If you’re an Apple shareholder who, after last week’s stellar earnings report, wondered why your stock’s value was down rather than up, the reason given – that chip scarcity will weigh on the near-term outlook – may not seem good enough. For a trader contemplating any short-term opportunity to get portfolio money to where the next quick buck is likely, all it takes is this “sell on the news” headline. Longer-term investors, however, should consider a recent fact about the company and negative headlines: Apple has overcome pretty much every short-term “selling headline” in the past few years on its way to becoming a $ 2 trillion company.
Trump’s trade war with China? No problem. The surprising decision to no longer offer instructions for iPhone units? Much ado about nothing, because the iPhone super cycle was coming anyway. As for the global semiconductor chip scarcity now spearheaded by Apple, it’s wise to keep in mind that Apple has long been fairly conservative with its outlook – formal earnings forecasts still haven’t returned. And one more thing: Tim Cook was named CEO after Steve Jobs because of his mastery of global logistics.
“Let’s face it, if Apple has trouble getting chips, every other company in the world is going to have ten times those problems,” said Nick Colas, co-founder of DataTrek Research. “If you’re really concerned about chip supply, you want to own Apple because it comes first in every chip factory.”
But there is a bigger question that is relevant for Apple and the rest of the market: How strong will the next phase of growth be for the market?
People visit the Apple Store on Oculus Mall in Manhattan on July 29, 2021 in New York City. Numerous stores in the mall, including the Apple Store, have urged guests to wear masks again as the Delta variant of Covid spreads in New York City.
Spencer Platt | Getty Images News | Getty Images
After the big tech selling-on-the-news, the immediate outlook for the market isn’t necessarily crying out for buy-on-the-dip, according to Colas. Seasonality is an immediate risk as market history in early August shows a volatile period for the VIX volatility index.
“It is a fair trade question of where to go for the trade dollar in August,” Colas said.
Short term trading versus longer term investing
Since 1990, the period in early August has been a period when the VIX is peaking. One reason for this is the lower volumes on the market in summer. “It’s a liquidity talent when people are on vacation … fewer traders and more volatility that comes with every news. I advise customers to be careful, ”he said.
From Wednesday to Friday of last week, the S&P 500 traded below its 30-day average.
For the short-term trader, a rotation away from the large-cap leaders towards small-caps, represented by the Russell 2000, which Colas described as “largely oversold” since its hot streak in early 2021, might make sense. “Small caps went parabolic in March and April and haven’t worked since because they were so far ahead,” he said.
That makes them cheap at the moment, at least statistically based on 100-day trailing returns.
But for investors who aren’t playing the market for a quick trade, Apple, Facebook, and Microsoft’s disappointing deals shouldn’t be too heavy after winning. Amazon was the outlier as it actually missed sales expectations instead of posting a big beat, making a sell-off on the news a “fair” reaction, according to Colas.
Big tech stocks got really high on the Q2 reports
It’s also important to remember that the big beats of the rest of big tech were already embedded in most stocks as they had a strong June and July based on correct market sentiments – that second quarter earnings would be outstanding. “The market put the names high for the quarter. The market caught the surprise and it all occurred, and when you see all stocks rallying to quarterly profit it’s just hard to keep that up. unless there’s a tremendous amount of good news and advice, “said Colas.” That’s normal capital market behavior.
In assessing the strength of these companies, he goes back to one important data point: They have doubled their profitability in the past two years. “Which is amazing,” he said. And that gives him more comfort in the longer term picture. “I don’t see any change. Big Tech is still the place.”
He gave two reasons.
Even if these companies have doubled their earnings growth, he doesn’t think they’re anywhere near peak earnings. “It’s just a much higher base to build on.”
Second, these companies have distinct advantages in the industry and do not compete directly in a zero-sum game in many strengths.
These companies have grown their profits so much because the pandemic has changed consumption patterns, made us all more technology-minded, and the market made a lot of money by doing exactly the way it did. But now the big question for big tech is not that their dominance is threatened – despite the threat of multiple cartel wars – but just figuring out how much more leeway they have to keep the profit growth rate higher.
“Tell me what you would pay for a company with a 30% ROI and structural growth of 10-15% and be able to do it for a decade? What is the multiple? Is it 30 times or 40 times? I don’t know, “said Colas,” but I know it’s not 20 times. “
Post-Pandemic Peak Growth and Peak Profits
Apple was one example of this group of price / earnings concerns. It lagged behind the rest of the tech giants for years, considered a hardware provider, and was weighed down by that market view until the services business skyrocketed due to the pandemic and the company was given a $ 2 trillion market cap. And again this year it was, in Colas’ words, “the one weird straggler” as its earnings return was about 10% year-to-date, compared to about 30% for Facebook and Microsoft.
Apple was also behind the S&P 500 ahead of earnings. One reason: it cost so much demand. Forward investors are rightly concerned that it will be more difficult to post good earnings numbers. But, Colas said, it could also mean it has the most headroom, even in the short term, as a new iPhone hits the market this fall and back to school boosts consumer tech spending.
The broader global growth story to which the entire stock market is tied is no lock. Indeed, the opposite happened amid the inflation panic earlier this year and expectations that 10-year US Treasury yields would rise. “The market fully understood that growth had peaked in the first quarter and began to decline towards the end of the quarter,” said Colas.
The interest rate story was wrong, but slower economic growth is now high on the list of investor concerns for a high P / E US market. Big Tech makes up 23% of the S&P 500 and that means whatever the market decides next about its high valuations will weigh on US stocks as a whole.
No big tech company is anywhere near top earnings on an absolute basis.
Nick Colas, Co-Founder of DataTrek Research
But investors around the world don’t have that many great opportunities. As the situation in China has resulted in massive losses between the government and its leaders in recent weeks, trade opportunities may arise, but emerging markets are no place for anything other than trade. And even if there are potential opportunities in other international markets like European financials, it will take time for interest rates to move in a direction that will benefit these stocks.
“What’s left? It’s the US and the top of the table,” said Colas. “That’s what you must own. Still going back to the same name.”
Looking back at sector weights to the 1970s and 1990s, he says there has never been a time when five companies weighed more. “It’s only 5 names, and it’s not like Exxon peaked in the S&P. It was a commodities game. These companies have enormous barriers to entry and very high structural returns.”
Despite these benefits, trying to figure out what their profitability will be after the pandemic, or at least during the world’s transition from the worst of the pandemic to the ongoing effects, is the bigger problem for big tech.
“What is a fair growth rate for 2022? This is difficult,” said Colas.
For Alphabet – the only one among the big tech names to report last week and soar after its profits – and for Facebook, which reiterated a previous warning of slowing sales growth, the cyclical nature of the advertising market can be relied on, and that hasn’t changed that much in the past few decades. Apple is tougher, however, because while it has made progress in moving beyond iPhone history and growing its service business into a huge growth driver, so much hardware demand has been brought forward.
For Amazon, Colas found that e-commerce’s share of demand rose from 17% to 24% in the second quarter of 2020 and then fell back to 20%. And every percentage point in that band has a tremendous impact on Amazon’s business model – in fact, it pointed out that Amazon was “stuck in this band” for nine months before moving into profits. From October 2020 to June of this year, Amazon was jumping around, but was not promoted like the other names until the pre-earnings run. Since the beginning of the year, after the decline in profits, the share has barely stuck to a profit of just under 3%.
What happened in all of these stocks right now was a high in earnings, but it’s nowhere near the highest in profit for these companies, Colas said. The concept of peak earnings that has worried investors implies that at some point in the cycle a company will have its absolute highest earnings growth. “That’s what peak earnings are about, and no big tech company is anywhere near peak earnings on an absolute basis,” said Colas. “Because they keep growing and their profit leverage is enormous.”
That’s more of a buy in the future after the sale has worn off on the news.
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