Stock-market volatility has exploded on COVID-19 fears, shattering
the Fed’s QE4-fueled levitation. The resulting stunning sentiment
shift has left investors and speculators wondering where these wild
markets are heading. This is an important time to check the latest
fundamentals underlying the big US stocks that dominate market
action. They just finished reporting their Q4’19 results, which
illuminate their valuations.
Recent weeks’ stock-market swings have been huge, driven by mounting
worries about the economic fallout from the COVID-19 pandemic. For
6 weeks I’ve covered this virus’s daily progression in depth in our
subscription newsletters, including many troubling reports
out of China that the media ignored. Before this selloff, I
recommended long-volatility and short-stock-market trades that
surged to big realized gains up to +145%.
By
last Friday, the flagship US S&P 500 had plummeted 12.8% in just 7
trading days! That made for its fastest formal-correction selloff
over 10% ever. In that same short time frame, the leading VIX fear
gauge skyrocketed 179.1% higher on close to 40.1. COVID-19 is
virulent and dangerous, super-infective with a mortality rate
believed to be running 20x to 40x that of the seasonal flu!
Traders really need to study it.
In
times of elevated market fear, understanding major stocks’
fundamentals is more important than ever. Because their latest
reporting quarter was last year’s final one, the deadline for
releasing 10-K annual results to the SEC was 60 days after
quarter-end. These full-year reports are larger, more complex, and
must be audited by independent CPAs. So many of these crucial 10-Ks
were finally released just last week.
The
biggest and best US companies are the big stocks in that S&P 500
index, or SPX. As nearly every fund’s top holdings are some
combination of them, they are owned by the vast majority of all
investors. SPX index funds are wildly popular, led by the mammoth
SPY SPDR S&P 500 ETF, IVV iShares Core S&P 500 ETF, and VOO Vanguard
S&P 500 ETF. These behemoths have sucked in epic amounts of
capital.
As
of the middle of this week, their net assets ran $279.4b, $204.2b,
and $133.3b! Going through all 500 10-Ks of the 500 SPX stocks is
way beyond the bandwidth of my small research company, so after
every quarter we delve into the top 34. That’s simply an arbitrary
number that fits neatly into the tables below, and a commanding
sample. As Q4’19 ended, these stocks accounted for fully 44.3%
of the entire SPX’s weighting!
Their colossal total $12.6t market cap is as large as the bottom 441
SPX companies’ combined. The big US stocks’ importance to the
markets and portfolios cannot be overstated, they lead the rest of
the stocks up and down. And given the wild stock-market swings over
the past year or so, these latest Q4’19 results just reported are
more important than usual. The market action since Q4’18 has truly
been extraordinary.
As
that quarter dawned, the Fed ramped its
quantitative-tightening campaign to full-speed. That pushed the
SPX to plummet 19.8% in just 3.1 months almost all in Q4’18, nearing
the new-bear-market threshold. That terrified Fed officials into
making its biggest policy course change ever. During 2019
they prematurely killed QT years early, shifted their rate outlook
from hiking to cutting, and slashed rates 3 times in 3 months!
All
these dovish actions
directly goosed
stock markets, but the coup de grace was the
Fed launching QE4
in mid-October and running large-scale Treasury monetizations
ever since. All that unprecedented and extreme easing catapulted
the SPX an astounding 28.9% higher in 2019! The big US stocks’
newest Q4’19 results compared to Q4’18’s illuminate whether that
massive Fed-fueled stock-market surge was justified.
The
tables below include key fundamental data from these elite US
companies as Q4’19 ended. The top 34 stocks’ symbols are
followed by their weightings within the SPX and SPY and market
capitalizations. The absolute year-over-year changes in these
market caps from the ends of Q4’18 to Q4’19 are noted. This is a
purer measure of value than stock-price changes, since it
effectively normalizes out stock buybacks.
That’s followed by quarterly revenues, operating cash flows, and
hard GAAP profits reported to the SEC, along with their YoY
changes. Finally trailing-twelve-month price-to-earnings
ratios are noted. A handful of these companies report on fiscal
quarters offset from calendar ones. In those cases we included the
latest-available quarterly data. Symbols highlighted in blue newly
climbed into the ranks of the SPX’s top 34.
This
latest fundamental data from the big US stocks was both impressive
and concerning. While they enjoyed sizable revenues growth and huge
profits growth, their valuations collectively remain way up near
formal bubble territory. That helps explain why they plunged so
hard on the growing COVID-19 pandemic fears. When stocks are
richly-priced relative to underlying earnings, they are far less
resilient to selloffs.
The
concentration of capital among the top US stocks is incredible. The
5 biggest companies in the SPX exiting 2019 were the usual
market-darling mega-cap techs everyone loves. Apple, Microsoft,
Alphabet, Amazon, and Facebook are universally heavily owned. They
are among the top holdings of nearly every fund. As capital floods
into stock-index ETFs, a proportionally-large share buoys these tech
behemoths.
Together these Big Five tech giants commanded a stunning 17.4% of
the entire SPX’s weighting at the end of Q4’19! That’s super-high
and risky, letting this handful of companies wield outsized
influence on the entire stock markets’ fortunes. For comparison
just three years earlier in Q4’16 when I started this research
thread, these same companies weighed in at 11.5%. They are gobbling
up the SPX like Pac-Man!
Contrarians who believe stock-market bull-bear cycles still exist
despite extreme interventionism by the world’s biggest central banks
marvel at the Big Five’s popularity. How can almost everyone be
willing to follow the herd to pile into the same few stocks? Don’t
they understand the great risks inherent in such a strategy?
Popular stocks that rise disproportionally to the markets in uplegs
amplify downside in selloffs.
In
2019 the top 34 SPX stocks averaged hefty 26.8% gains in their
market caps, which is slightly below the overall S&P 500’s huge
28.9% gain last year. Yet these Big Five tech stocks’ popularity
and growing share of index capital commanded catapulted them to
far-greater 47.6% average gains! That compares to just 23.2%
for the rest of the top 34. Investors and speculators love chasing
winners, allocating more to them.
But
surprisingly techs’ outsized downside has been fairly muted.
Between February 19th and 28th, the SPX again plummeted 12.8% from
QE4-fueled all-time-record highs. The Big Five’s average losses
over that span were just 13.2%, pretty much in line with the broader
markets! And back in Q4’18’s SPX near-bear severe correction of
19.8%, the Big Five fell 24.8% on average. That’s just 1.25x the
overall index drop.
So
despite their outsized bull-market gains, so far they haven’t
suffered similar outsized losses in both big and sharp bull-market
corrections. That could certainly change during the next bear
market, but traders’ fanatical faith in these tech giants is
understandable. They are boosting the entire stock markets, and
crazily enough their fundamentals somewhat justify such
outperformance! Their results are far superior.
In
Q4’19, the top 34 SPX companies’ revenues collectively grew 3.6%
year-over-year. That isn’t much, but sales growth from
already-large bases is hard to achieve. Yet the top-line revenues
growth Apple, Microsoft, Alphabet, Amazon, and Facebook put on the
scoreboard totaled an enormous 15.5% YoY despite their massive
sizes! The rest of the top 34 were comparatively poor, adding up to
0.1% shrinkage.
In
my line of work as a speculator and newsletter writer, I’m blessed
to be able to watch the markets all day every day. Hardly a day
goes by when CNBC and Bloomberg don’t have multiple experts
extolling the virtues of the Big Five tech giants. They argue that
despite being crowded trades, that’s where all the revenue growth
is. It is amazing these huge mature companies have expanded at the
rates they’ve clocked.
This
is true on the operating-cash-flow-generation front too. Overall
the top 34 SPX companies’ total OCFs skyrocketed 84.8% higher YoY,
which is incredible. The problem is that is wildly distorted by the
four mega-bank stocks among the biggest US companies. These are
JPMorgan, Bank of America, Wells Fargo, and Citigroup. Their
financial reporting is mind-bogglingly complex, all but impossible
to understand.
I
started my career as an auditor for a Big Six CPA firm, and have
kept my CPA license current and active since 1997. I’ve spent
decades wading through 10-Qs and 10-Ks both as an auditor and a
speculator, which I find very interesting. Yet even with my
experience I can’t begin to comprehend the mega-banks’ financials.
Their operating cash flows in particular are so volatile they
aren’t reported on earnings news releases!
They
literally vary by tens of billions of dollars from quarter to
quarter, somewhat dependent on stock-market fortunes and trading.
Consider the biggest US bank, JPMorgan. In Q3’19 it reported
year-to-date OCFs of -$77.0b, which sounds apocalyptically bad. But
by Q4’19, those OCFs had skyrocketed $83.1b to +$6.0b YTD! Stuff
like this is why Wall Street SPX data is often presented without
financial stocks.
Those 5 elite mega-cap tech stocks dominating the SPX saw their
total OCFs surge 18.7% YoY, strong growth. Meanwhile the rest of
the top 34 excluding those four mega-banks reported aggregate OCFs
that slumped 2.7% YoY. The bifurcation between mega-cap-tech
growth and the rest of the markets is just massive. While these
beloved market darlings are still very overvalued, their
fundamentals improve fast.
Although many professional investors are nervous about the
concentration of capital in the Big Five tech stocks, that’s where
the fundamental growth has been. Their performances on all kinds of
metrics are just dominating the rest of the markets. That’s true on
the earnings front as well, even ignoring all the adjusted-earnings
nonsense and focusing on hard profits per Generally Accepted
Accounting Principles.
Overall SPX-top-34 profits skyrocketed an astounding 49.1% higher
YoY in Q4’19, which defies belief. Interestingly that is wildly
skewed by the largest big US company after the mega-cap techs, the
famed Warren Buffett’s Berkshire Hathaway. It is a colossal
investment holding company, owning a wide variety of companies
across different industries. Every quarter its investments must be
marked to market prices.
Buffett hates this GAAP rule that flushes changes in investment
portfolios through net income, he rails against it every chance he
gets! With the SPX soaring 28.9% higher in 2019 on that extreme Fed
easing, fully 89% of Berkshire’s full-year profits came from
investment gains. In Q4’19 in particular, $24.7b of its $29.2b in
accounting earnings came from rising investments! Those certainly
aren’t normal operating profits.
And
back in Q4’18 when the SPX mostly plunged 19.8% in that near-bear
severe correction, Berkshire had to dump $28.1b of investment losses
through its earnings. So the SPX-top-34 total profits comparison
from Q4’18 to Q4’19 includes $52.8b of unrealized investment
swings through Buffett’s giant company! These colossal veers
must be excluded to get a better picture of how big US stocks’
profitability is faring.
Those elite Big Five mega-cap tech stocks saw their GAAP profits
surge 16.8% YoY in Q4’19, incredible growth given their massive
sizes. Yet the rest of the top 34 excluding Berkshire’s huge
investment gains and losses saw their total earnings fall a
sizable 8.3% YoY! Without the market-darling tech giants, the
earnings picture for the rest of the big US stocks is quite weak.
That’s a serious problem for these stock markets.
Exiting Q4’19 and into the first half of Q1’20, stock prices were
super-high. Between the Fed launching its QE4 Treasury
monetizations in mid-October and mid-February, the SPX achieved an
incredible 35 new all-time-record closing highs! By mid-February
the Fed’s balance sheet had ballooned 11.2% over just 5.5 months.
Its QE4 Treasury buying was running at a monthly pace exceeding
$80b, way over the $60b target!
Before hyper-complacent American stock traders realized COVID-19 is
no mere bad flu, the SPX had surged 17.0% in the 4.4 months QE4 was
underway! That left stock prices exceedingly high, which is evident
in price-to-earnings ratios. Even exiting Q4’19 with only about 70%
of the SPX’s total QE4 gains in, the top 34 US stocks averaged
trailing-twelve-month P/Es of 27.5x. That’s perilously high by
historical standards.
Over
the last century and a quarter or so, fair value has averaged around
14x earnings. Double that at 28x is where stock-market bubbles
begin, and that’s right where the top stocks’ valuations were
running! And that’s where the Big Five tech giants were vulnerable,
with average P/Es way up at a nosebleed 39.5x compared to 25.5x for
the rest of the top 34! In Q4’18 these elite tech stocks averaged a
similar 39.3x.
Thus
their big market-leading earnings growth was insufficient to offset
their huge stock-price appreciation over this past year. The
mega-cap techs’ lofty valuations make them particularly vulnerable
to the next bear market. The whole purpose of bears that eventually
follow bulls is to force stock prices sideways to lower long enough
for earnings to catch up with stock prices to lower
valuations. That still needs to happen.
With
the Fed’s massive QE4 Treasury monetizations still injecting vast
amounts of liquidity into markets, it’s hard to imagine a
long-overdue stock bear getting underway. The stock markets
surged
dramatically under QE1, QE2, QE3, and
now QE4. The
Fed is fighting a stock bear with everything it has got, as evident
in its shocking emergency 50-basis-point rate cut this week!
The stock-market wealth effect is too powerful.
When
Americans’ stock-market wealth plunges in bears, they naturally get
depressed and really curtail spending. That slows down the entire
US economy, plunging it into a recession at best. I suspect the top
Fed officials actually fear a depression next time around,
which is why they desperately try to short-circuit every material
stock-market selloff. Stock markets have grown too big relative to
the underlying economy.
Their near-bubble valuations leave them vulnerable, which makes this
COVID-19 pandemic such a stellar wildcard risk. Regardless of how
dangerous that virus really proves, people are justifiably scared of
contracting it. That caused the entire country of China to all
but shut down, and it still hasn’t come fully back online
despite Beijing pushing hard to force people back to work.
COVID-19’s economic impact is big.
As
it spreads around the world, people are avoiding spending that may
expose them. This is hitting travel industries like airlines,
hotels, cruise ships, and conventions really hard. Local industries
like restaurants, movie theaters, and sports events face massive
losses of revenues too if people decide to stay home more. These
kinds of family-preservation behaviors to avoid COVID-19 exposure
will weigh on corporate earnings.
Examples are already legion. The SPX’s biggest company and
most-important American stock at the end of Q4’19 was mighty Apple.
It has major supply-chain problems, with Chinese factories
that manufacture its products stopping operations for weeks and
still not running at normal capacity. Apple is increasingly having
trouble meeting demand, and its P/E ratio already soared 87% YoY to
24.5x which is very high for it.
Many
other SPX-top-34 companies source goods from China, including Amazon
and Walmart. Disney is in a world of hurt if families decide it
isn’t worth the infection risks to visit the theme parks. Boeing
has really struggled with that whole 737 MAX fiasco, but imagine how
its future looks if Americans decide to fly less in years ahead.
The implications of COVID-19 for the US economy and thus corporate
earnings are huge.
If
the big US companies’ total profits take a hit on COVID-19 fears,
which seems unavoidable, it is going to force valuations even
higher into dangerous bubble territory! The Fed’s QE4 and rate
cuts may be able to stave off a normalization for some time, but not
forever. So downside risks remain considerable in these still-lofty
super-overvalued stock markets. The beloved mega-cap techs won’t be
immune to any selloff.
If
big US stocks’ Q4’19 results showed fundamentals leaving them closer
to 14x-earnings fair value, the potential selling would be much more
modest. But trading twice that high near 28x bubble territory
really amplifies the risks. The Fed’s vast QE4 liquidity injections
mitigate that as long as they’re underway, but COVID-19’s
spending-curtailing impacts catapult them way back up. We need to
remain wary on these markets.
This
latest monster stock bull artificially goosed by the Fed’s ZIRP,
QE1, QE2, QE3, and now QE4 is the second-largest and first-longest
in US history at epic 400.5% gains over 11.0 years! At some point
it has to give way to the overdue next bear, which will maul
valuations back down to reasonable levels. No one knows when that
will awaken, but it is inevitable at some point regardless of the
Fed’s endless machinations.
Stock bears aren’t to be trifled with! The SPX plummeted 56.8% over
1.4 years in the last one ending in March 2009, obliterating naive
buy-and-hold investors! And the bear before that wasn’t much
better, with a 49.1% SPX plunge over 2.6 years into October 2002.
The higher big US stocks’ valuations, the greater the odds the next
bear will begin soon. The COVID-19 economic slowdown will likely
accelerate that timeframe.
Since the Fed can’t artificially stave off the long-overdue bear
forever,
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The
bottom line is the big US stocks’ just-reported Q4’19 results
certainly don’t justify their near-bubble valuations. All the
revenues and earnings growth was concentrated in a handful of
mega-cap tech stocks. The rest of these elite companies dominating
the stock markets saw flat sales and declining profits, which is an
ominous omen. That was despite a full year of the most extreme
easing the Fed has ever undertaken!
And
last quarter COVID-19 wasn’t even identified yet. That’s a game
changer for the economy and stock markets unlike anything I’ve seen
in my lifetime. Avoiding exposure to that deadly pathogen
necessitates reduced spending, which will further weaken corporate
profits. Sooner or later that adverse economic impact will
overpower QE4 Treasury monetizations. So these super-overvalued
stock markets remain very risky. | 
