Stocks continue to back off after completing a full recovery of the December declines.
Here’s another look at the chart we observed on Monday, where you can see the big technical area of resistance (three prior highs) — and today we close back on the 200-day moving average (the purple line).
As we discussed on Monday, the failure of this level shouldn’t be too surprising, as a reasonable technical area to take some profits.
As stocks slide back, the media is quick to turn the attention back toward fears of global economic slowdown. What’s the big difference between now and December? The Fed has moved from telegraphing rate hikes to ‘neutral’ and sitting/watching. The PBOC (central bank in China) has done more to stimulate their economy (to incentivize bank lending) and this morning, the ECB has come in with more easy money policies. Both the Fed and ECB were pre-emptive shots.
Like 2016, the response from central banks has been aggressive and coordinated to ward off slowdown and/or a stock market destabilization. That recipe worked well in 2016. I suspect it will work well this year.
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There’s a lot of excitement about the building IPO docket for the year. Let’s take a look of the lay of the land …
There is said to be more than 220 companies planning to go public in 2019.
On Friday, Lyft filed an S1 with the SEC (a prospectus like document) in preparation for an IPO. This will be the first Silicon Valley darling to go public this year.
Lyft is the second largest ride-sharing company — owns about a third of the U.S. market, with Uber owning the rest. Uber is expected to go public this year. The other big ones coming: Airbnb, WeWork and Palantir.
We’ve clearly had a boom cycle in Silicon Valley over the past decade. But are these IPOs coming late the party?
Remember, we have an administration in Washington that has tightened the regulatory screws on the dominant publicly-traded tech giants (Facebook, Amazon, Google). The regulatory tailwinds (or lack thereof) that they enjoyed along the path of their disruptive growth, have now turned into headwinds. And the stocks have all been hit, as a result.
Keep in mind, the private market valuations were pumped-up in these IPO candidates when public equity markets were offering little optimism about future returns. With that, pension money was flowing into the coffers of Silicon Valley private equity firms. And private equity fund managers were throwing money at things — and companies have been burning through that money, ramping staff, buying fancy offices and inundating us with blitz advertising campaigns.
Safe to say there has been an overhyping of the term “disrupters.” In many cases, we’re looking at startups trying to underprice and outspend (with our pension money) in a traditional business, without having the hurdle of making money (maybe ever). Not surprisingly, there have been market share wins.
But public companies tend to be held to a standard: profitability. We’ll see how they do with the shifting market environment (i.e. late cycle Silicon Valley).
Lyft will be an early indicator. Its last private investment valued the company at $15.1 billion. For that, in their filing, they revealed a company doing a little over $2 billion in revenue, while losing almost a billion dollars last year. Revenue growth has been slowing, losses have been widening as the private equity investors attempt to cash out in the public markets.
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If you are a regular reader of my daily notes, you’ll know I’ve suspected we are seeing an end to the “wild west” days in Silicon Valley.
I think we’ve finally seen it play out in the stock market in the past month.
The media has spent the past month pontificating about big macro economic stories and how these risks have driven this correction stocks. But the intermarket correlations don’t support it. Despite the sharp slide in stocks, money hasn’t fled to the safety of bonds. The currency market has shown little to no stress. And gold has been relatively quiet. This is all antithetical to what you would find in a world shaken from elevated global risks.
Ultimately, this correction has been about repricing the tech giants. And one of the power players in Silicon Valley said about as much this week.
Peter Theil, founder of PayPal and the first investor in Facebook said he doesn’t expect to see another innovative breakthrough consumer internet company. I agree (for a number of reasons).
With that, I want to revisit my note from March of 2017, as Trump was just getting his feet wet as President:
TUESDAY, MARCH 7, 2017 “A big component to the rise of Internet 2.0 was the election of Barack Obama.
With a change in administration as a catalyst, the question is: Is this chapter of the boom in Silicon Valley over?
Without question, the Obama administration was very friendly to the new emerging technology industry. One of the cofounders of Facebook became the manager of Obama’s online campaign in early 2007, before Obama announced his run for president, and just as Facebook was taking off after moving to and raising money in Silicon Valley (with ten million users). Facebook was an app for college students and had just been opened up to high school students in the months prior to Obama’s run and the hiring of the former Facebook cofounder. There was already a more successful version of Facebook at the time called MySpace. But clearly the election catapulted Facebook over MySpace with a very influential Facebook insider at work. And Facebook continued to get heavy endorsements throughout the administration’s eight years.
In 2008, the DNC convention in Denver gave birth to Airbnb. There was nothing new about advertising rentals online. But four years later, after the 2008 Obama win, Airbnb was a company with a $1 billion private market valuation, through funding from Silicon Valley venture capitalists. CNN called it the billion dollar startup born out of the DNC.
Where did the money come from that flowed so heavily into Silicon Valley? By 2009, the nearly $800 billion stimulus package included $100 billion worth of funding and grants for the ‘the discovery, development and implementation of various technologies.’ In June 2009, the government loaned Tesla $465 million to build the model S.
When institutional investors see that kind of money flowing somewhere, they chase it. And valuations start exploding from there as there becomes insatiable demand for these new ‘could be’ unicorns (i.e. billion dollar startups).
Who would throw money at a startup business that was intended to take down the deeply entrenched, highly regulated and defended taxi business? You only invest when you know you have an administration behind it. That’s the only way you put cars on the street in NYC to compete with the cab mafia and expect to win when the fight breaks out. And they did. In 2014, Uber hired David Plouffe, a senior advisor to President Obama and his former campaign manager to fight regulation. Uber is valued at $60 billion. That’s more than three times the size of Avis, Hertz and Enterprise combined.
Will money keep chasing these companies without the wind any longer at their backs?“
Again, this note above was from about 18 months ago. And administration change has indeed become a problem for these emerging monopolies.
Trump’s scrutiny has come, and so has the regulatory scrutiny. But admittedly is has taken longer than I expected.
Still, it has become clear now to lawmakers (in the U.S. and abroad) that the lack of regulatory oversight of these companies (if not regulatory favor) has created a “winner takes all” environment. And the power transfer into so few hands has quickly become a big threat.
Now these companies look forward to the next decade of regulatory purgatory. But given the maturity of these tech giants, higher regulation only strengthens their moat. That means there will never be a competition to Facebook emerging from a dorm room or garage. The compliance costs will be too high.
But regulation on the tech giants also creates the prospects for those “old-economy” competitors that have survived, to bounce back.
Yesterday we talked about the risks surrounding markets (Italy, Interest Rates, China), and said these risks are likely serving as a catalyst to start the correction in tech stocks.
And we looked at this chart on Amazon as the key one to watch.
Here’s what the chart looks like today …
This big trendline broke today, a line that represents the more than doubling of Amazon in a little more than one year’s time. This is a company that went from a valuation of $500 billion to $1 trillion in a year.
So we get this big technical break, and Amazon is now down 14% from the highs.
Again, as we’ve discussed here in my daily note many times, at a trillion dollar valuation, the market was pricing Amazon like a monopoly that would go unchecked, and allowed to destroy any and all industries in its path.
But Trump has made it clear that he’s not going to let it happen. Amazon, Facebook and Google have all been subject to Trump threats to rein them in through regulation — to level the playing field for their competition. And if there’s one thing we know about Trump, as the President: he will follow through on threats, and he likes a good fight.
With that, the FANG (Facebook, Amazon, Netflix, Google) trade, after being UP as much as 50% this year (as an equal weighted group), isfinally breaking down. And that is creating some shock waves in broader markets.
So, is this the beginning of a bigger global meltdown or will it ultimately be a repricing of the tech giants. I think the latter.
Remember, the tech heavy Nasdaq, for much of the year, performed with near impunity from any geopolitical turmoil. As trade rhetoric heightened, the Dow would suffer, while the Nasdaq continued to climb. At one point this summer, the Nasdaq was up double-digits on the year, while the Dow was down.
So this is more likely a rebalancing (the rotation from tech giants to value stocks).
As we go into third quarter earnings, we continue to run at 20% earnings growth on the year. The P/E for stocks remains low, in a low/accommodative interest rate environment (yes, 3.2% 10-year yield remains low relative to history). And the economy is hot, with low and stable inflation.
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Yesterday we talked about the case for breaking up Amazon, on the day it crossed the trillion-dollar valuation threshold. Today the stock was down 2%.
Also today, Facebook and Twitter executives visited Capitol Hill for a Congressional grilling.
If you listened to Zuckerberg’s Congressional testimony in April, and today’s grilling of Jack Dorsey (Twitter) and Sheryl Sandberg (Facebook), it’s clear that they have created monsters that they can’t manage. These tech giants have gotten too big, too powerful, and too dangerous to the economy (and society).
All have emerged and dominated, thanks in large part to regulatory advantage – operating under the guise of an “internet business.” And it all went unchecked for too long. These are monopolies in the making. But, as we know, Trump is on it.
As we discussed yesterday, Amazon has to, and will be, broken up. As for Facebook, Google, Twitter, Uber: the regulatory screws are tightening. Those businesses won’t look the same when it’s over. But it’s complicated. The higher the cost of compliance, the smaller the chances that there will ever be another Facebook or challenger. That goes for many of the tech giants.
With that in mind, regulation actually strengthens the moat for these companies.
That would argue that they may ultimately go the way of public utilities (in the case of Facebook, Google and Twitter).
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As we end the week, let’s take a look at a few charts ….
We had the first look at Q2 GDP today. Here’s an updated look at the chart of the average four-quarter annualized growth rate we looked at
yesterday ….
This number will be formally revised two more times, but the “advance” number came in at 4.1%. Yesterday we talked about the prospects for the highest four-quarter annualized growth rate since 2006. We just missed it, in this first reading. But the Q1 number was revised UP to 2.2%, so adding in today’s Q2 number, and we get 3.1% four-quarter average annualized growth. Only for a moment, in 2010, was it better (at 3.15%).
I suspect we will see a bigger number in the coming Q2 revisions. And if sentiment on trade indeed bottomed out on Wednesday, with the EU concessions, we will likely have a big Q3 growth number coming.
That steadily rising trend, since the election, in the four-quarter average growth rate is a big deal. With that, I would call the above chart, the most important chart of the week…
Let’s look at the second most important chart of the week ….
I’ve been making the case that the massive Nasdaq outperformance, relative to the Dow, would begin correcting. In the chart above, you can see that it’s starting (Dow moving up, Nasdaq moving down). And it’s being led by strength in the blue chips following strong Q2 earnings, and weakness in two of the big tech giants (Netflix and Facebook) following big misses. With that, Facebook has quickly revisited levels of early May (which should give us all perspective on how aggressive this run in the tech giants has been over the past two months).
The question: Is it “peak Zuck?”
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The sharp swings continue in stocks, with the bias toward the downside. And as we’ve discussed over the past two weeks, it’s all led by the tech giants. Remember, on Friday we looked at the most important chart in the stock market: the chart of Amazon (as a proxy on the tech giants). Early this afternoon, Amazon was outpacing the S&P 500 to the downside by 4-to-1, and finally the broader market cracked to follow it.
This all continues to look like the market is beginning to price in a world where the tech giants, that have taken dangerously significant market share over the past decade, are on the path of tighter regulation and a leveling of the playing field, which will result in higher costs of doing business. That will change their position of strength and open the door to a resurrection of the competition.
Remember, on the stock slide of this past Friday, the S&P 500 hit the 200-day moving average and bounced sharply. It now looks like we’ll get another test of it, probably a break, and maybe take another peak at the February lows.
Here’s a look at the chart ….
You can see in the chart above the technical significance of these levels. This represents the trend from the oil price induced lows of 2016. And the slope of this trend incorporates the optimism from the Trump election and the outlook on pro-growth policies.
With that significance at play, a breach of this support, at least for a short time, would all play into the scenario that we’ll see more swings in stocks (pain for the bulls) until we get to earnings season, which kicks into gear on April 13. And as we discussed, that should begin the data-driven catalyst for stocks (earnings and growth, fueled by fiscal stimulus).
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Stocks were down big today. The media will have fun touting the Dow’s 700-point loss. But while 700 points has good shock value, on a Dow at 24,000, it’s not what it used to be.
Still, as we’ve discussed, the media and Wall Street are programmed to fit a story to the price. And there are no shortages of potential risks to point to when stocks fall. We have trade posturing in Washington. We have a Fed that’s in a tough position, trying to balance a bullish view on growth with the perception that rising rates could choke off that growth. And we have more regulatory scrutiny growing against the tech giants — with Facebook being the latest in the hot seat.
All of that sounds like bad news. But we also have corporate earnings on pace to grow at nearly 20% this year. And that could be an undershoot, given the inability of Wall Street to calibrate the effects of tax cuts on demand. And we have a big trillion-dollar plus infrastructure plan coming down the pike too. This is all as consumers are in as healthy a position as we’ve seen in more than a decade.
But what about a trade war? Doesn’t that threaten the earnings and growth outlook. Not more than nuclear war. And that was, in the public perception, probably as much of a risk last year, as a trade war is now. Stocks went up 20% last year.
Most importantly, we’ve discussed the merits of fighting China’s currency manipulation. If we don’t, we (and the rest of the world) are destined to repeat the cycles of credit booms and busts, with a persistent wealth drain along the way.
It has to be done. And it’s best done when there is leverage. And there is leverage now, as our economic recovery has the chance to lift the global economy out of the rut of the post-crisis stagnation (i.e. everyone needs our fiscal stimulus-driven recovery to work, including China).
Now, as we’ve discussed for quite some time: Markets will correct, as they have. And corrections are a gift to buy stocks on sale. But we won’t likely see a resumption of the long-term trend higher in stocks (and likely new highs by year end) until we start seeing hard evidence that fiscal stimulus is working. And we’ll see that in earnings and growth data, much of which is still a month out.
With all of this said, we pointed last week to the signals that predicted this latest down-leg. It was the big technical reversal signals across the tech heavyweights: Amazon, Apple and Microsoft. Those three stocks led the bounce from the February lows. And those three stocks have predicted this slide and maybe retest back toward the February lows.
What may be the real casualty left from this correction in stocks, when it’s all said and done? It may be those tech giants. As we’ve discussed, the heyday of crushing competition with the advantage of little-to-no regulation, are probably coming to an end. That will change the way these companies (Facebook, Amazon, Google, Uber, Airbnb, etc) operate.
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While the President’s pro-growth plan had some wins this year, it was a slow start.
Going after healthcare first was a mistake. Fortunately, a pivot was made, and we now have a big tax bill delivered. And we have what will likely exceed a couple hundred billion dollars in government spending on hurricane/natural disaster aid underway (the early stages of a big government spending/ infrastructure package).
Last year this time, I predicted that Trump’s corporate tax cut would cause stocks to rise 39%. That’s a big number, that’s only been done a handful of times since the 1920s. We got a little better than half way there.
But, here’s the good news: We got there on earnings growth, ultra-low rates and an improving economy. All of that still stands for next year, PLUS we will have the addition of an aggressive tax cut that will be live day one of 2018.
With that, my analysis from last year still stands! Let’s walk through it (yet) again.
S&P 500 earnings grew by 10% this year. S&P 500 earnings are expected to grow at about the same rate next year. And that’s before the impact of a huge cut in the corporate tax rate. The corporate tax rate now goes from 35% to 21% – and for every percentage point cut in that rate, we should expect it to add at least a dollar to S&P 500 earnings.
With that, the forecast on S&P 500 earnings for next year is $144. If we add $14 to that (for 14 percentage points in the corporate tax rate) we get $158. That would value stocks on next year’s earnings, at today’s closing price on the S&P 500, at just 17 times earnings (just a touch higher than the long-term average). BUT, the Fed has told us that rates will continue to be ultra-low next year (relative to history). When we look back at ultra–low interest rate periods, the valuation on stocks runs higher than average—usually north of 20 times earnings.
If we take the corporate tax cut driven earnings of $158 and multiply it times 20, we get 3,160 on the S&P 500. That’s 18% higher than current levels. This analysis doesn’t incorporate the impact of a potentially hotter than expected economy next year (thanks to the many other areas of fiscal stimulus). So, as we’ve discussed throughout the year, the backdrop continues to get better and better for stocks.
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We had a jobs report this past Friday. The unemployment rate is at 4.1%. We’re adding about 172k jobs a month on average, over the past twelve months. These are great looking numbers (and have been for quite some time). Yet employees, broadly speaking, still haven’t been able to command higher wages. Wage growth continues to be on the soft side.
With little leverage in the job market, consumers tend not to chase prices in goods and services higher — and they tend not to take much risk. This tells you something about the health of the job market (beneath the headline numbers) and about the robustness of the economy. And this lack of wage growth plays into the weak inflation surprise that has perplexed the Fed. And the weak growth that has perplexed all policy makers (post-crisis). That’s why fiscal stimulus is needed!
And this could all change with the impending corporate tax cut. The biggest winners in a corporate tax cut are workers. The Tax Foundation thinks a cut in the corporate tax rate would double the current annual change in wages.
As I’ve said, I think we’re in the cusp of an economic boom period — one that we’ve desperately needed, following a decade of global deleveraging. And today is the first time I’ve heard the talking heads in the financial media discuss this possibility — that we may be entering an economic boom.
Now, we’ve talked quite a bit about the run in the big tech giants through the post-crisis era — driven by a formula of favor from the Obama administration, which included regulatory advantages and outright government funding (in the case of Tesla). And we’ve talked about the risk that this run could be coming to an end, courtesy of tighter regulation.
Uber has already run into bans in key markets. We’ve had the repeal of “net neutrality” which may ultimate lead big platforms like Google, Twitter, Facebook and Uber, to transparency of their practices and accountability for the actions of its users (that would be a game changer). And we now know that Trump is considering that Amazon might be a monopoly and harmful to the economy.
With this in mind, and with fiscal stimulus in store for next year, 2018 may be the year of the bounce back in the industries that have been crushed by the “winner takes all” platform that these internet giants have benefited from over the past decade.
That’s probably not great for the FAANG stocks, but very good for beaten down survivors in retail, energy, media (to name a few).
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