Time for a trim?
The Curious Investor - May 17, 2021
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What the Market?
It’s been a heck of a strange, socially-distanced party that has lasted for months, and Mr. Market feels like taking a breather. It’s at that point in the party when some people want to party till sunrise, and others just feel like going to bed. Is the party over? Well, it depends who you ask. Tech and growth are exhausted, but value stocks have been pacing well with lots of energy to keep going.
What’s driving the market?
Inflation, Inflation, Inflation: Let’s talk about the elephant in the room; consumer prices rose 4.2% in April. The increase is the fastest growth reading since 2008 and well above the expected consensus of 3.6% with a month-over-month gain of 0.8% vs. the 0.2% expected. Note: this includes the price of energy and food which tends to be volatile. Energy prices have increased 25% YoY (remember just one year ago when oil prices were negative?) and commodities are flirting with all-time highs. The jump is a combination of both base effect inflation, and commodity-driven supply chain inflation. So far, there doesn’t appear to be anything to worry about and the Fed has yet to pull on any of their levers. Most likely, the Fed is prioritizing the long-term stability of economic conditions (aka jobs) rather than short-term spikes in prices. Keep an eye on the Core Personal Consumption Expenditure Price Index and PPI figures to help make sense of the complete situation.
What’s an investor to do?
For the last couple of weeks the overarching equity market narrative has been heavily influenced by accelerating inflation and underwhelming economic data which has ultimately damaged tech and high growth stocks. Analysts always expected Q2 to be somewhere between a rock and a hard place for the Fed. As the economy reopened and inflation set in, the Fed's dovish policies came into question. Think long-term and boring. The tech and growth party may be over and it may be time for a reality check. Sure, Google is great, but is it worth 75x next year’s earnings? Just saying…
Remember the whole rebalancing thing we were talking about? The Nasdaq has been trailing the S&P and Dow Industrial Average this year and has dropped below its 50-day moving average. There is still time to cut some losses and start considering more sustainable and longer-term value position exposure. As the economic data unfolds, it seems that the tech and growth rally we’ve experienced for the past year may be wrapping up.
Keep an eye on the economy
FOMC minutes: On Wednesday, the minutes from the April 28th meeting will be released. Although we expect no further insight after Powell’s “now is not the time to talk tapering”, analysts will be looking for any suggestions on posturing towards a less dovish approach in the near future. Such news would be positively taken by markets.
The Curious Investor:
Hot Vax Summer? Over the past 30 years, the stretch between Memorial and Labor day has typically been underwhelming. Aligned with the infamous Wall St. saying “Sell in May and Go Away,” summer months have often been plagued by low volumes and little directionality. As America goes into vacation mode amid an increase in the vaccinated population trading volume is expected to decrease. People are more focused on where to take a few weeks off rather than what to invest in. Summer months are typically a good time to diversify into safer havens and stay liquid while waiting for pullbacks and opportunities.
Stocks come back to Earth: After a year of market growth fueled by hope of the pandemic ending and businesses recovering despite horrid economic data, companies reporting earnings are having a hard time living up to their astronomical valuations. Many companies are getting a haircut despite posting strong earnings results. Consider it the grounding; valuations have to come back from space and find some grounding in rational fundamentals. On the backdrop of inflation fears, weak retail sales data, and a broader market pullback from tech and growth plays, no one is immune from the capital flight to quality and value. Let’s take a look at one of the key players experiencing a pullback, Microsoft.
Microsoft: (Disclosure, WTM is long MSFT):
MSFT shares are known to dip slightly after posting earnings with many investors often taking profits from one of Wall Street’s top performers over the past 5 years. However, the recent dip saw MSFT shares take a 9.5% haircut in the weeks following their Q3 fiscal earnings, approaching correction territory (+10%). Microsoft beat analyst expectations and experienced significant top line growth in each of its segments while improving its operating margin to 40% (which has been steadily increasing since 2018).
Let’s talk numbers:
Revenue: reported $41.7B vs. expected $41.1B
Adjusted Annualized revenue growth: +19%
EPS: reported $1.95 vs. expected $1.78 (10.8% surprise)
YoY Growth in Azure Revenue: 50% vs. expected 46.3% (for reference AWS grew 32% in the same quarter)
Why the dip? The reason for the dip is unclear as a look under the hood shows a strong performance with lots of upside potential. Perhaps it is Microsoft’s guidance that cloud growth from Azure will decelerate, a leading revenue driver for MSFT. Azure which currently makes up 20% of the global market share, second only to Amazon’s AWS platform, actually experienced accelerating growth this quarter after consecutive quarters of decelerating growth pre-pandemic. Perhaps the dip is stemming from the broader inflation fears, tech correction, or a fear of profits normalizing after the pandemic recovery (e.g., the More Personal Computing segment grew revenues by 19% driven by content and services for the Xbox gaming console amid the pandemic).
Conclusion: Microsoft continues to grow company-wide while steadily improving operating margins. At Microsoft’s size, it is not uncommon for growth to decelerate as the revenue base from which future growth is measured increases. Concerns of decelerating growth from key business segments must take into account the size and scale at which Microsoft is growing relative to competitors and their ability to maintain operating margin as they scale. Microsoft is currently moving the right direction on both accounts and is poised to continue being a leader in the tech space.
Monday: Chinese Retail sales and industrial production, Japanese Q1 GDP data revision, Bank of England speeches, Fed speech
Tuesday: UK unemployment report, Eurozone Q1 GDP data revision, employment report and trade balance, ECB speech, US housing data
Wednesday: UK and Eurozone CPI and PPI, ECB speech, FOMC Minutes,
Thursday: PBOC interest rate decision, ECB and Bank of England speeches, US Jobless Claims, Japanese CPI
Friday: Eurogroup meeting, Eurozone UK and US PMI, Eurozone consumer confidence
If you didn’t know, now you know
It is impossible to provide a short summary of the escalating conflict between Israel, Hamas controlled Gaza, and Palestine in a few sentences. However, it is crucial that we understand the layers to the conflict that has been ongoing for over 70 years. We’ve compiled a few videos that we believe are more objective than most to understand some of the key events that have led to the recent escalation. These videos will not provide all of the context, but are a good starting point.
What we’re vibing:
But I Still Love You by Bohan Phoenix. A new release from Chinese-American rapper Bohan Phoenix bringing a message of love and unity amid a rise in Asian hate crimes. All proceeds of the production will be donated to #Hateisavirus. You may also spot one of WTM’s writers among the extras.
Experience by Ludovico Einaudi. For those into classical music, this is a truly emotional piece with strong uplifting energy. You’ve probably heard it in a couple of Netflix’s Chef’s Table episodes.
This writing is for informational purposes only and the author/s undertake/s no obligation to update this article even if the opinions expressed change. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services in any jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. The author/s expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.