The
mega-cap stocks that dominate the US markets are just finishing
another monster earnings season. It wasn’t just profits that soared
under Republicans’ big corporate tax cuts, but sales surged too.
That’s no mean feat for massive mature companies, but sustained
growth at this torrid pace is impossible. So peak-earnings fears
continue to mount while valuations shoot even higher into dangerous
bubble territory.
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 Q2’18 ended, the smallest
SPX stock had a market cap of $4.1b which was 1/225th the size of
leader Apple.
The
middle of this week marked 39 days since the end of calendar Q2, 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, Cisco, and NVIDIA have
fiscal quarters ending a month after calendar ones, so their
“Q2” results weren’t out yet as of this Wednesday. They’ll arrive
in 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 huge net
assets of $271.3b! The IVV iShares Core S&P 500 ETF and VOO
Vanguard S&P 500 ETF also track the SPX with $155.9b and $96.6b 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, and a
dominant sample.
As
of the end of Q2’18 on June 29th, these 34 companies accounted for a
staggering 42.6% 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 431 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 Q2’18. 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. Unfortunately most
companies are now obscuring quarterly OCFs by reporting them in
year-to-date terms, which lumps in multiple quarters together. So
these tables only include Q2 operating cash flows if specifically
broken out by companies.
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 Q2’18 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.
Not
surprisingly in the second quarter under this new
slashed-corporate-taxes regime, many of the mega-cap US stocks
reported spectacular Q2’18 results. For the most part sales,
OCFs, and earnings surged dramatically. The big problem is such
blistering tax-cut-driven growth rates are impossible to sustain for
long at the vast scales these huge companies operate at. Downside
risks are serious with bubble valuations.
The
elite market-darling mega tech stocks continue to dominate the US
stock markets. Most famous are the FANG names, Facebook, Amazon,
Netflix, and Alphabet which used to be called Google. Apple and
Microsoft should be added to those rarified beloved ranks. Together
these half-dozen companies alone accounted for nearly 1/6th
of the SPX’s entire market cap! That’s an incredible concentration
of capital.
This
highlights the extreme narrowing breadth behind this
very-late-stage bull market. At the month-end just before Trump’s
election victory in early November 2016, these same tech giants
weighed in at 12.3% of the SPX weighting compared to 16.4% today.
And if you go all the way back to this bull’s birth month of March
2009, MSFT, GOOGL, AAPL, and AMZN weighed in at 5.4%. FB and NFLX
weren’t yet in the SPX.
Ever
more capital is crowding into fewer and fewer stocks as fund
managers chase the biggest winners and increasingly pile into them.
And these 6 elite mega techs’ Q2’18 results show why they are widely
adored. Their revenues rocketed 30.3% YoY on average, more than
doubling the 14.0% growth in this entire top-34 list! Excluding
these techs, the rest of the top 34 only grew their sales by 10.0%
or a third as much.
That
vast outperformance is reflected in their market-cap gains too,
which again normalize out all the big stock buybacks. Overall these
top SPY companies’ values surged 23.5% higher YoY, nearly doubling
the 12.2% SPX gain from the ends of Q2’17 to Q2’18. But these top 6
tech stocks’ stellar average gains of 57.5% YoY dwarfed the
rest of the top 34’s 16.2% annual appreciation! These stocks are
loved for good reason.
The
same is true on the profits front, with AAPL, AMZN, GOOGL, MSFT, FB,
and NFLX trouncing the rest of these biggest US stocks. These 6
tech giants saw staggering average earnings growth of 289.1% YoY,
compared to 30.9% for the rest of the top 34. That former number is
heavily skewed by Amazon’s results though, as its profits
skyrocketed an astounding 1186% from $197m in Q2’17 to $2534m in
Q2’18.
Netflix had a similar enormous 484% YoY gain in earnings from a
super-low level. Interestingly the rest of these big 6 tech stocks
saw average growth of just 16.0% YoY, only about half that of the
rest of the top 34. That proves the enormous surge in mega-cap-tech
stock prices over this past year wasn’t driven by earnings as
bulls often claim. Stock-price appreciation has far outstretched
profits growth, an ominous sign.
In
conservative hard trailing-twelve-month price-to-earnings-ratio
terms, the big-6 tech giants sported an incredible average P/E of
107.3x earnings exiting Q2! That is deep into formal
stock-bubble territory over 28x, which is itself double the
century-and-a-quarter
average fair
value of 14x in the US stock markets. Again AMZN and NFLX are
skewing this way higher though, with their insane 214.8x and 263.9x
P/E ratios.
P/Es
are the annual ratio of prevailing stock-price levels to
underlying profits. So they can be viewed as the number of years it
would take a company to earn back the price new investors today are
paying for it. A stock bought at 200x earnings would take 200 years
to merely recoup its purchase price through profits, assuming no
growth of course. Buying at these heights is crazy given humans’
relatively-short investing lifespan.
Assuming people start investing young at 25 years old and retire at
65, that gives them about 40 years of prime investing time. So
buying any stock above 40x implies a time horizon well beyond what
anyone actually has. And provocatively even excluding the crazy
P/Es of Amazon and Netflix, the rest of these big 6 tech stocks
still average extremely-high 41.2x P/Es. And ominously that is
right in line with market averages.
Without those elite tech leaders, the rest of these top 34 SPY
stocks had average TTM P/Es of 41.0x when they exited Q2. History
has proven countless times that buying stocks near such extreme
bubble valuations has soon led to massive losses in the
subsequent bear markets that always follow bulls. So these stock
markets are extraordinarily risky at these valuations, truly an
accident waiting to happen.
When
stocks are exceedingly overvalued, the downside risks are radically
greater than upside potential. After everyone is effectively all-in
one of these universally-held mega tech stocks, there aren’t enough
new buyers left to drive them higher no matter how good news happens
to be. And these investors who bought in high and late can quickly
become herd sellers when some bad news inevitably comes to pass.
Q2’18’s earnings season has already proven this in spades despite
the extreme euphoria surrounding the stock markets and elite tech
stocks in particular. Fully 3 of the 4 beloved FANG stocks showed
just how overbought stocks react to news. The recent price action
in Amazon, Netflix, and Facebook following their Q2 results is a
serious cautionary tale for investors convinced mega tech stocks can
rally indefinitely.
Everyone loves Amazon, but it is priced far beyond perfection. Its
stock skyrocketed 75% YoY to leave Q2 with that ludicrous P/E of
214.8x. When any stock gets so radically overbought and overvalued,
it has a tough time moving materially higher no matter what
happens. Normally stocks shoot higher on blowout quarterly results
as new investors flood into the strong company. But Amazon couldn’t
find many buyers.
After the close on July 26th Amazon reported a monster blowout Q2.
Its earnings per share of $5.07 was more than double
analysts’ estimate of $2.50! Revenues, operating cash flows, and
profits rocketed up an astounding 39.3%, 93.5%, and 1186.3% YoY.
AMZN’s revenue guidance for Q3 at a midpoint running $55.8b also hit
the low end of Wall Street expectations. Any normal stock would
soar the next day on all that.
But
while Amazon stock mustered a decent 4.0% gain at best the next day,
that faded to a mere +0.5% close. AMZN was priced for perfection,
so not even one of its best quarters ever was enough to bring in
more buyers. Everyone already owns it, so who is left to deploy new
capital? AMZN slumped 1.7% over the next several trading days,
though it has since recovered to new record highs with the strong
stock markets.
Netflix was the best-performing large US stock over the past year,
skyrocketing 162% higher between the ends of Q2’17 to Q2’18! It had
an absurd TTM P/E of 263.9x leaving Q2, more extreme than Amazon’s.
But man, investors love Netflix with a quasi-religious fervor and
believe it can do no wrong at any price. So Wall Street was eagerly
anticipating NFLX’s Q2 results that came out after the close back on
July 16th.
And
they were really darned good. EPS of $0.85 beat the expectations of
$0.79. On an absolute basis, sales and profits soared 40.3% and
484.3% YoY! Netflix did report negative operating cash flows, but
it has been burning cash forever so that was no surprise. Yet
despite these strong results this priced-for-perfection
market-darling stock plunged 13%ish in after-hours trading! Good
news wasn’t good enough.
Investors weren’t happy because subscriber growth was slowing. NFLX
reported 5.2m net new streaming subscriptions in Q2, below the 6.3m
expected and 7.4m in Q1. Netflix itself had provided earlier
guidance of 1.2m US adds, but the actual was way short at 0.7m. So
NFLX stock plummeted as much as 14.1% the next trading day before
rebounding to a still-ugly -5.2% close. It couldn’t rally on great
Q2 financial results.
And
universally-held big stocks not responding favorably to quarterly
results can quickly damage traders’ euphoric enthusiasm for them.
The selling in Netflix’s stock gradually cascaded following that big
hit on Q2 results. Over the next couple weeks, NFLX dropped 16.4%
from its close just before that Q2 earnings release! The mega tech
stocks aren’t invincible, and are very risky trading so high with
everyone all-in.
With
the possible exception of mighty Apple, Facebook was widely
considered the least risky of the elite tech stocks as Q2 ended.
Its 32.5x P/E was almost low by mega-tech standards, only bested by
the 17.9x of Apple which is in a league of its own. FB reported
after the close on July 25th, and shared great results led by a
modest EPS beat of $1.74 compared to $1.72 expected. But the
absolute gains were really big.
Facebook’s sales, operating cash flows, and profits soared 41.9%,
17.5%, and 31.1% YoY! That top-line revenue growth in particular
was huge, nearly the best out of all these top 34 SPY stocks. And
FB’s profits were growing so fast that it was the only elite
mega-tech stock to see its TTM P/E actually decline YoY,
retreating 14.2%. So FB looked much safer fundamentally than the
other FANG stocks dominating the SPX.
But
Facebook’s stock effectively crashed in after-hours trading
immediately after those Q2 results, falling as much as 24%! The
reason? It guided to slowing sales growth in Q3 and Q4 in the high
single digits. FB was obviously priced for perfection and
universally owned too, leaving nothing but herd sellers when
anything finally disappointed. The next day FB stock plummeted a
catastrophic 19.0%, stunning investors.
That
wiped out an inconceivable $119.4b in market capitalization! That
was the worst ever seen in one day by any single company in US
stock-market history. More than ever investors and speculators need
to realize that their beloved FANG stocks along with MSFT and AAPL
aren’t magically exempt from serious selloffs. When any stocks are
way overbought and wildly overvalued, it’s only a matter of time
until selling hits.
Without these mega tech stocks, the US stock markets never would’ve
gotten anywhere close to their current near-record heights. The
flood of investment capital into Netflix over this past year was so
huge it catapulted that company well into the ranks of the top 34.
Its symbol is highlighted in light blue, along with a few other
stocks, because it is new in the SPX’s top 34 in Q2. Outsized tech
gains can’t happen forever.
Interestingly I found something else in their quarterly reports I
haven’t yet seen discussed elsewhere. The total debt of these top 6
mega tech stocks soared an average of 36.5% higher YoY! That is way
beyond the rest of the top 34 excluding the giant banks which have
very-different balance sheets. Those other 18 top-34 SPY companies
saw total debt only climb 6.0% YoY. Mega-tech debt is rocketing at
6.1x that rate!
While the elite tech stocks do have huge cash hoards, their
spiraling debt is ominous. With the Fed deep into its
latest rate-hike
cycle, the carrying costs of debt are rising fast. With each
passing month and each bond companies roll over, their interest
expenses increase. At best those will cut into their profits,
which will push their nosebleed P/Es even higher. They will have to
slow debt growth and eventually pay back much.
We
are talking huge amounts, $588.2b of total debt across Apple,
Amazon, Google, Microsoft, Facebook, and Netflix alone! The main
reason most of these companies are ramping their debt so fast is to
finance massive stock buybacks propelling their share prices
higher. They will have to really slow or even stop their huge
buyback campaigns if their total debt or the carrying costs on it
grow too large, a serious threat now.
These top 34 SPX stocks collectively had an extreme average
trailing-twelve-month price-to-earnings ratio of 53.4x
leaving Q2! That is nearly double historical bubble levels,
exceedingly dangerous. There are far-higher odds the next major
move in these hyper-expensive stock markets will be down rather than
up. The next couple quarters face very different psychology and
monetary winds than this rallying past year.
In
both Q3 and Q4 last year, traders were ecstatic over the
Republicans’ record corporate tax cuts that were excitingly
nearing. In Q1 and Q2 this year, traders were dazzled by the
incredible profits growth largely driven by sharply-lower taxes.
While that will continue to some extent in Q3 and Q4 this year, the
initial exuberance has mostly run its course. Big US stocks are
facing tougher comparables going forward.
But
the real threat to these bubblicious extreme stock markets is the
Fed’s young
quantitative-tightening campaign. It started imperceptibly in
Q4’17 to begin unwinding the staggering $3625b of
quantitative-easing money printing the Fed unleashed over 6.7 years
starting in late 2008. Total QT in Q4’17 was just $30b. But it
grew to another $60b in Q1’18 and then another $90b in Q2’18. And
it is still getting bigger.
In
this current Q3’18, another $120b of QE is going to be wiped out by
QT. And finally in Q4’18, this new Fed QT will hit its terminal
speed of $150b per quarter. That’s expected to last for some time.
If the Fed merely wants to reverse just half of its extreme QE, it
will have to run QT at that full-speed $50b-per-month pace for
fully 2.5 years. That extreme monetary-destruction headwind is
unprecedented in world history.
Today’s enormous stock bull grew so extreme because the Fed’s epic
QE levitated stock markets, driving their valuations to
nosebleed heights. What Fed QE giveth, Fed QT taketh away. At the
same time the European Central Bank is tapering its own colossal QE
campaign to nothing too. Between the Fed and ECB alone, 2018 will
see $900b less
central-bank liquidity than 2017! That’s certainly going to
leave a mark.
The
odds are very high that a major new bear market is
awakening. Stock markets
inexorably
levitated by long years of extreme central-bank easing now face
record tightening as that easing finally starts to be unwound.
Thanks to that extreme QE as well as the Fed’s
radically-unprecedented 7-year-long zero-interest-rate policy, this
SPX bull extended to a monster 324.6% gain over 8.9 years as of its
late-January peak!
That
is nearly the second-largest and easily the second-longest stock
bull in all of US history. Stock bulls always eventually peak in
extreme euphoria, and then give way to subsequent proportional
bears. With today’s valuations so deep into dangerous bubble
territory, not even blowout earnings will be enough to keep stocks
from sliding. Normal bear markets after normal bulls often maul
stock markets down 50% off highs!
And
after this epic QE-fueled largely-artificial monster stock bull, the
inevitable bear to come is very likely to prove much bigger and
meaner than normal. If the Fed’s QT doesn’t spawn it, peak earnings
will. The past year’s extreme growth rates in sales and profits at
the largest US companies from already-high base levels aren’t
sustainable mathematically. Traders will freak out when they
see growth slow or even reverse.
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 soon, 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!
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 the 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 the end of Q2, all 1012 stock trades
recommended in real-time to our newsletter subscribers since 2001
averaged stellar annualized realized gains of +19.3%!
Subscribe today
and take advantage of our 20%-off summer-doldrums sale before
it ends.
The bottom line is
the big US stocks’ latest quarterly results again proved amazingly
good. Sales and profits soared year-over-year on those record
corporate tax cuts and the widespread optimism they fueled. But
earnings are still way too low to justify today’s super-high stock
prices, spawning dangerous bubble valuations. That portends
far-weaker markets ahead, led by serious selling in market-darling
mega techs.
These
near-record-high stock markets are reaching buying exhaustion, when
stocks can’t rally much on good news and plummet on bad news.
Earnings are likely peaking with the corporate-tax-cut euphoria as
well, with deteriorating profits growth ahead. As if that’s not
worrisome enough for hyper-overvalued stocks, these
priced-for-perfection markets face accelerating Fed QT in coming
quarters. Talk about bearish! | 
