Most companies are having a great time. Most. Social media companies (Facebook, down -17.8% for last week through today’s close; Twitter, down -26.6% over the same period) have fallen sharply even as the broader markets are outperforming. When good times come, the stock market parties like it’s 1999. When unexpected news arrives, there's a stampede for the exits. This time, Facebook may well have been the instigator for a stampede out of popular tech names over the past week. Technology (ie Silicon Valley et al) and Discretionary (ie retail stores et al) declined while the broader S&P 500 advanced. Infrastructure-related and the Energy sectors saw the biggest gains, although the meaninfulness of this move may be limited since these sectors have been largely trading in sympathy with the whims of oil markets and government/trade commentary. Some recent movement in other areas may be meaningfully attributable to rotations from growth into value.
The S&P 500 is largely used as a proxy for the broader stock market, considered as somewhat representative of the performance of US companies. The index is living and breathing, with companies added and removed depending on circumstances, and may sometimes consist of more or less than 500 companies. Want to know how trade tensions or other factors are affecting the USA? Look at earnings and other company data and interpolate. It’s a wonderful and powerful tool. Read about how the S&P 500 is constructed at The Motley Fool.
The Facebook Situation. Everyone knows Facebook, so let’s focus on that company for a bit. Even after the recent selloff, Facebook’s market cap is still around some $514 BILLION. It’s been a crowded trade and a perennial favorite of hedge funds and all manner of index funds alike. Facebook, along with several other companies, can affect broader index performance simply because of their size. And last week, Facebook disappointed investors and ended up making its mark on history for all the wrong reasons (this article by Marketwatch comments on the historic nature of Facebook’s one-day fall).
The race to $1 TRILLION. Four companies are currently viable contenders to reach the historic valuation milestone, with Apple, market cap $956 billion, by far the leader. Google, Amazon, Microsoft are almost neck-in-neck for second place with valuations in the mid-to-high $800-million range. All of these are currently (key word, currently, since this will soon change) placed in the Technology sector. With such a huge valuation, these companies have an "outsized" impact on its host sector's performance. Read about the race to $1 trillion and analysts’ favorite at Bloomberg.
By now, we’ve all been deluged by all the information thrown at us about what’s wrong at Facebook. The summary from the earnings report and conference call is that: 1) revenue disappointed and margins are forecast to contract and remaining subdued for the near-term, and 2) global daily active user growth slowed (key word: slowed; growth slowed, but there still is growth). Facebook, the website, is currently the earnings Goliath for Facebook, the company. The stock price then dropped as shares sold off. However, let’s take a quick break here. Step away, and consider for a moment how investors assign valuations to companies.
The long-term Facebook story remains unchanged, but the company's projected performance over the next several years is below what analysts had been hoping (and planning?) to see. These analysts must now change their Facebook model inputs which may result in different valuation targets. Don’t forget, the investment suitability of a public company generically depends on stock market price, profitability, and potential for growth. Hedge funds and all types of other funds may need to adjust their positioning both in Facebook and the broader market in response.
The long-term Facebook story remains unchanged, but the company's projected performance over the next several years is below what analysts had been hoping (and planning?) to see. These analysts must now change their Facebook model inputs which may result in different valuation targets. Don’t forget, the investment suitability of a public company generically depends on stock market price, profitability, and potential for growth. Hedge funds and all types of other funds may need to adjust their positioning both in Facebook and the broader market in response.
But what of Facebook? The company remains THE powerhouse in the social networking space. The company's dominance hasn't faltered and monetization options for its COLOSSAL user base across the Facebook website and other platforms remain plentiful (click here for a CNBC interview about Facebook monetization options). In other words, the long-term Facebook story appears to remain intact, even in the face of narrower (near-term) margins and stricter privacy regulations. Therefore, long term investors will probably look at this event and shrug. Please note that The Ignorant Investor is talking through considerations surrounding Facebook as a case study in dissecting what's important to keep in mind during "emotional" quarterly earnings events. As always, remember to consult your investment professional before making any moves in the markets.
Trade, Rhetoric, and Results
US President Donald Trump is proving to be very hands-on when it comes to matters of trade. Every week the situation seems to change, with Twitter soundbites countered with official statements or discussions resulting from in-person meetings. Markets appear to have become more insulated over time and reactions more muted to sudden statements about industries and – gasp – individual companies on Twitter. There is no doubt that the trade issue (problem?) has been advancing quickly, however. The Ignorant Investor went as far as to compile a list of no fewer than a dozen meaningful statements from the USA and other countries threatening additional trade barriers or other types of positioning ahead of trade negotiations since my last post.
USA-China Trade. Rhetoric doesn’t mean much amid the rattling of sabers and positioning ahead of trade talks, as long as engagement between the affected parties is maintained and those trade talks are ongoing. Recently, The Ignorant Investor took note when White House National Economic Council Director Larry Kudlow stated that China was not meaningfully engaging in trade talks with the USA, partially by not responding "adequately" to concerns of intellectual property theft (although China had in previous talks offered some concessions on lowering trade barriers and buying more USA products). China responded strongly to Kudlow’s statements (read more on China’s response from this article at Bloomberg). In the investment world, there is no shortage of authoritative figures speaking out on all manner of subjects. Its important to identify which voices to listen to during confusing times. The Ignorant Investor respects Larry Kudlow’s opinions on markets and free trade and tends to believe his words to be credible. Yesterday, the media postulated that there are indications that USA-China trade discussions may resume soon. This is hopeful news, but in the meantime - as discussed previously - tread very carefully around companies that deal in markets that could get caught up in the crossfire.
China Trade issues: What if it’s all about the system? The Ignorant Investor fears that both the USA and China are approaching the trade talks from different intractable ideological positions. For example, China is willing to purchase more goods from the USA to help with what Trump thinks is a problem (ie the trade deficit); however, China will never be willing to change the established Chinese government system. In Communist China, the government has last say in everything and has strict oversight over any business operating in its territory. If foreign companies can operate with total independence, the Chinese system must necessarily have changed. The USA perhaps views the Chinese intransigence on this position as a stubborn attachment to a policy that violates the spirit of free trade. Unless both sides are willing to reach a compromise, this trade spat may turn even uglier. Read about the relatively fruitless recent US-China Trade negotiations in this article by Bloomberg.
USA-Europe Trade. Good news! Last week, the US and the EU announced that they had struck some form a preliminary trade deal and agreed to sit down for detailed negotiations and avoid new tariffs, for now. The Ignorant Investor felt this deserved a mention, although no one necessarily expected at trade war with Europe. The New York Times has more details on what transpired and what this “agreement” currently looks like.
Prescription drug prices voluntarily capped. Pfizer shocked investors when it announced on July 10th that it would cap price hikes for the remainder of 2018, supposedly to give President Trump time to develop (and market?) his plan to lower prescription drug prices. This came after Trump tweeted that “Pfizer & others should be ashamed that they have raised drug prices for no reason.” Even more surprising is that, following Pfizer's lead, Merck, Novartis, Roche, and Sanofi have made similar commitments. Remember Martin Shkreli and the days of 5,500% drug price increases? Apparently, the drug industry has learned from that debacle back in 2015 and is battening down the hatches until the current public and legislative scrutiny dies down or is attracted elsewhere. USA Today has an excellent article summarizing the industy's posture.
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Amid all the concerns floating around the market today (pullback warnings from Morgan Stanley, 10-year yield still flirting with 3%, amid others), The Ignorant Investor recommends stepping back and looking at the big picture. Always consider the fundamentals before making any hasty moves!
