The
mega-cap stocks that dominate the US markets are just wrapping up a
truly-extraordinary earnings season. Naturally this first quarter
under Republicans’ new corporate tax cuts fueled surging profits.
But sales were up big too, which is no mean feat for massive
companies. With sustained growth at this torrid pace impossible,
peak-earnings fears are mounting. And valuations stayed extremely
expensive exiting Q1.
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 contain the
best fundamental data available to investors and speculators. They
dispel all the sentimental distortions inevitably surrounding
prevailing stock-price levels, revealing the 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
single stock in the flagship S&P 500 stock index, which includes the
biggest and best American companies. As Q1’18 ended, the smallest
SPX stock had a market cap of $2.1b which was 1/410th the size of
leader Apple.
The
middle of this week marked 39 days since the end of calendar Q1, so
almost all of the big US stocks of the S&P 500 have reported. The
exceptions are companies running fiscal quarters out of sync with
calendar quarters. Walmart, Home Depot, and Cisco have fiscal
quarters ending in April instead of the usual March, so their “Q1”
results weren’t out yet as of this Wednesday. They’ll arrive in the
coming weeks.
The
S&P 500 (SPX) is the world’s most-important stock index by far,
weighting the best US companies by market capitalization. So not
surprisingly the world’s largest and most-important ETF is the SPY
SPDR S&P 500 ETF which tracks the SPX. This week it had net assets
of a staggering $256.7b! The iShares Core S&P 500 ETF and Vanguard
S&P 500 ETF also track the SPX with $149.9b and $88.5b of net
assets.
The
vast majority of investors own the big US stocks of the SPX, as they
are the top holdings of nearly all investment funds. So if you are
in the US markets at all, including with retirement capital, the
fortunes of the big US stocks are very important for your overall
wealth. Thus once a quarter after earnings season it’s essential to
check in to see how they are faring fundamentally. Their results
also portend stock-price trends.
Unfortunately my small financial-research company lacks the manpower
to analyze all 500 SPX stocks in SPY each quarter. Support our
business with enough newsletter subscriptions, and I would gladly
hire the people necessary to do it. For now we’re digging into the
top 34 SPX/SPY components ranked by market capitalization. That’s
an arbitrary number that fits neatly into the tables below, but a
commanding sample.
As
of the end of Q1’18 on March 29th, these 34 companies accounted for
a staggering 41.7% of the total weighting in SPY and the SPX
itself! These are the mightiest of American companies, the
widely-held mega-cap stocks everyone knows and loves. For
comparison, it took the bottom 426 SPX companies to match its top 34
stocks’ weighting. The entire stock markets greatly depend on how
the big US stocks are doing.
Every quarter I wade through the 10-Q SEC filings of these top SPX
companies for a ton of fundamental data I dump 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 Q1’18. That’s followed by
the year-over-year change in each company’s market capitalization, a
critical 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 changes.
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 earnings growth driven by
cost-cutting is inherently limited.
Operating cash flows are also important, showing how much capital
companies’ businesses are actually generating. Using cash to make
more cash is a core tenet of capitalism. While most of these elite
US companies reported Q1’18 OCFs as they should, some obscured
quarterly results by lumping them in with the past 6 or 9 months.
So these tables only include Q1 operating cash flows if specifically
reported.
Next
are the actual hard quarterly earnings that must be reported to the
SEC under Generally Accepted Accounting Principles. Late in bull
markets, companies tend to use fake pro-forma earnings to
downplay real GAAP results. These are derided as EBS earnings,
Everything but the Bad Stuff! Companies often arbitrarily ignore
certain expenses on a pro-forma basis to artificially boost their
profits, which is very misleading.
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 ratio as
of the end of Q1’18 is 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 obscures these hard P/Es by using
the fictional forward P/Es instead, which are literally mere guesses
about future profits that often prove far too optimistic.
As
expected given the largest corporate tax cuts in US history going
live, the big US stocks generally reported spectacular Q1’18
results. Sales, OCFs, and earnings surged dramatically! But much
of this tax-cut windfall was anticipated, as valuations remained
dangerously high at the end of last quarter. It’s hard to imagine
such blistering growth of such enormous mega-cap companies being
able to persist for long.
Not surprisingly
the S&P 500’s top-constituent list was little changed over the past
year. Most of these elite American companies investors love only
grew larger. Three stocks did claw their way into the top 34 since
Q1’17, and their symbols are highlighted in light blue. Boeing,
AbbVie, and DowDuPont saw their stocks soar enough to help knock out
GE, IBM, and Altria from the ranks of the top 34 big US stocks.
From the ends of
Q1’17 to Q1’18, the SPX itself powered 11.8% higher. This past year
was one of great anticipation and euphoria for the expected big
corporate tax cuts coming soon. These top 34 SPY stocks
outperformed the markets considerably, with big average market-cap
gains of 14.6% YoY. More capital inflows concentrating in fewer
stocks highlights the increasing narrowness and riskiness of
these toppy markets.
As bull markets
mature, the breadth of their advances increasingly narrows.
Investors flock into the best-performing stocks to chase their
superior gains. Thus decreasing numbers of market-darling stocks
are wielding outsized influence on overall stock-market fortunes.
They shoulder more of the burden, which is a double-edged sword.
When selling erupts in these leaders for any reason, it hits the
broader markets hard.
Ominously the
universally-adored and -owned mega-cap tech stocks still dominated
the SPX at the end of Q1. That was despite the SPX
suffering its
first correction in 2.0 years, a sharp-yet-shallow plunge of
10.2% in just 9 trading days. That started to crack this past
year’s extraordinary tech-stock euphoria, but that selloff was too
short to really change psychology. So investors still love the
leading technology stocks.
Apple, Alphabet,
Amazon, and Microsoft tower over the rest of the top SPY stocks,
alone accounting for 1/8th of the entire SPX’s weighting!
Facebook wasn’t far behind at 6th after Warren Buffett’s Berkshire
Hathaway. In Q1’18 these top 5 tech stocks indeed seemed to earn
their keep, with average results far better than the other big US
companies. They reported incredible average top-line sales growth
of 29.8% YoY!
At 30% annual
revenues growth, sales will double about every 2.6 years. That’s
never sustainable for long even in far-smaller companies, and is
economically impossible at the size and scale of the mega-cap
techs. Despite their awesome and amazing success, these 5 US
companies aren’t going to take over the entire US economy. This
past year was an extreme outlying anomaly that inevitably has to
mean revert.
Never before have
stock markets relentlessly powered higher to seemingly-endless new
record closes with the lowest volatility ever witnessed. Especially
with the stock markets literally trading at bubble valuations all
year. Never before have the entire American business and investment
communities been able to spend over a year eagerly anticipating the
biggest corporate tax cuts in US history.
2017 wasn’t normal!
I’ve been blessed
to spend decades studying the markets full-time, all day every day.
And certainly one of the most stunning revelations is how broadly
and deeply stock-market fortunes affect nearly everything else
in the entire economy! Record-high stock markets breed epic levels
of optimism about the future and thus abnormally-high levels of
spending, both from businesses and individuals. That greatly boosts
sales.
These mega-cap
tech stocks had the great fortune of riding that
big-tax-cuts-coming-soon wave of stock-market euphoria. Americans
eager to splurge flocked to buy Apple’s latest iPhones and iPads,
which are great but expensive products. If the stock markets had
ground lower breeding pessimism, that big Apple upgrade cycle
would’ve lengthened as people made do with older devices with almost
the same functionality.
Businesses rushed
to capitalize on the gold rush of surging consumer spending,
advertising heavily on both Alphabet and Facebook. They also rushed
to expand their online operations by leasing cloud servers and
services from Amazon, Microsoft, and Alphabet. What will happen to
this huge business spending to market and grow as stock markets roll
over and consumers and companies pull in their horns?
The sheer levels
of spending over this past totally-unique year that fueled such
incredible sales growth aren’t sustainable. Both consumers and
businesses racked up huge new debt to fuel their euphoric
buying binges. They won’t keep stacking on debt with interest rates
rising and the once-in-a-lifetime extreme optimism on big tax cuts
soon fading. The mega-cap tech stocks, and all big US stocks, face
slowing sales.
The real shock is
not that sales ballooned so dramatically in such a perfect year for
bullish sentiment, but that Wall Street is arguing such growth is
the new norm. These top 34 SPX companies that had reported Q1
results as of this Wednesday had $789.0b of revenues. Those would
double about every 5.3 years even at Q1’s average 14.0% YoY growth
rate. These 34 companies can’t gobble up the entire world economy!
These big US
stocks’ operating cashflows in Q1 highlight the unsustainability of
these results. The 24 top SPY components reporting Q1 OCFs saw
incredible average gains of 52.5% YoY. There’s just no way giant
mature companies can keep expanding their businesses’ cash
generation at such blistering rates. OCFs leverage revenues both
ways, so naturally sharply-rising sales are going to catapult OCFs
higher.
Of course profits
also amplify sales, so the corporate profits of these top 34 US
companies surged even more dramatically in Q1. They averaged
gargantuan growth of 45.9% YoY! While not sustainable, that’s a
reasonable 3.3x the increase in sales. The total earnings of the 31
of these 34 giant companies that had reported as of the middle of
this week ran a colossal $116.0b, making for profit margins of about
1/7th.
While those are
big profits, surprisingly they only grew 3.4% quarter-on-quarter
from Q4’17. Remember that quarter was the last under the old
higher-corporate-tax regime. Given all the corporate-tax-cut hype
leading into Q1’18 which was again the tax cuts’ maiden quarter,
you’d think corporate profits would’ve surged far more than 3.4%
QoQ. But that gain is somewhat understated given big adjustments on
Q4’17 results.
In my recent essay
on big US stocks’
Q4’17, I discussed how nearly all of these elite companies had
to make significant-to-huge earnings adjustments to account for the
new Tax Cuts and Jobs Act of 2017. With corporate tax rates being
slashed, the values of existing deferred tax assets and liabilities
on many corporate balance sheets changed dramatically. These
differences had to be flushed through Q4 income statements.
Basically
companies that had overpaid or underpaid their taxes in the past had
to adjust for new lower corporate tax rates going forward. The
absolute value of all these adjustments for the top 34 US stocks was
a mind-boggling $209.2b in Q4’17, dwarfing actual GAAP profits of
$112.2b! But interestingly it was a wash overall, with positive
profits boosts and negative profits hits evening out to a net gain
of just $2.7b.
Without those big
one-time corporate-tax-cut earnings adjustments, overall
top-34-SPY-company profits were up 6.0% QoQ in Q1’18. That’s big,
not still not as hefty as stock-market euphoria seemed to imply was
coming. When corporate-sales growth inevitably stalls, so will
profits growth. If revenues actually start to shrink, earnings will
decline at several times that rate. So the peak-earnings
fears are righteous!
Since it’s hard to
imagine a better year psychologically for driving big spending than
2017, odds are the corporate-sales environment will mean revert
lower with stock-market fortunes and sentiment. And if that indeed
proves true, corporate profits have hit or are hitting their
high-water mark for a long time to come. We really may not see such
crazy earnings growth again until the next secular stock bull tops
years into the future.
The SPX-leading
market-darling tech stocks Alphabet, Amazon, Microsoft, and Facebook
rely heavily on business spending. Last year was a banner
year for business confidence on the coming huge tax cuts, leading to
giant leaps in spending for online advertising and back-office data
services. When the next recession inevitably arrives with the
overdue stock bear, much of that euphoric spending will wither and
reverse.
On the valuation
front, these big US stocks were frightfully expensive exiting
Q1’18. They sported scary average trailing-twelve-month
price-to-earnings ratios of 46.0x. That’s closing in on double
the classic bubble threshold of 28x! Over the past century and
a quarter or so, the average fair-value valuation for the stock
markets was half that at 14x. So there’s no doubt these stock
markets are exceedingly expensive.
Since these TTM
P/E ratios came from the end of Q1 before its big surge in earnings,
we can attempt to adjust for that. With these top 34 SPX companies’
profits up 6.0% QoQ excluding tax-cut adjustments, we can generously
assume valuations fell 10%. But even if that is somehow 20%, the
big US stocks’ average P/Es are still well into bubble territory at
36.8x. Traders have anticipated tax-cut profits for over a year.
Thus the big
corporate tax cuts’ earnings boost has long since been more than
fully priced in. But maybe offsetting these extreme
overvaluations a bit is those big TCJA adjustments in Q4. One
reason the P/Es of Alphabet and Microsoft are so high is they took
colossal $9.9b and $13.8b hits to earnings in Q4’17 to account for
lower corporate taxes going forward. These are one-time distortions
not reflective of ongoing operations.
But on the other
hand, other top US companies had massive profits boosts in Q4 that
artificially lowered their own P/Es. Chief among them is Berkshire
Hathaway, which enjoyed a gargantuan $29.1b boost to profits in Q4
due to that one-off TCJA adjustment. So its TTM P/E collapsed from
26.4x at the end of Q4 to 10.8x at the end of Q1. The unique Q4
earnings impacts of the tax cuts distorted various P/Es in both
directions.
Seeing 33 of these
top 34 SPX companies report big one-time profits adjustments in
Q4’17 is surely unprecedented in all of history. These won’t roll
off of trailing-twelve-month P/E-ratio calculations until the Q4’18
results come out early next year. So unfortunately we are
going to suffer distorted P/Es through all of 2018. But since the
overall TCJA adjustment was largely flat, the P/E skew should
largely cancel out too.
One of the
most-bullish arguments for stock markets going forward is large US
companies are taking their higher profits from the corporate tax
cuts and plowing them into stock buybacks. So Wall Street is
salivating at that pushing stock markets to new record highs.
Recent developments with mighty Apple, the king of stock buybacks,
demand caution on that bullish thesis. Stock buybacks can’t
overcome selloffs.
In its Q1’18
results recently reported on May 1st, Apple added a staggering $100b
to its record stock-buyback campaign taking it to $310b total. Last
quarter alone, Apple spent an
all-time-record-for-the-entire-stock-markets $22.8b buying back its
own shares! Nevertheless Apple’s stock still slipped 0.9% lower
in Q1 because of the SPX correction. Even relatively-mild selling
overpowered epic stock buybacks!
If Q1’18 is indeed
as good as it gets or darned close, these bubble-valued stock
markets are in serious trouble as sales growth mean reverts
dramatically lower. That will be leveraged several times or so in
earnings. Seeing the top 34 SPY companies’ sales up an average of
14.0% YoY, and the 5 mega-cap tech stocks’ sales skyrocketing 29.8%
YoY, can’t be sustainable. This cycle’s peak earnings is likely
really here.
That greatly ups
the odds that a new bear market is awakening. Thanks to
extreme
central-bank easing led by the Fed’s radically-unprecedented
7-year-long zero-interest-rate-policy, the SPX’s bull ballooned to
freakish proportions. As of late January’s peak, it had extended to
a monster 324.6% gain over 8.9 years! That was nearly the
second-largest and easily the second-longest stock bull in all of US
history.
The powerful
stock-market melt-up over the past year to many new all-time highs
was a typical late-bull sentiment thing amplified by
big-tax-cut-soon-hope euphoria. That extreme optimism greatly
boosted corporate sales and profits, but nowhere near enough to
rescue valuations from bubble extremes. As psychology mean reverts
to neutral then overshoots to bearish, earnings won’t protect stocks
from getting mauled.
Despite the recent mild correction, these stock markets remain
exceedingly overvalued and dangerous. The big US stocks’ Q1’18
fundamentals prove corporate earnings still remain too low to
justify such lofty stock prices. That’s terrifying in 2018 where
the Fed and ECB will collectively
remove $950b of
liquidity compared to last year! Regardless of valuations, this
alone would plunge these stock markets into a new bear.
Investors really
need to lighten up on their stock-heavy portfolios, or put stop
losses in place, to protect themselves from the coming
central-bank-tightening-triggered valuation mean reversion in
the form of a major new stock bear. Cash is king in bear markets,
as its buying power grows. Investors who hold cash during a 50%
bear market can double their stock holdings at the bottom by buying
back their stocks at half-price!
SPY put options
can also be used to hedge downside risks.
They are still relatively cheap now with complacency rampant, but
their prices will surge quickly when stocks start selling off
materially again. Even better than cash and SPY puts is
gold, the anti-stock trade. Gold is a rare asset that tends to move
counter to stock markets, leading to
soaring
investment demand for portfolio diversification
when stocks fall.
Gold surged nearly
30% higher in the first half of 2016 in a new bull run that was
initially sparked by the last major correction in stock markets
early that year. If the stock markets indeed roll over into a new
bear in 2018, gold’s coming gains should be much greater. And they
will be dwarfed by those of the best gold miners’ stocks, whose
profits leverage
gold’s gains. Gold stocks skyrocketed 182% higher in 2016’s
first half!
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The bottom line is
the big US stocks’ latest quarterly results proved amazingly good.
Sales and profits both rocketed higher as extreme stock-market
optimism and big-corporate-tax-cut hopes fueled massive spending.
But that was still nowhere near enough to justify stocks’ bubble
valuations, portending way-weaker stock markets ahead. That will
sap last year’s exceptional confidence and erode results going
forward.
As businesses and
consumers pull in their horns and stop borrowing to spend big in
this new rising-rate environment, revenues and earnings growth will
stall and reverse. That’s what happens after euphoric bull-market
tops. That will fuel stock selling dragging the markets lower,
which will further weigh on both sentiment and spending. So there’s
a very-good chance we are seeing peak earnings in this bull-bear
cycle. |