The S&P 500 Continues to Thrive
The S&P 500 continues to move higher. But how did we get here? Let’s oversimply things and take a quick walk through recent months. In December, recession fears dominated US stock market movements amid a lingering US-China trade war. January was all about the government shutdown and questions around the target Federal Funds rate; meanwhile, US-China trade tensions were easing. February saw global growth concerns rise even as the market adjusted to a more accommodative Fed (which chose to leave target rates unchanged for 2019) and potential political fallout from the much-anticipated Mueller report. In March, uncertainty rose as the flattening yield curve inverted again. April revolved around predicted first quarter 2019 earnings growth declines, which were proved inaccurate as corporate America, through a Herculean effort, managed to keep blended earnings growth in positive territory, if close to the flatline.The US equity market moved through all this uncertainty to again reach ever higher, hitting historic levels, with the S&P 500 gaining a whopping 25% from December 24th lows through today’s close. Tell anyone this would be the case back in December and they would have called you crazy. There continue to be questions around the sustainability of this rally, however, since the move higher has not been broad-based, but very concentrated in the Tech, Discretionary, and Communications sectors.
FAANG is dead, all hail FAAN
Those who stuck with the tried and the true by looking to these old favorites in 2019 have been very handsomely rewarded. Facebook is the leader, up a massive 47% year-to-date. This is followed by Netflix (38%), Amazon (28%), and Apple (27%). Alphabet, Google’s parent, has sadly lagged, up a solid but meager-in-comparison 14% following its ad sales growth stumble earlier today.
Beleaguered Health Care
While the S&P 500 continues to test historic levels, market participation has decreased and rotations have occurred, differentiating this high from the last high of early October 2018. While every component index of the S&P 500 has advanced, Health Care has severely lagged the recent rally and has only advanced 3.2% year-to-date (this up from a sharp decline seen earlier in April that briefly brought the subindex to a negative 2019 return). Indeed, between April 10th and April 17th, the entire Health Care component of the S&P 500 fell more than six percentage points.
For those of us familiar with the biotech drug discovery area of the Health Care sector, we are well accustomed to such sharp moves in individual names depending on the development status of various experimental treatments for diseases. However, this April selloff was broad-based, hitting the entire sector and moving everything lower. In this particular case, the cause of the selloff originated in Congress (CNBC has a quick summary of what was happening in Congress at the time). The Health Care sector frequently becomes the fall guy during political discourse, and in this case, many senators and potential candidates had begun to push for various health care plans and rail against the pricing strategies of American pharmaceutical companies. Health Care reform is very important for the American people, but what that reform looks like and how it is done can significantly affect investments.
For those of us familiar with the biotech drug discovery area of the Health Care sector, we are well accustomed to such sharp moves in individual names depending on the development status of various experimental treatments for diseases. However, this April selloff was broad-based, hitting the entire sector and moving everything lower. In this particular case, the cause of the selloff originated in Congress (CNBC has a quick summary of what was happening in Congress at the time). The Health Care sector frequently becomes the fall guy during political discourse, and in this case, many senators and potential candidates had begun to push for various health care plans and rail against the pricing strategies of American pharmaceutical companies. Health Care reform is very important for the American people, but what that reform looks like and how it is done can significantly affect investments.
The Ignorant Investor will simply note here that the Health Care index was oversold and mostly recovered its losses, although some specific names have continued to show weakness. As in any investment, quality is ultimately the name of the game. There are always opportunities, overlooked companies with compelling stories. However, as the political landscape continues to take shape in the months ahead of the 2020 United States Presidential Elections, sharp, broad-based market moves in the Health Care sector may be expected to become more commonplace.
Rumblings in the Oil Markets
One would think after all the drama the oil markets have encountered over the last five years that somebody would get it right. But no! The so-called “smart money” was mostly behaving in way not represented by its name, selling off long positions in the commodity in January right as the bottom was forming in the most recent price arc. Now, we sit nicely near 2019 highs with the potential of an even tighter oil market ahead of us (yes, we can thank the perfect storm created by OPEC+ production cuts, instability in Venezuela and Libya, and the full implementation of US oil sanctions against Iran- as promised, but delivered later-than-promised by President Trump).There is sanity among the supermajors, after all
Chevron was wise enough to make the first move, bidding approximately $33 billion ($50B including debt according to Chevron) for one of US shale’s “best” performers and Permian darling, Anadarko Petroleum Corporation on April 12th. This was, astoundingly, more than a 35% premium to Anadarko’s closing price the day before. Oil production companies' stock prices have been very subdued relative to crude oil’s sharp gains over the last four months. Indeed, it seems as if in this case (along with several other high-quality names that The Ignorant Investor will allow to remain unnamed) the baby had indeed been thrown out with the bathwater. But this tale does not end here.
Suddenly, on April 24th, larger shale oil rival Occidental Petroleum launched a hostile $38 billion for Anadarko Petroleum, topping Chevron’s bid, to the cheers of Anadarko’s existing shareholders. Also surprisingly, Warren Buffet’s name came up as it became known that Berkshire Hathaway was joining Occidental’s bid by providing $10 billion in financing (in a very sweet deal - perhaps too sweet - for Buffett too). Anadarko Petroleum’s board has most recently announced it plans to accept Occidental's bid (read about the announcement at CNN). As a quick evaluation, The Ignorant Investor will simply note that amid sharp, unpredictable, and unknowable moves in oil prices, debt can quickly become first a trap and then a tomb for debt-laden shale oil companies in the event of an extended downturn. Chevron could counter-bid at this juncture, and may indeed be the superior choice in this situation as a much larger and much more liquid long-term partner. However, as an investor, one must simply note that sharks are currently on the prowl, and that raises the question: who’s next?
Filling in the Blanks
Unicorns and IPOs
Lyft Inc (LYFT is the Nasdaq ticker) went public on the final day of March and it has seemingly been all downhill from there: the stock has fallen more than 23% on a closing basis from the end of March until closing earlier today. The ride-hailing company's IPO has seemingly disappointed many enthusiastic retail investors, including millennials, who bought into the company in the initial days after it went public. Next up, Pinterest Inc (NYSE PINS) went public on April 18th, but unlike Lyft has continued to rise: up nearly 27% through closing earlier today. Totally different business model, The Ignorant Investor does realize. It is, however, another example of a large unicorn with a multi-billion-dollar valuation. Finally, we come to the elephant in the room. Uber, a so-called once-in-a-generation company, is going public with a valuation that could be north of $80 billion (for reference, this is similar in size to the industrial equipment giant Caterpillar or the drugstore chain parent CVS Holdings Inc). However, after “rival” Lyft’s unflattering post-IPO performance, this could change (WSJ has a good article on Uber lowering its valuation targets, which occured after the Lyft IPO). While not interested in investing in these companies, The Ignorant Investor is watching with some interest, even hope. Perhaps a decent performance from some higher-quality names among these IPOs could help entice millennials, scarred by the so-called “Great Recession” (read more about the event at Entrepreneur), back into the stock market.
In any case, the day of reckoning has finally arrived: are large unicorns worth the hype, as an investment? There seems to be no shortage of disruptive companies which, although promising, almost literally burn through cash hand over fist and yet have many multiple-billion-dollar valuations. These have also typically opted to remain private for many years. The ultimate proof is in the pudding, and one-by-one these companies are going public, preparing carefully for the accompanying transparency and extra scrutiny that accompanies large IPOs (thankfully, the alleged fraud at the infamous Theranos was exposed before the company had the chance to also fleece ordinary retail investors in a public offering, read more about the debacle here at Forbes). Beyond further examination of financials plans and business metrics, only time will tell which of these companies are good investments.
Cash is King
Saudi Aramco is indeed the most profitable company in the world, dethroning Apple and debunking some lingering financial questions, as the country reveals many details about the national oil company ahead of a massive debt sale and, further afield, a potential IPO. However, while massively profitable at current oil prices, Aramco doesn’t appear to be as efficiently run as Big Oil. The Financial Times has a great article based on knowledge gleaned from the Saudi Aramco Prospectus that was distributed earlier this month.
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As always, The Ignorant Investor advocates a cautious approach towards investing in equities in 2019. Quality is the name of the game: solid companies with compelling stories and pristine balance sheets. And remember: “Be fearful when others are greedy and greedy when others are fearful" - Warren Buffett
