Guest Post from Adam Hamilton at Zeal LLC:
The big US stocks dominating markets and investors’ portfolios are drifting in a technical no man’s land. While formally still languishing in a bear market, they wouldn’t have to rally far to regain bull territory. Enthusiastic traders are increasingly anticipating such a breakout. But plenty of storm clouds are building on the horizon, including generally-bearish fundamentals revealed in the just-completed Q1’23 earnings season.
The mighty flagship S&P 500 stock index has enjoyed a solid 2023, rallying 7.8% year-to-date. The US stock markets have apparently successfully weathered raging inflation, ongoing extreme Fed tightening, major US bank failures, and the threat of a US debt default! Given these serious challenges, the big US stocks have certainly outperformed in recent months. That has left them feeling increasingly impervious.
Yet 2022’s bear market where the SPX plunged 25.4% between early January to mid-October remains in force. These long grinds sideways to lower are punctuated by strong bear-market rallies. Today’s current one erupted out of that latest bear-market low, propelling this leading US stock-market benchmark up 16.9% at best as of early February. While big, that was short of the 20% gains necessary to declare a new bull.
During the several months since, the SPX’s advance has totally stalled out. The US stock markets fell 7.8% into early March’s banking-crisis fears, and then rebounded 8.1% into late April. But that surge failed just shy of new bear-rally highs. As of mid-week, the SPX would have to climb another 3.7% to achieve bull-dom. So big US stocks’ latest quarterly results must be framed against this live-bear backdrop.
Bear markets exist to normalize excessive valuations, and usually don’t hibernate before they accomplish that mission. Late in major bulls, greed and euphoria fuel momentum-chasing buying catapulting stock prices to unsustainable levels relative to underlying corporate earnings. That spawns bears, which maul stock prices sideways to lower long enough for profits to catch up. So fundamentals govern bears’ longevity.
Thus the big US stocks’ new Q1’23 results are important for gaming the stock markets’ likely direction in coming months. For 23 quarters in a row now, I’ve analyzed how the 25-largest US companies that dominate the SPX fared in their latest earnings seasons. These behemoths alone commanded a massive 42.5% of the SPX’s total market cap exiting Q1! Their latest-reported key results are detailed in this table.
Each big US company’s stock symbol is preceded by its ranking change within the S&P 500 over the past year since the end of Q1’22. These symbols are followed by their stocks’ Q1’23 quarter-end weightings in the SPX, along with their enormous market capitalizations then. Market caps’ year-over-year changes are shown, revealing how those stocks performed for investors independent of manipulative stock buybacks.
Those have been off the charts for years, fueled by the Fed’s previous zero-interest-rate policy and trillions of dollars of bond monetizations. Stock buybacks are deceptive financial engineering undertaken to artificially boost stock prices and earnings per share, maximizing executives’ huge compensation. Looking at market-cap changes rather than stock-price ones neutralizes some of stock buybacks’ distorting effects.
Next comes each of these big US stocks’ quarterly revenues, hard earnings under Generally Accepted Accounting Principles, stock buybacks, trailing-twelve-month price-to-earnings ratios, dividends paid, and operating cash flows generated in Q1’23 followed by their year-over-year changes. Fields are left blank if companies hadn’t reported that particular data as of mid-week, or if it doesn’t exist like negative P/E ratios.
Percentage changes are excluded if they aren’t meaningful, primarily when data shifted from positive to negative or vice-versa. These latest quarterly results are very important for American stock investors, including anyone with retirement accounts, to understand. They illuminate whether the US stock markets are fundamentally sound enough to stave off this napping bear before its teeth and claws demand more flesh.
Ominously this faltering bear-market rally has seen narrow breadth, with gains concentrated in a handful of market-darling stocks. Stunningly these top 25 US stocks again command fully 42.5% of the entire S&P 500’s market cap! The usual big-four mega-cap tech stocks are leading the way, along with artificial-intelligence play NVIDIA. Yet their collective market caps are still down 17.6% YoY, worse than the SPX’s -9.3%.
Apple’s dominance of the US stock markets continues to mount, accounting for 7.2% of the entire SPX! That’s the highest on record for a single stock, incredible concentration. If Apple sneezes, the entire US stock markets will catch a cold. And despite being an amazing company universally loved, even Apple isn’t immune from business slowing. That’s actually happening despite Wall Street’s deceptive misdirection.
Given its vast weighting, Apple’s quarterly results are the most-highly-anticipated in any earnings season. And after the close last Thursday this behemoth reported great Q1 results, crushing expectations. Sales and earnings per share of $94.8b and $1.52 were way ahead of analysts’ forecasts of $93.0b and $1.43. So the next day AAPL stock euphorically surged another 4.7%, powering up to a major new bear-rally high.
But Wall Street’s silly expectations game almost always lowers bars to be beatable. Actually last quarter, Apple’s revenues and bottom-line accounting earnings slipped 2.5% and 3.4% YoY. And that made for a slowing trend, as during the previous Q4’22 Apple also suffered sales and profits sliding 5.5% and 13.4% YoY! That has left AAPL valuations very high, with a 28.1x TTM P/E exiting Q1 and 29.1x as of mid-week.
As a professional speculator and financial-newsletter guy for a quarter-century now, I have CNBC and Bloomberg on in my office all day every day. Wall Street analysts often argue that Apple’s business is unstoppable because no one will give up their precious iPhones. That’s true, but the real threat to Apple is simply slowing upgrades. While a new iPhone every couple years is nice, they work fine for four or five.
Apple’s revenues and earnings sliding for two consecutive quarters implies this is happening! Pinched by raging inflation jacking up prices of life’s necessities, Americans are putting off discretionary purchases like new iPhones. This trend will worsen as the colossal price jumps in food, shelter, insurance, energy, and essential expenses in the last couple years remain entrenched. AAPL stock will eventually reflect this.
While Apple’s slowing business is a big risk for the US stock markets, NVIDIA sure reflects the irrational euphoria this bear needs to eradicate. This company makes computer graphics processing chips, which are used in data-center and gaming applications. But the latter traditional business has cratered due to pinched consumers and sky-high prices for NVIDIA’s latest graphics cards, which run as high as $1,600 each!
Thus this company’s latest quarterly sales and profits crashed 20.8% and 52.9% YoY, an utter disaster for an elite stock! That left NVDA with an insane 118.2x TTM P/E at the end of Q1’23, since ballooning to a crazy-dangerous 163.9x this week. Yet because of the mania in artificial intelligence which NVIDIA’s processors are used for, investors have so far overlooked these dreadful fundamentals. But they won’t forever.
Like everyone else I love Apple’s and NVIDIA’s products, but their lofty-to-extreme valuations are a big risk for stock markets in an ongoing bear market. The second-largest US company Microsoft reported a far-better and impressive Q1’23, with revenues and earnings surging 7.1% and 9.4% YoY. Yet it is still trading at a bubble-valued 32.2x TTM P/E. Stock prices are way too expensive relative to underlying profits!
This bear market’s claw prints are very apparent over this past year. From the ends of Q1’22 to Q1’23, these 25 largest US stocks saw their collective market capitalizations fall 14.0%. That is again worse than the overall S&P 500’s 9.3% decline in that span. The other mega-cap-tech market-darlings Alphabet and Amazon, which were also long considered impervious, saw their market caps collapse 30.6% and 36.3%!
So despite the SPX bumping up against bear-rally highs recently, all is not well in equity-land. This bear’s essential valuation-mean-reverting work is still being done, but stealthily through sideways grinding. Yet while bear-market rallies may linger, they eventually roll over into serious maulings pummeling stocks to new bear lows. Those start at mid-October’s 3,577 nadir, or 13.5% below this week’s S&P 500 levels.
In Q1’23 the SPX-top-25 companies’ aggregate revenues looked good on the surface, growing by a solid 3.1% YoY to $1,093.7b. But those nominal dollars are actually well behind inflation, which surged 5.0% in the year ending March 2023 according to the headline Consumer Price Index read! So big US stocks’ sales are really deteriorating when adjusted for inflation, as their cash-strapped customers scale back buying.
Even the SPX top 25’s weak nominal revenues growth last quarter was the slowest seen by far since Q4’20, when the US economy had recently emerged from pandemic lockdowns. In the eight quarters between then and Q1’23, average SPX-top-25 sales growth ran a hefty 17.5% YoY. So clearly a major slowdown is underway, reflecting the US economy being forced into a severe recession by extreme Fed tightening.
Yet paradoxically the big US stocks’ Q1 earnings looked very strong, blasting up 20.0% YoY to $176.8b! Some outstanding individual performers helped drive this, including Exxon Mobil’s bottom-line profits skyrocketing 108.6% YoY. But that was mainly due to a massive $3.4b impairment charge in Q1’22 when this company walked away from a giant Russian oil-and-gas project after that country invaded Ukraine.
Walmart’s earnings also soared 76.2% YoY, but that’s probably a contrary economic indicator. Inflation-ravaged Americans are flocking to Walmart to find the lowest-priced groceries. But for many that involves trading down to lower-quality foods. Megabank JPMorgan Chase’s profits blasted up 52.4% YoY on far-higher interest rates boosting its interest income a similar degree. All three of these are unusual situations.
Other big US companies including Apple, Alphabet, NVIDIA, Tesla, and Meta saw their Q1’23 earnings fall, mostly sharply. The dominant reason the overall SPX-top-25 profits jumped so much came from Warren Buffett’s huge Berkshire Hathaway investment conglomerate. Its bottom-line GAAP profits shot stratospheric last quarter, up a shocking 550.3% YoY to a colossal $35.5b! But that is mostly investment gains.
Endlessly irritating Buffett, US accounting rules require companies to run unrealized stock gains and losses through net income each quarter. With the SPX’s bear-market rally driving it a big 7.0% higher in Q1’23, Berkshire’s vast holdings surged proportionally. So its total $35.5b earnings last quarter included fully $34.8b of “Investment and derivative contract gains”! Almost 98% of BRK’s profits were market-driven.
Those are ethereal, quickly reversing when US stock markets suffer down quarters. A year earlier in Q1’22, Berkshire’s total profits of $5.6b included $2.0b of investment losses. If both quarters’ mark-to-market unrealized gains or losses are adjusted out, BRK’s real operating earnings actually cratered 90% YoY last quarter to just $0.7b! And this conglomerate’s broad holdings really represent the wider US economy.
If the SPX top 25’s total earnings in these comparable quarters back out Berkshire’s volatile investment swings, instead of soaring 20.0% YoY they actually shrunk 4.9%! That is really ominous considering the dangerously-high stock-market valuations. While the big US stocks’ average trailing-twelve-month price-to-earnings ratios contracted a nice 21.1% YoY, they still exited Q1’23 at 30.3x which remains in bubble territory.
Over the past century-and-a-half in US stock markets, fair value has averaged around 14x earnings. The reciprocal of that is a 7.1% earnings yield, a fair price for companies to pay and investors to earn for using their scarce capital. Double historical fair value at 28x is where formal stock-market bubbles begin. Despite this bear mauling stocks in 2022, average valuations of the biggest US stocks remain at bubble levels.
And with earnings generally weakening as inflation strangles Americans’ purchasing power, valuations are heading even higher. Remember bear markets exist to normalize valuations. Major bears typically run until big US stocks’ average P/E ratios are at least mauled back near 14x fair-value. Serious bears rage until those near deeply-undervalued levels around half that or 7x. So this bear’s work is far from done.
Again at worst in mid-October, the SPX had merely suffered a 25.4% mauling. This week this flagship US stock index is only down 13.7% from its last bull’s all-time-record peak in early January 2022. Yet both losses are small for secular bears spawned and fueled by extreme bubble valuations. From October 2007 to March 2009, the SPX plummeted 56.8% in 17.0 months! Ursa majors are nothing to be trifled with.
The secular bear before that crushed the SPX 49.1% lower over 30.5 months between March 2000 to October 2002. So don’t buy into Wall Street’s fanciful assertion that a mere 25% bear is enough with big US stocks still trading in bubble territory. Odds are this bear will at least need to slash stock prices in half before returning to hibernation. That would necessitate a 2,398 SPX, a brutal 42.0% below this week’s levels!
The primary reason this bear hasn’t been worse yet is the ongoing gigantic stock buybacks these big US companies are using to manipulate their stock prices and earnings per share higher. Yet SBBs are really waning with profits under increasing pressure. The top 25 US companies’ stock buybacks totaled $85.3b in Q1’23, which fell 11.6% YoY. And that was the fourth quarter in a row they’ve suffered sizable retreats.
Between Q2 to Q4 last year, SPX-top-25 SBBs contracted 10.0%, 20.1%, and 31.9% YoY! The mega-cap techs continue to dominate stock buybacks, but they can’t sustain their blistering paces. Last quarter for example, Apple’s, Alphabet’s, NVIDIA’s, and Meta’s buybacks plus dividends ran 96%, 97%, 93%, and 164% of their Q1’23 earnings! Plowing everything into SBBs isn’t sustainable even with massive cash hoards.
Corporate stock buybacks have proven the single largest source of stock demand by far for many years, since the Fed originally slashed interest rates to zero way back in December 2008. But after the violent 500 basis points of rate hikes during this past year or so, the economics of SBBs are radically worse. As they continue to wane under higher rates and mounting earnings pressure, that will really weigh on stock prices.
Big companies have to cut their buybacks way before dividends, which are an essential income stream for many investors. Dividends didn’t budge much last quarter, with the SPX top 25’s total slipping just 0.5% to $40.4b. Operating-cash-flow generation excluding the hyper-volatile megabanks was strong, climbing 11.1% YoY to $194.9b for these elite companies. But much of that upside had an interesting driver.
One crushing area of inflation is medical prices, which people generally have to pay whether they can afford to or not. UnitedHealth is the world’s largest health-insurance company. Last quarter premiums made up nearly 4/5ths of its colossal $91.9b of quarterly revenues, which actually rivaled Apple’s $94.8b! Medical insurance is a vast business, and surprisingly UNH’s operating cash flows more than tripled in Q1 to $16.3b!
Shockingly that matched Exxon Mobil’s $16.3b in OCFs, which doesn’t make any sense. Yet UNH’s were an anomaly fueled by $11.2b in “Unearned revenues”. That was Medicare and Medicaid premiums paid in March but not due until April, not from business growth. Exclude that, and SPX-top-25 OCFs last quarter only grew 4.7% YoY. That is really slowing from the previous four quarters’ 14.4%-YoY average growth.
So despite Wall Street playing its usual deceptive earnings-season games of lowering expectations bars, the SPX top 25’s collective results were generally bearish. Revenue growth fell behind headline inflation, earnings dropped without Berkshire Hathaway’s huge unrealized investment gains, stock buybacks were pared back again, and valuations remained stuck in dangerous bubble territory. So this bear has work to do.
Given this bearish backdrop, investors should be wary of their heavy capital allocations to these biggest US stocks dominating the markets. They should consider diversifying into gold. Exiting Q1 when all 500 SPX companies commanded a mighty $36,845.8b market cap, the gold-bullion holdings of the leading American GLD and IAU gold ETFs were only worth $86.9b. That implies gold allocations around just 0.2%!
That’s essentially zero, radically below the 5% minimum prudent investors have run for many centuries. Even better, gold soared during the only other two inflation super-spikes of this modern monetary era during the 1970s. In monthly-average-price terms from trough-to-peak CPI-inflation months, gold nearly tripled during the first before more than quadrupling in the second! Gold ought to at least double during today’s.
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The bottom line is big US stocks’ latest quarterly results looked bearish. Their collective revenues barely grew, actually shrinking when adjusted for inflation. That implies the US economy is buckling under the monster Fed rate hikes. While bottom-line earnings did surge, that was only because of huge unrealized investment gains in one conglomerate. Adjusting those out reveals overall corporate profits rolling over.
That is a serious problem with average valuations of these elite companies still way up in dangerous bubble territory. Bear markets’ sole reason for existence is to maul stocks sideways to lower long enough for earnings to catch up with stock prices. At worst today’s bear has only lopped off a quarter, but it will probably need to reach half before valuations sufficiently mean revert. So stock investors should diversify into gold.