With the market near a critical juncture during the most extreme economic dislocation of our lifetimes, the fundamentals have never been more important…
With the stock markets near a critical juncture during the most-extreme economic dislocations of our lifetimes, big US stocks’ fundamentals have never been more important. After plummeting in a brutal stock panic on the catastrophic economic damage caused by governments’ draconian lockdowns to fight COVID-19, stocks have skyrocketed in a monster rally. Are these gains righteous or doomed to fail?
Mid-February feels lifetimes ago, when the flagship US S&P 500 stock index (SPX) surged to a series of new all-time-record highs. The last one at 3386.2 capped an epic secular bull that powered 400.5% higher over 11.0 years. That proved the second-largest and first-longest in all of US stock-market history, freakishly huge. Then COVID-19 viciously slammed the markets like a sledgehammer to the skull.
Over the next 23 trading days into late March, the SPX plummeted an astounding 33.9%! Within that was an ultra-rare stock-panic-grade plunge, a 20%+ collapse in 2 weeks or less. That was one of the biggest and fastest craterings ever witnessed. And due to the powerful wealth effect of the stock markets, that stock panic alone had a real chance of throwing the US into a devastating full-blown depression.
So the Federal Reserve started panicking late in that plummeting, spinning up its printing presses to dizzying speeds. Between mid-March to late April, its balance sheet exploded a wildly-absurd record 54.4% or $2,344.0b higher in just 7 weeks! Much of this was US Treasuries monetized by the Fed’s radically-expanded QE4, which soared a jaw-dropping 57.4% or $1,448.4b higher in that same short span.
That mind-boggling deluge of freshly-conjured fiat money catapulted the SPX a neck-snapping 31.4% higher by late April! While technically a new bull market with a 20%+ gain, this crazy move looks exactly like a monster bear-market rally both technically and sentimentally. Whether a new bull is underway or a vicious bear remains alive and well is absolutely the most-crucial question faced by all traders today.
While the Fed’s near-hyper-inflation has temporarily overpowered everything else, the ultimate arbiter of whether the SPX continues higher or rolls over to new bear lows is the fundamentals of its components. And its biggest and most-important ones just finished reporting their Q1’20 results in a fascinating earnings season unlike any other. They clearly reveal whether a new bull or ongoing bear is more likely.
The amount of capital invested in the biggest and best US companies dominating the SPX is just staggering. Some combination of them are nearly every fund’s top holdings, so they are heavily owned by the vast majority of all investors and speculators. 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 vast amounts of capital, with net assets running a truly-colossal $252.6b, $178.0b, and $129.7b in the middle of this week! Their top components effectively are the US stock markets, so all traders need to stay abreast of how they are faring. Thus right after every quarterly earnings season, I wade through the latest 10-Q results submitted to the SEC by the SPX’s top 34 stocks.
While that’s simply an arbitrary number that fits into the tables below, it is a commanding sample. At the end of Q1’20, these top 34 SPX components accounted for a huge 46.7% of this flagship stock index’s total market capitalization! The top 34’s massive collective market cap of $10,805.3b exceeded the combined total of the bottom 453 SPX components. These big US stocks utterly dominate the markets.
Q1’20’s stock-market action was some of the most extreme ever seen, making corporate results in that quarter much more important than usual. More than half of it was the best of times, the SPX levitating to relentless new record highs on the Fed’s QE4 Treasury monetizations. But then the COVID-19 stock panic obliterated that euphoria even before governments’ draconian lockdowns started in mid-March.
I can’t imagine a quarter with wilder internal variance in market and economic conditions. And how the elite big US stocks fared last quarter including its last couple weeks where economic activity collapsed under the COVID-19 lockdowns is critical to gaming where they’re likely heading. Were they earning sufficient profits to justify their lofty mid-quarter bull-market peak, or their later monster post-panic rally?
The tables below include key fundamental data from these elite US companies as Q1’20 ended. The top 34 stocks’ symbols are followed by their weightings within the SPX and its tracking ETFs, then market capitalizations. The absolute year-over-year changes in the latter from the ends of Q1’19 to Q1’20 are noted. This is a purer measure of value than stock-price changes, since it effectively normalizes out 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 proved quite concerning. Outside of the handful of mega-cap-tech market-darlings, the rest of the top US companies were already struggling with declining sales and profits! Even as Q1 ended before the US economy really started collapsing in April, the top US companies were already ominously trading at dangerous valuations deep into formal bubble territory.
After bubble valuations, the most-troubling aspect of US stock markets’ epic secular bull in recent years has been the increasing concentration of capital in the beloved mega-cap tech stocks. The Big Five are well-known, universally admired, and widely-held by virtually everyone. The are Microsoft, Apple, Amazon, Alphabet, and Facebook of course. You can’t turn on CNBC for 5 minutes without someone touting them.
While they’ve mostly been expensive in classic trailing-twelve-month price-to-earnings-ratio terms, they still offered fund managers amazing growth despite their colossal sizes. So ever-more capital funneled into fewer and fewer stocks. As Q1’20 ended, these elite technology giants collectively commanded an astounding 19.8% of the SPX’s entire market cap! That’s incredibly narrow and top-heavy, super-risky.
That all-time-record-high SPX weighting for its top-5 components exceeded the previous record of 18.3% seen in early 2000 by Microsoft, GE, Cisco, Intel, and Walmart. That narrow market concentration also capped a monster secular bull, paving the way for a 49.1% SPX bear over the next 2.6 years. Today’s record concentration grew even worse in late April, with the SPX’s top-5 components nearing 22% of its total!
If there’s any significant slowing in the Big Five mega-cap techs’ businesses, their stocks are going to drag the rest of the markets lower. That sure hadn’t started in Q1. Overall revenues among the SPX top 34 did retreat 2.1% YoY to $949.1b. But that masks the incredible outperformance of the market-darling tech giants. Their collective sales soared an amazing 14.0% YoY to $227.7b, fantastic growth at any size!
But the rest of the top 34 excluding these mega-cap techs were already faring much worse even though governments’ heavy-handed COVID-19 house-arrest orders had barely begun. Their total Q1’20 sales actually plunged 6.3% YoY to $721.4b! That would be an ominously-sharp business slowdown in any quarter, heralding a recession. But it is crazy considering over half of Q1 was in a euphoric stock boom.
There are 13 weeks in a calendar quarter, and the SPX was powering to new record highs fueled by the Fed’s QE4 Treasury monetizations in 7 of Q1’s weeks. The next 4 or so saw the SPX plunge into that stock panic, which seriously damages the optimistic psychology necessary to fuel strong spending and business activity. But it was just the last 2 weeks where state governors started garroting their economies.
So big US stocks’ revenues should have risen for most of Q1, stalled during the panic, and then only began to fall during the lockdowns into quarter-end. Before I did this research work, I assumed the top 34 SPX stocks excluding the Big Five techs would have flat to slightly-lower sales. But it was surprising to see them plunge 6.3% YoY, which is so bad it would normally reflect the US economy in a severe recession.
Part of this is explainable by the SPX top 34’s composition changing over this past year. The four new stocks that surged enough to climb into these elite ranks, which are again highlighted in light-blue, had average quarterly revenues of just $5.3b. They include richly-valued technology stocks NVIDIA, Adobe, and Salesforce.com that are revenue-light compared to the larger companies they replaced from Q1’19.
Those averaged revenues of $18.2b that quarter and included Wells Fargo, Boeing, and Citigroup. But even accounting for the shifting SPX top 34, revenues were still weak outside of the mega-cap techs. And slumping sales are really amplified by earnings, which will force the big US stocks’ high valuations even higher. That’s a real threat with Q2’20 going to prove disastrous given the ongoing lockdowns during it.
On the operating-cashflow-generation front, the huge bifurcation between the mega-cap techs and the rest of the big US stocks was even more apparent. Microsoft, Apple, Amazon, Alphabet, and Facebook reported total OCFs soaring 17.8% YoY to $56.3b. But the rest of the SPX top 34 excluding the huge US banks fell 8.5% YoY to $91.3b. The banks’ OCFs are so incredibly volatile that they are totally ignored.
Statements of cash flows are prominent in most quarterly results, but mega-banks not only don’t include them in press releases but never talk about them. They are only found buried deep in 10-Qs reported to the securities regulators. Big-bank financials are the most complex I’ve ever seen by far, and even as a CPA and former Big Six auditor I can’t hope to understand their exceedingly-specialized and opaque results.
Interestingly big US companies heavily hoarded cash in Q1 as they saw the writing on the wall from the shutdowns’ dire economic impact. Their overall cash treasuries surged 11.5% YoY to $911.7b! And that wasn’t skewed heavily to the Big Five techs. While their epic cash holdings did grow 12.5% to $458.5b, the rest of the SPX top 34 also boosted their cash by 10.4% to $453.2b. Companies were getting worried.
Cash is life in dark economic times. The more cash corporations and even individuals have heading into a crisis, the longer they can pay the bills and survive with impaired revenues. The leading US companies were clearly already preparing for a serious storm. And the easiest way for them to cut expenses is to fire employees, which we’re seeing in spades with the tens of millions of American jobs destroyed so far in Q2.
The SPX top 34’s overall hard earnings under Generally Accepted Accounting Principles were disastrous in Q1, plummeting 61.9% YoY to $57.0b! Thankfully that number was heavily skewed by a couple major factors. First it includes Warren Buffett’s massive investment holding company Berkshire Hathaway. It is required to flush its gargantuan investment gains and losses through its income statement every quarter.
Buffett has long railed against this and hates it. In Q1’20 Berkshire was forced to report a net loss of $49.7b due to the stock markets plunging into quarter-end! The total investment losses were actually worse at -$55.6b, with actual operating earnings of the large stable of Berkshire companies running at +$5.9b. In Q1’19, Berkshire reported $16.1b in investment gains contributing to GAAP profits way up at +$21.7b.
Berkshire is the largest SPX component after the Big Five mega-cap techs, but its reported earnings are so crazily-volatile that they are best just excluded. Without Berkshire’s results in both Q1’20 and Q1’19, the rest of the SPX top 34 still saw overall GAAP earnings plunge 16.7% YoY to $106.8b! That’s quite a drop for a mostly-good quarter, and implies current bubble stock-market valuations are heading even higher.
The monumental disconnect between mega-cap tech and the rest of the big US stocks is even more apparent in Q1’20 earnings. The Big Five market-darling techs saw their total profits surge 9.9% YoY to $36.3b. That’s certainly an impressive feat to have strong businesses as the dire economic impact of the lockdowns loomed. Microsoft, Apple, Amazon, Alphabet, and Facebook all benefit from Americans stuck at home.
Microsoft sells productivity software and cloud services, and companies have been forced to quickly add remote servers with their employees under house arrest. With connectivity more important than ever, people have to upgrade old Apple devices and stay in touch with friends through Facebook. Everyone is buying everything from Amazon to get delivered, fueling its colossal 26.4% YoY sales surge even in Q1!
Companies cutting their budgets don’t want to stop advertising, and Alphabet and Facebook offer them the widest reach and the best bang for their bucks. So very fortuitously the draconian orders from governments to fight COVID-19 really favor the mega-cap tech stocks. But man the rest of the big US companies were already struggling even in Q1 before the lockdowns went universal to strangle the economy.
The rest of the SPX top 34 excluding these Big Five tech giants and Berkshire saw their GAAP earnings plunge 25.9% YoY in Q1 to $70.5b! That implies their lofty valuations are heading even higher, even deeper into dangerous bubble territory. But thankfully this decline is overstated due to the churn in the SPX top 34’s ranks. Those 4 new companies in Q1’20 had average quarterly profits of just $0.6b, really small.
Yet the 4 they replaced averaged $3.5b in Q1’19. Playing with these averages, the annual drop in profits among the same big US stocks from a year ago was closer to 13.7%. That’s still precipitous in a quarter with a bunch of SPX record highs, and where the lockdowns only eviscerated the last couple weeks. Odds are corporate earnings are going to plummet dramatically in this current Q2 with Americans unable to spend.
Between being unconstitutionally confined to our homes and the tens of millions of jobs killed by these insane lockdown orders, Q2 results are going to be disastrous. It wouldn’t surprise me to see the big US stocks’ total earnings be cut in half this quarter! That’s a huge problem given the bubble valuations in these elite stocks. Their average trailing-twelve-month price-to-earnings ratios exiting Q1 were super-high.
The SPX top 34 averaged a scary 57.4x P/E at the end of Q1’20, which soared 88.8% YoY! Yet that was really skewed by new addition Salesforce.com, which was sporting a ridiculous 985.2x P/E. Excluding it that average collapses to 28.4x, which is way better but still in formal bubble territory which begins at 28x earnings. That was actually 6.5% lower and better than Q1’19’s average, stocks were less overvalued.
But real bubble valuations in hard trailing-twelve-month terms as Q1’20 ended are super-bearish for the US stock markets going forward! Ultimately all stock prices must reflect some reasonable multiple of underlying corporate earnings. The Fed can distort this truth for a time by aggressively printing money, but eventually fundamentals overpower that inflation. And the Fed’s wildly-expanded QE4 is running out of steam.
The Fed’s far-beyond-extreme balance-sheet growth peaked in mid-March, exploding 12.6% or $586.1b higher in a single week! In the 5 weeks since that has steadily contracted to just 1.3% and $82.8b in the latest reporting week before this essay was published. So the Fed has drastically squeezed shut that epic liquidity spigot that catapulted the SPX higher after the stock panic. The flow of money has greatly slowed.
However much SPX earnings plunge this quarter because of the lockdowns and resulting catastrophic American job losses, SPX valuations will rise somewhat proportionally. If profits indeed collapse by 50% this quarter, valuations will certainly shoot at least 25% higher. The reason they wouldn’t double on that is it’s just one quarter out of four in the TTM P/E calculation. That would still push the SPX top 34’s P/Es to 35.5x!
The century-and-a-quarter average for the US stock markets is 14x earnings, which has proven the long-term fair-value level historically. In order to get anywhere near there, the big US stocks’ prices would have to be slashed in half. That implies the bear market is alive and well despite the monster rally since the stock-panic lows. It has a lot of mauling work left to do before it returns to its cave for a long hibernation.
At worst the SPX plummeted 33.9% into late March, a blisteringly-fast collapse. Yet in bear-market terms that is minor. The prior two SPX bears ended in October 2002 and March 2009. They clocked in total losses of 49.1% over 2.6 years and 56.8% over 1.4 years! There’s no way our current bear will prove far milder given prevailing bubble valuations and the unprecedented economic collapse caused by the lockdowns.
And if that latest bear really ended in late March at just that 33.9% loss, its total duration would’ve been just 0.1 months. That’s ridiculously short, way too brief to accomplish a bear’s mission of forcing stocks to undervalued levels and eradicating all greed and bullish sentiment. The big US stocks’ Q1’20 results argue the bear market remains very much alive and well, so the recent bounce was an epic bear-market rally.
Bear markets are exceedingly devious, taking their sweet time to inflict the most pain possible on the greatest number of traders. So sharp plunges to new bear-market lows that generate fear are quickly followed by massive bear-market rallies. These are the biggest and fastest gains ever seen in all of stock-market history by far! They quickly reestablish complacency, duping traders into believing the bear is over.
The classic bear-market strategy is selling stocks and holding cash. If a bear market cuts stocks in half, holding cash through it doubles purchasing power so twice as many shares can be bought back once it runs its course. But cash not only doesn’t appreciate, its value is rapidly being eroded at a wildly-unprecedented pace from the Fed’s colossal panicked money printing. The world is being flooded with new dollars.
Thus a far-superior strategy is to weather this overdue and necessary stock bear in gold and the stocks of its miners. Gold tends to power higher on balance in strong bulls after stock panics, and there is nothing more bullish for gold than astounding currency debasement. The gold miners’ stocks soar during gold bull markets, with their profits growth amplifying the yellow metal’s gains. That’s well underway today!
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The bottom line is big US stocks’ just-reported Q1’20 results already showed significant weakness even with the lockdowns only starting into quarter-end. While the market-darling mega-cap techs dazzled, the rest of the leading US companies struggled with shrinking revenues, operating cash flows, and earnings. They sure knew big trouble was brewing too, as they greatly ramped their cash to ride out this economic storm.
Yet they still exited last quarter averaging dangerous bubble valuations, despite having just suffered a brutal stock panic! That virtually guarantees the bear market is still prowling despite the monster Fed-conjured post-panic bounce. As sales and profits collapse in Q2 with spending plunging on the house-arrest orders and the resulting tens of millions of American jobs needlessly lost, stocks will be forced far lower.
Adam Hamilton, CPA