The magic continued this week as all three major U.S. averages closed higher. I’ve always liked the fourth quarter, and not just because of Halloween, Thanksgiving, and Christmas. It’s also the quarter investor are most hopeful and optimistic. While that isn’t always the case, I’m looking at you 2018, this quarter appears to be following the pattern. Earnings announcements were a little less positive this week, yet investors seemingly didn’t care. And that’s what’s so confounding about the stock market and makes it impossible to time. What investors cared about one week, maybe totally irrelevant the following week. If only there was some rhyme or reason to the short-term volatility. Ultimately, we invest for the long-run, recognizing the best companies perform over years, not weeks.
One thing that keeps popping up on the earnings calls is that the strong value of the U.S. Dollar is presenting a significant headwind. Among those companies reporting, the currency impact on revenues is as follows: IBM -9%, Coca-Cola -8%, Netflix -7%, McDonalds -7%, Pfizer -6%, Johnson & Johnson -6%, Nike -6%, Levi Strauss -6%, 3M -5%, and Microsoft -5%. I am the first to point out when companies make up excuses to explain away poor performance. However, this quarter the reasoning is legitimate. On the flip side, to the consternation of the Federal Reserve, companies are offsetting higher labor costs, higher materials costs, and higher transportation costs by simply raising prices (exacerbating the problem with inflation). As one example, Kraft Heinz delivered Q3 results ahead of consensus expectations. The consumer staple company reported revenue grew 11.6% during the quarter vs. 9% consensus, consisting of a 15.4% benefit from price increases and a 3.8% drop in volume. To clarify, they sold less product but at a considerably higher price. And that, in a nutshell, is the problem with the economy today.
As for economic indicators, while slowing, they still are robust. By that I mean weekly jobless (unemployment) claims remain low, and Q3 GDP came in at a strong 2.6%, after two quarters of negative growth, and a technical recession. Additionally, what used to be called the PCE Deflator, now called the PCE Price Index, came in at 4.2% compared to 7.3% prior. This is a measure of inflation, specifically the prices people in the U.S. pay for goods and services. It is known for capturing inflation across a wide range of consumer expenses and reflecting changes in consumer behavior. The fact that it has fallen so quickly suggests the official CPI number will follow suit. To some extent, that is what drove the markets higher this week. With inflation falling, investors are beginning to consider what a post-rate hike environment may look like. While the Fed will almost assuredly raise interest rates another 0.75% next week, it is now quite possible they will raise rates at a slower pace going forward. At least that’s what the market believes.
On another note, we’ve all heard the saying, the bigger they are the harder they fall. For more than a decade now, the technology sector has led the markets to ever higher valuations. To a large extent, growth was driven primarily BY the technology sector. We didn’t see that kind of explosive revenue growth from any other sector, i.e. utilities, consumer staples, materials, or industrials, etc. Investors were willing to pay a premium for growth the likes of the FAANG stocks were experiencing. More recently, the FAANG stocks have stumbled a bit as growth has slowed and expectations have come crashing down. Facebook, Amazon, Alphabet, Netflix, and Apple have all struggled this year. In truth, their stock prices have fallen from 33% to 70%, except for Apple. Somehow, Apple continues to meet or beat expectations despite the difficult environment. In this regard, Apple is the last FAANG standing. It can be considered the winner of the Squid Games, or perhaps if you are of another generation, the Hunger Games. We don’t expect the tech names to stay down forever, but not unlike the tech bubble from 2000-2002, there could be new “winners” coming out the other side.
In closing, since we’re talking about tech companies, I figured we could all sympathize for a moment with Mark Zuckerberg. Meta, previously called Facebook, has had a particularly difficult year, down 70%. The company had a market cap of almost $1 trillion at the end of last year. It now has a market cap of only $272 billion, knocking it out of the top twenty largest companies. But what of Mark? His net worth fell by $100 billion in just thirteen months. Yesterday alone, his net worth fell $11 billion. He is now only worth $38 billion, oddly the same number as his age. I know $38 billion is still an awful lot of money, but you might feel just a bit sorry for his loss. I know I do. I figure he has a few more chapters ahead of him, but for now he’s almost like you and me. Now you know.Bruce J. Mason, MBA