29th July 2024

Weekly Index Movement

S&P500-0.8%
Nasdaq-2.5%
Aussie All Ords-0.7%

Markets don’t like uncertainty and Biden pulling out has made the Trump presidency less certain. In fact, in one poll, Harris is already ahead. That’s really why markets fell last week.

It didn’t help that Tesla and Amazon disappointed on earnings either. More on that later.

It is still early days in the presidential race and we will learn more as we get closer, but seeing as we have already had a Trump presidency, Trump 2.0 should not be too different.

I took a look at what happened in 2016 between election day and the end of the year to see which sectors could benefit, should be be re-elected.

  • US equities outperformed rest of world stocks by a wide margin (+4 – +14 percent versus -1 pct).
  • The Russell 2000 was the standout US equity market index performer, up 13.6 percent to the S&P 500’s 4.6 pct advance. Interestingly, the equal-weight S&P (+5.5 percent) barely outperformed its market cap-weighted counterpart. Investors went all the way to the smallest market cap names rather than opting for smaller names in the S&P 500.
  • The standout sectors in the weeks after the 2016 election were Financials (+16 pct), Energy (+9 pct), Industrials (+7 pct) and Materials (+5 pct). Markets clearly saw the possibility for deregulation (benefiting Financials and Energy/Materials) as well as increased infrastructure spending (helping Industrials). These groups’ sudden rallies also help explain why the Russell outperformed the S&P 500 just after the election, since this US small cap index has higher weightings to cyclical sectors.

The year after the 2016 election saw US/global equities perform very well, with the Nasdaq (+28 percent) and non-US stocks (+24 pct, +52 pct for Chinese stocks) outperforming the S&P 500 (+19 pct). However, for all the initial enthusiasm about US small caps just after the election, the Russell did not follow through in 2017, up only 13 percent. Reducing corporate taxes and encouraging repatriation of foreign earnings, 2 early Trump Era initiatives, were distinct positives for large caps/Tech stocks.

Echoes of 2016 are strong in the current market. The Russell has just enjoyed an anomalously strong rally, and cyclical groups are performing well. As long as markets believe former President Trump may win this November, “Trump Trade 2.0” will likely exert some force over stock prices.

Just when it seemed like mega-caps may never go down and small-caps may never go up again, we’ve seen a short-term reversal of epic proportions. How can we tell? Over the last 12 trading days, the Nasdaq 100 is down 8.3%, while the small-cap Russell 2,000 was up 9.3%.

The “big shift” into smaller-than-mega-cap stocks began in earnest when the June CPI report on July 11th came in weaker than expected. That report caused investors to believe that (another) green-light was given to the Fed to cut rates. But another thing that happened in early July was a political shift that saw former President Trump’s poll numbers tick solidly ahead of President Biden’s.

Based on the price action, it appears that investors think a Trump victory would be more beneficial to smaller-cap stocks and less advantageous to mega-cap Tech stocks that have already had big runs. Now that Biden is gone and it looks like VP Harris will be the Democratic Party’s nominee, we’ve seen a slight tick lower in Trump’s odds of victory. We’ll continue to watch the action in sectors and groups to see what they might be predicting about the outcome of the election as well.

A look at how various ETFs across asset classes have performed since the June CPI release shows that while the Nasdaq 100 (QQQ) is down 8%, the Russell 2,000 (IWM) is up 9.3%! S&P 500 Growth is down 7.4%, while small-cap Value is up 10.5%. These are some huge swings! At the sector level as well, we’ve seen Tech fall 9% while Real Estate, Financials, and Industrials have all risen more than 3%.

Earnings News

We have already had 41% of earnings results announced this season and so far the results are underwhelming. Whilst most have been showing growth, the revenue numbers have disppointed slightly, but the big factor impacting earnings is cost. It appears companies have not done enough to reduce their costs to generate upside earnings surprises. I expect this will leads to further cost cutting in Q3 and Q4.

First up – Alphabet (GOOG)

Advertising and cloud giant Alphabet (GOOGL) reported a 3% adjusted EPS beat on revenues 1% higher than expected. While YouTube disappointed, other revenue sources beat. Revenue growth for advertising writ large continued at a double-digit YoY pace which is a positive signal for the economy both globally and in the US, while the AI frenzy is supporting further acceleration in cloud growth.

Management says they are “innovating at every layer of the AI stack” as they “pursue many opportunities ahead”.

The stock fell 2% after hours as the market is harsh to high fliers and an average beat just isn’t good enough. You have to smash it to be rewarded.

My view – double digit yearly revenue growth is great. There is no reason to doubt Alphabet’s future ability to grow.

Then there was Tesla (TSLA)

The company has seen a big hit to sales volumes and rising inventories over the past few quarters with demand in its home US market and China both appearing weak. While revenue beat on the quarter despite that weak demand signal (by 4%), adjusted EPS missed by 13%. Free cash flow missed by 30%, operating income missed by 11%, and gross margins for the auto business (excluding regulatory credit revenues) hit their lowest levels since Q1 of 2019. Of course, forward-looking statements were more optimistic: plans for robotaxis and more affordable models remain “on track”, a “sequential increase in production” is expected for Q3, the factory dedicated to building semi trucks will “begin production by the end of 2025”, and the Cybertruck is “on track to profit” by the end of the year.

Overall, revenues were 7% lower than last year. This is a business in decline.

My view – you really have to believe Elon can pull off his dreams to want to buy this stock at these prices. The business as it stands is going backwards. The only thing that can save it is a hail mary pass from Elon. But lots of people think the quarterback CEO can throw such a pass. Not me.

Put it this way, let’s say you wanted to buy $10,000 of TSLA. Would you be willing to take that $10k and place it on black at the casino? Because that is what buying Tesla is. None of us have any idea if his ideas will work or not. We are guessing at best. You can guess it will come up black. What’s the difference?

Musk himself admitted what I have always said about Telsa. Tesla is nothing about the cars it sells now. It is all about whether it can crack automated driving. This is what the great man said himself:

“If you believe Tesla will solve autonomy, you should buy Tesla stock,” Musk said. “And all these other questions are in the noise.”

My view is automated driving is a long way off and plenty of other companies are trying to solve the same thing. A good example is Waymo, which is owned by Google.

No one knows who will crack the code. But even if one does, you can bet the others won’t be far behind.

So, even if Musk pulls the rabbit out of the hat, how much value will it add?

UBS Investment Bank analyst, Joseph Stark, agrees with me. He thinks the stock is worth about $74 a share.

While we are on the topic of declining businesses…….

I’m Just An S&P Loser Baby

A lot gets spoken about the best winning stocks of the year, but what about the losers? Here are the biggest losers of 2024 from the S&P500 index

Some of these stocks like Walgreens (WBA) and CVS have been perennial losers, while we’re more used to seeing others like Lululemon (LULU) and Ulta Beauty (ULTA) on lists of winners rather than losers over the years.

In Tech, the biggest loser this year has been Intel (INTC), which may be surprising given that it’s a semiconductor name.  It wasn’t long ago that Intel (INTC) was the biggest semi-stock in the market (and not much longer before that when it was one of the largest stocks in the world), but eight stocks in the Philly Sox index currently have larger market caps, including AMD which used to be seen as Intel’s little brother.  Now AMD has a market cap nearly twice the size of INTC’s ($260 billion versus $140 billion).

INTC is a good lesson in nothing lasts forever. Go and take a look at CSCO from 1998 to 2001 and then ask yourself if you really want to pay 72 times last year’s earnings for NVidia right now.

Or Lululemon, LULU. In 2018 it is a fast expanding high street fashion brand that now has shops all over the world, including the centre of the world, Miranda, in the Sutherland Shire. But in 2024 it is the second biggest faller in the index.

Nothing lasts forever in the stock market.

How close to a bubble are we in big-tech?

The AI Boom has been the driver behind mega-cap gains over the last couple of years. The non-NVDA mega-caps keep spending on GPUs while NVIDIA keeps cranking them out. I like to use October of 2022 as the start date of the AI bull market as that is the date ChatGPT launched to the public.

The release of Netscape in the 1990s was a similar event. So this week I looked at the performance since ChatGPT verses the market performance after Netscape.

As you can see, the Nasdaq is up nearly the exact same amount since ChatGPT’s release as it was just over 400 trading days following Netscape’s release in late 1994. What’s interesting is that right now we’d be in August 1996 if we tracked ChatGPT’s release to the release of Netscape, which was only a few months before Fed Chair Alan Greenspan made his famous “irrational exuberance” comments about the frothiness of the market.

It often fascinates me how the market rhymes with history and by this analysis we can expect further gains in the Nasdaq.

In fact, if we extend this out into the future, by looking at the 1990s then we could still have a long way to go.

While valuations are certainly elevated now, they were also elevated in 1996. Remember, we have yet to see hardly any IPOs related to the AI Boom, which will eventually come if the tech is truly game-changing. That’s when we can really start getting concerned about another round of truly irrational exuberance.

Next Week

It will be a big week with the Fed meeting and interest rate announcement on Wednesday. Powell will keep rates on hold but the market is looking for confirmation of a cut at the next meeting in September. In addition there will be a slew of high profile earnings results. McDonalds, Microsoft, Apple, Amazon, Chevron and Exxon.

Hold on tight as we could have a bumpy ride.

Warning

Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account and might not be suitable for you.