Whether or not Apple’s revenue warning ends up being seen, in hindsight, as a harbinger of cascading guide-downs from companies whose supply chains and product markets are exposed to the coronavirus outbreak, Tuesday does serve as yet another cautionary tale about a market that’s arguably too dependent on a handful of tech behemoths.
To be sure, this is a somewhat tired discussion. Digital reams have been written on the extent to which US equity benchmarks are beholden to a few monopolies, all of which seem to have a date with regulatory destiny.
“We are seeing extraordinary concentration of returns at the very top of the market”, Morgan Stanley’s Mike Wilson cautioned last month. He added the following particularly poignant color:
The five largest companies, or the top 1%, currently make up 18% of the market cap of the S&P 500. This is the most extreme this metric has ever been. The last time we saw something even remotely this high was 1999, at the end of the tech bubble…. While we don’t think there is a valuation bubble in tech anywhere near the scope of what we experienced in 1999, the concentration in tech stock performance is unhealthy in our view and arguably unsustainable.
It’s through that lens that market participants should view days like Tuesday, when some exogenous shock outside the control of even the most skilled corporate luminaries undercuts the near-term revenue prospects for one of the companies which shoulders a disproportionate share of the burden when it comes to keeping the broader market buoyant.
In a true testament to this, SocGen’s Andrew Lapthorne wrote the following, in a note dated Monday:
With the bulk of US companies having reported, we have summed up the report and accounts posted so far. Despite strong markets last year, net income barely moved, with a rise of just 0.3%. More worrying is without the Big 5 companies (Microsoft, Alphabet, Apple, Amazon and Facebook), net income fell 7.5%.
The following visualization shows annual growth rates for companies in the S&P 1500 that have reported.
(Data from SocGen, Factset)
“This is due to higher costs (SG&A) and a significant rise in both interest expense and taxes”, Lapthorne says, before noting that “interest costs rising so quickly despite low rates is remarkable and a challenge to policymakers”.
In other words: In a world awash with debt, higher rates may be a non-starter. Policy normalization may have been rendered impossible by the very debt accumulation it engendered and facilitated.
Another thing that sticks out (like a sore thumb) in the visual is that when it comes to buybacks, the Big 5 are the last men/women standing, so to speak.
“With 80% of the overall value of buybacks reported so far, buybacks are 20% lower in 2019 than 2018 – excluding the Big 5, the figure is down 32%”, Lapthorne marvels.
The takeaway, he says, is simple: “That the Big 5 continue to buy back while the rest cut back no doubt helps explain the performance divergence” between those names and the rest of the market.
Trying to conjure up a mental image of that chart with the caption “Strongest economy ever.” Not having much luck.
Seems to be an inconsistency between MS’s Exhibit 5 which suggests that the Big 5’s share of earning dropped in 2019 while SocGen’s data is that income of all others dropped by 7.5% meaning Big 5 earnings had to increase to hold total earning approximately flat. If Big 5’s earning increased while all others dropped, Big 5’s share of earning had to increase further. Any explanattion for that
Well, there’s a lot to try and reconcile there. For one thing, MS is S&P 500. SocGen is S&P 1500. MS’s chart is from January 15. SocGen’s is from yesterday with ~80% of companies having reported. SocGen’s is ex-Big 5 and ex. Financials (not sure about MS’s). Etc. Etc.
SocGen are permabears.
With regard to the Ex-Big 5, Ex-Fin portion of the SocGen chart, I was surprised that Sales Growth was that high/good. But since it didn’t translate into Earnings Growth (not even close), that bodes very ill for the forthcoming revenue disappointments resulting from the continued slowdown in Europe and the inevitable virus wreckage throughout Asia. How far will Earnings Growth fall when top line growth flip negative?
Corp Bal sheets are horrific. Productivity is not great. Cash flow is getting more challenged. Valuations are high.
What happens if inflation picks up and rates move higher and refi is challenged?
There is a reason why the top names have worked. But we will see their cyclicality as well and it may shock some people.
It is a mess, when reality hits it will be ugly. Dec 18 will look like paradise. Imagine declining earnings due to weaker revs and margin contraction combined with PE contraction as buyers stay away (corps as well as individuals – and short covering is not there).
Would not surprise me at all if the SP500 gives up all the gains during trump’s years sometime in 2021 as stagflation begins.
I wonder what happens to buybacks and cash interest coverage if corporate taxes get hiked by the next administration…