calendar ones, so its results are as of the end of February.
Offset reporting ought to be banned.
Reporting on offset quarters renders companies’ results way less
comparable with the vast majority that report on calendar quarters.
We traders all naturally think in calendar-quarter terms too.
Decades ago there were valid business reasons to run on offset
fiscal quarters. But today’s sophisticated accounting systems that
are largely automated running in real-time eliminate all excuses for
not reporting normally.
Stocks with symbols highlighted in blue have newly climbed into the
ranks of the SPX’s top 34 companies over the past year, as investors
bid up their stock prices and thus market caps relative to their
peers. Overall the big US stocks’ Q1’19 results looked pretty
mixed, with slight sales growth and strong earnings growth. But
these growth rates are really slowing, and valuations remain
extreme relative to underlying profits.
From
the ends of Q1’18 to Q1’19, the S&P 500 rallied 7.3% higher. While
solid, that’s not much relative to the extreme euphoria and
complacency during this latest earnings season. These stock markets
could really be in a massive-triple-top scenario after this record
bull run, a menacing bearish omen. The SPX initially peaked at
2872.9 in late January 2018, mere weeks after those record corporate
tax cuts went into effect.
Then
it quickly plunged 10.2% in 0.4 months, a
sharp-yet-shallow-and-short correction. But with overall SPX
earnings growth exceeding 20% YoY comparing post-tax-cut quarters to
pre-tax-cut ones, this key benchmark clawed back higher and hit
2930.8 in late September 2018. That was merely a 2.0% marginal gain
over 7.8 months which saw some of the strongest corporate-profits
surges ever from already-high levels.
From
there the SPX plummeted 19.8% in 3.1 months in that severe near-bear
correction largely in Q4. This trend of slightly-better record
highs followed by far-worse selloffs is troubling. By late April
2019 the SPX had stretched to 2945.8, just 2.5% above its initial
peak 15.1 months earlier. Such paltry gains in a span with record
corporate tax cuts and resulting torrid earnings growth
should really give traders pause.
Technically these three major record highs look like a massive
triple top. The big US stocks’ Q1 results are critical to
supporting or refuting this bearish technical picture. The SPX/SPY
top 34 did enjoy superior market-cap appreciation from the ends of
Q1’18 to Q1’19, averaging 12.8% gains which ran 1.7x those of the
entire SPX. That exacerbated the concentration of capital in the
largest SPX stocks, the mega-cap techs.
As
Q1 ended, 5 of the 6 largest SPX stocks were Microsoft, Apple,
Amazon, Alphabet, and Facebook. Together they accounted for a
staggering 15.8% of this flagship index’s entire market cap,
closing in on 1/6th! These companies are universally adored by
investors, owned by the vast majority of all funds and constantly
extolled in glowing terms in the financial media. Investors think
mega-cap techs can do no wrong.
Last
summer these incredible businesses were viewed as recession-proof,
effectively impregnable. But even if there’s some truth to that, it
doesn’t guarantee mega-cap-tech stock prices will weather a
stock-market selloff. During that 19.8% SPX correction mostly in
Q4, these 5 dominant SPX stocks and another SPX-top-34 tech darling
Netflix averaged ugly 33.3% selloffs! They amplified the SPX’s
decline by 1.7x.
No
matter how amazing the sales growth among the mega-cap techs, they
aren’t only not immune to SPX selloffs but their lofty stock prices
make them more vulnerable. Overall the SPX/SPY top 34
companies reported Q1’19 revenues of $969.3b, which was 0.9% YoY
higher than the top 34’s in Q1’18. That’s not great performance
considering how universally-loved and -owned these companies are
among nearly all funds.
Those 6 mega-cap tech stocks did far better, enjoying
order-of-magnitude-better revenues growth of 9.9% YoY! Excluding
them the rest of the SPX top 34 actually saw total sales slump
1.8% lower YoY, which sure doesn’t sound like a strong economy.
If this trend of stalling or slowing revenue growth continues,
profits growth will have to start falling sharply in future
quarters. Earnings ultimately amplify sales trends.
Even
more bearish, Wall Street analysts headed into Q1’19’s earnings
season expecting all 500 SPX companies to enjoy 4.7% total revenues
growth. But the top 34 that dominate the US stock markets did much
worse at 0.9% even with mega-cap techs included. That was
definitely a sharp slowdown too, as the SPX top 34 saw 4.2% YoY
sales growth in Q4’18. Slowing revenue growth is a real threat to
the stock markets.
Remember the SPX surged dramatically in Q1, fueling quite-euphoric
sentiment leading into quarter-end. At the same time traders mostly
believed that a US-China trade deal would soon be signed, removing
the trade-war risks. High tariffs are a serious problem for the
gigantic multinational companies leading the SPX, potentially
heavily impacting sales. Yet revenue growth was already slowing
even before this week!
Trump had twice delayed hiking US tariffs on Chinese imports from
10% to 25%, a good-faith sign giving time for real trade-deal
negotiations. But his patience ran out this past Sunday after China
backtracked on key previous commitments. So Trump tweeted the
current 10% US tariffs on $200b of annual Chinese imports would
surge to 25% today, and warned that 25% tariffs were coming
“shortly” on another $325b!
China will retaliate as long as high US tariffs remain in effect.
That will really retard US sales from top-34 SPX companies in that
country. Beloved market-darling Apple is a great example. This
second-biggest stock in the S&P 500 did $10.2b or 17.6% of its Q1’19
sales in China! The US-China trade war heating up in a serious way
portends even-weaker revenues going forward for the big US stocks
dominating the SPX.
The
total operating cash flows generated by the top 34 SPX/SPY companies
looked like a disaster in Q1, plummeting 64.4% YoY to $67.8b.
Thankfully that is heavily skewed by a couple of the major US
banks. JPMorgan Chase and Citigroup reported staggering negative
OCFs of $80.9b and $37.6b in Q1, due to colossal $123.1b and $30.4b
negative changes in trading assets! This seems really
confusing to me.
Mega-bank financials are fantastically-complex, and no one
can hope to understand them unless deeply immersed in that world.
I’ve been a certified public accountant for decades now, spending
vast amounts of time buried in 10-Qs and 10-Ks to fuel my stock
trading. Yet even with my background and experience I can’t
interpret mega-bank results. It seems weird trading assets
plummeted in Q1 as the SPX surged sharply.
But
rather than getting bogged down in mega-bank arcania that may be
impossible to comprehend by outsiders, we can just exclude the four
SPX-top-34 mega-banks from our OCF analysis. They include JPMorgan
Chase, Bank of America, Wells Fargo, and Citigroup. Without them,
the rest of the SPX top 34 reported total OCFs of $163.2b in Q1’19.
That was dead-flat ex-banks, up just 0.3% YoY from Q1’18’s OCFs.
So
the big US stocks’ operating-cash-flow generation really slowed too
in Q1, stalling out compared to hefty 11.5% YoY growth in Q4’18.
That’s another sign that the US economy must be slowing
despite the red-hot stock markets. That’s ominous and bearish
considering the coming headwinds if the trade wars continue and if
the stock markets roll over decisively. Future quarters’ business
environments won’t be as good.
Earnings were a different story entirely last quarter, soaring
dramatically among the SPX/SPY top 34. They totaled $149.8b,
surging an enormous 36.1% YoY! But that was skewed way higher by
Warren Buffett’s famous Berkshire Hathaway, the biggest SPX stock
after the mega-cap techs. BRK reported a monster Q1 profit of
$21.7b, compared to a $1.1b loss a year earlier. That accounted for
1/7th of the top 34’s total.
But
Berkshire’s epic profits are due to the sharp stock-market rebound
rally, not underlying operations. A new accounting rule that Warren
Buffett hates and rails against at every opportunity requires
unrealized capital gains and losses to be flushed through
quarterly profits. Thus when the SPX plunged in Q4’18, BRK reported
a colossal $25.4b GAAP loss. That was largely reversed in Q1’19
with its gigantic $21.7b gain.
Excluding the $16.1b of BRK’s Q1 profits that were mark-to-market
stock-price gains, the SPX top 34’s total profits grew 21.5% YoY to
$133.6b in Q1. That’s still impressive, but it masks some big
problems on the corporate-earnings front. Those 6 elite mega-cap
tech companies dominating the SPX actually saw their collective Q1
GAAP profits plunge 11.2% YoY! Apple, Alphabet, and Facebook
suffered sharp declines.
Usually mega-cap tech stocks are the profits engine driving the
entire SPX higher. If these market-darling companies that are
universally-loved and -held struggled with earnings growth in Q1,
what does that say about profits going forward? And again profits
can be manipulated quarter-to-quarter by playing with all kinds of
accounting estimates. So if anything corporate profits are
overstated instead of understated.
One
of Wall Street’s great farces is the game of comparing quarterly
results to expectations instead of what they were in the
comparable quarter a year earlier. Mighty Apple is a great
example, reporting after the close on April 30th. Its Q1 earnings
per share and sales of $2.47 and $58.0b came in ahead of Wall Street
expectations of $2.37 and $57.5b. So Apple’s stock surged 4.9% the
next day on those “great results”.
But
that expectations bar had been lowered dramatically, which is the
only reason Apple beat. On an absolute year-over-year basis
compared to Q1’18, Q1’19 saw sales drop 5.1%, OCFs plummet 26.3%,
and earnings plunge 16.4% YoY! That was quite weak, and couldn’t be
considered good by any honest measure. In this recent Q1 earnings
season, the fake expectations game obscured plenty of real
weakness.
Yet
overall SPX-top-34 profits growth still remained strong, with
companies suffering drops offset by other companies seeing big
jumps. But earnings can’t be considered in isolation, they are only
relevant relative to underlying stock prices. Imagine you own a
rental house and someone offers you $1000 a month to move in. The
reasonableness of that earnings stream is totally dependent on the
value of your property.
If
your house is worth $100k, $1k a month looks great. But if it’s
worth $1m, $1k a month is terrible. The profits anything generates
are only measurable relative to the capital invested in that
asset. The classic trailing-twelve-month price-to-earnings ratios
show how expensive stock prices are relative to underlying corporate
profits. Big SPX-top-34 earnings growth isn’t bullish if overall
profits are low compared to stock prices.
At
the end of Q1’19 proper before these Q1 results were reported, the
SPX/SPY top 34 component stocks averaged TTM P/Es of 30.4x. That is
definitely improving compared to the prior four quarters’ trend of
46.0x, 53.4x, 49.0x, and 39.7x. But 30.4x is still dangerously high
absolutely. Over the past century-and-a-quarter or so, fair value
for the US stock markets
was 14x.
Double that at 28x is where bubble territory begins.
So
the big US stocks were literally trading at bubble valuations
exiting Q1! Their stock prices were far too high relative to their
underlying earnings production compared to almost all of US
stock-market history. And this wasn’t just a mega-cap-tech-stock
thing, with these elite companies often being bid to really-high
valuations compared to other sectors. The 6 mega-cap techs we’ve
discussed indeed averaged a crazy 52.0x.
But
the other 28 top-34-SPX companies remained very expensive near
bubble territory even excluding the tech giants, averaging 25.8x!
Even the strong Q1’19 earnings growth didn’t help much. At the end
of April as those Q1 results started to work into TTM P/E
calculations, the SPX top 34 averaged a slightly-higher P/E of
31.0x. Literal bubble valuations with stock markets trading near
all-time record highs are ominous.
Just
last Friday when the SPX closed right at its highest levels in
history, I wrote a contrarian essay on these “Dangerous
Stock Markets”. It explained how high valuations kill bull
markets, summoning bears that are necessary to maul stock prices
sideways to lower long enough for profits to catch up with
lofty stock prices. These fearsome beasts are nothing to be trifled
with, yet complacent traders mock them.
The
SPX’s last couple bears that awoke and ravaged due to high
valuations pummeled the SPX 49.1% lower in 2.6 years leading into
October 2002, and 56.8% lower over 1.4 years leading into March
2009! Seeing big US stocks’ prices cut in half or worse is
common and expected in major bear markets. And there’s a decent
chance the current bubble valuations in US stock markets will soon
look even more extreme.
Over
the past several calendar years, earnings growth among all 500 SPX
companies ran 9.3%, 16.2%, and 20.5%. This year even Wall Street
analysts expect it to be flat at best. And if corporate
revenues actually start shrinking due to mounting trade wars or
rolling-over stock markets damaging confidence and spending, profits
will amplify that downside. Declining SPX profits will
proportionally boost valuations.
If
the big US stocks’ fundamentals deteriorate, the overdue bear
reckoning after this monster bull is even more certain. Cash is
king in bear markets, since its buying power grows. Investors who
hold cash during a 50% bear market can double their holdings at the
bottom by buying back their stocks at half-price. But cash doesn’t
appreciate in value like gold, which actually grows wealth
during major stock-market bears.
Gold
investment demand
surges as stock markets weaken, as we got a taste of in
December. While the SPX plunged 9.2%, gold rallied 4.9% as
investors flocked back. The gold miners’ stocks which
leverage gold’s
gains fared even better, with their leading index surging 10.7%
higher. The last time a major SPX selloff awakened gold in the
first half of 2016, it soared 30% higher fueling a massive 182%
gold-stock upleg!
Absolutely
essential in bear markets is cultivating excellent contrarian
intelligence sources. That’s our specialty at Zeal. After decades
studying the markets and trading, we really walk the contrarian
walk. We buy low when few others will, so we can later sell high
when few others can. While Wall Street will deny
this coming stock-market bear all the
way down, we will help you both understand it and prosper during it.
We’ve long
published acclaimed
weekly and
monthly newsletters for speculators and investors. They draw on
my vast experience, knowledge, wisdom, and ongoing research to
explain what’s going on in the markets, why, and how to trade them
with specific stocks. As of Q1 we’ve
recommended and realized 1089 newsletter stock trades since 2001,
averaging annualized realized gains of +15.8%! That’s nearly double
the long-term stock-market average.
Subscribe today
for just $12 per issue!
The bottom line is
the big US stocks’ Q1’19 results were pretty mixed despite the
surging stock markets. Revenues and operating cash flows only grew
slightly, which were sharp slowdowns from big surges in previous
quarters. While earnings somehow defied sales to soar dramatically
again, that disconnect can’t persist. A slowdown looked to be
underway even before the US-China trade war flared much hotter this
week.
Even the surging
corporate profits weren’t enough to rescue super-expensive stock
markets from extreme bubble valuations. They are what spawn major
bear markets, which are necessary to maul stock prices long enough
for valuations to mean revert lower. Make no mistake, these
overvalued stock markets are still an accident waiting to happen.
Stock investors should diversify, adding substantial gold
allocations. |