August 14, 2018

There has been a lot of cheer recently that Apple (AAPL) has become the world’s first trillion-dollar corporation. This is a major milestone and it has been anticipated for the past several years.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

It may surprise you to find out, though, that Apple is not nearly the biggest company in human history, not by a longshot. In 1637, the Dutch East India Company was worth $7.9 trillion, adjusted for inflation.

Now that we’ve seen the $1 trillion barrier broken, it may pave the way for larger and larger companies to follow suit. The stage is certainly set for more mergers and stock buy-backs, as I wrote about in my white paper for Navellier & Associates (click to view), Honey I Shrunk the Stock Market. In short, tax reform enabled companies to bring home cash earned overseas at very low tax rates, leading to record buy-backs.

Companies are buying back their own stock at a record pace this year. In the first quarter of 2018, companies completed $178 billion of buy-backs, up more than 42% from Q1 2017, according to S&P, blowing away the previous quarterly record from the third quarter of 2007.

While it’s true that we are in a slowly rising interest rate environment, we still have historically low rates. It’s still relatively cheap for corporate borrowing in order to fund operations or even fund more buy-backs.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Then we have the strength of the U.S. dollar. Foreign national currencies are eroding in value relative to the U.S. dollar on a significant scale. As tariffs heat up and the trade-war continues to drive headlines, it looks as though the U.S. dollar is winning, including this huge rise in the second quarter:

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Finally, we have another record earnings season. With 91% of the S&P 500 having reported earnings, 79% of those companies have beaten earnings expectations, the highest on record since FactSet started tracking in 2008. We have the second-highest earnings growth since 2010, at 24.6% according to FactSet. In addition, 72% of companies are beating revenue estimates, well above the 5-year average of 58%.

So, we have low corporate tax rates, near-record low interest rates, a strong U.S. dollar, record buy-backs, record sales and earnings, and a near-record high stock market. That’s a lot of record highs. It makes me wonder why so many people worry. I think it speaks to human nature. We humans seem happiest when we have something to fret about. I think newspapers and the media figured this out a long time ago…

Growth Companies are Routinely Beating Expectations

As trade-war talk intensifies, it would seem logical that sector leadership would favor the more defensive sectors. Several weeks ago, we saw a visible rotation towards more defensive sectors, as investors used the trade-war headline fears to take profits out of growth. It seemed, for a moment, that a large rotation was underway, and growth was going to log some bench time. But that fear quickly faded away as more evidence emerged. There is a premium being paid for growth. In talking to several Wall Street traders I know, I have heard what seems like the same discussion many times about stock stories along these lines.

A stock trades at what seems like a rich multiple. For example, let’s imagine a stock heads into earnings at a 48 price/earnings (P/E) multiple. Wall Street analysts have high expectations. The shorts pile in because even if the company meets expectations there is a good chance it will trade down because analysts were not stunned. The short interest on the stock swells to nearly 15%. The stage is set, and the market closes on earnings day. The report comes out, and the company absolutely shatters all expectations and guides higher for the ensuing quarter and year. There is only one place for the stock to go, and that’s straight up. That’s precisely what happens to The Trade Desk (TTD) as it closes up +37% on Friday.

Guess what? That premium for growth that seemed so unreasonable the day before earnings came out, now looks conservative or even silly compared to the “new” premium for the growth of that company.

We are seeing outsized moves to the upside for many growth companies beating expectations. This translates into sector leadership, now populated with growth stocks. Last week, for instance, saw a rise in Consumer Discretionary stocks, up +0.79%. Telecommunication was strong but it has a very small makeup of only a handful of stocks. We’ll leave the sector alone for the moment. Information Technology was next in line. Tech and consumers are where the growth is. And in a week that saw the S&P 500 down -0.25%, these two growth sectors were positive. This was largely attributed to strong earnings.

We have seen growth take a pause for a few weeks and it can be seen in the 3-month sector leaderboard. It was a mixed bag with Health Care, Consumer Staples, Consumer Discretionary, Utilities, Infotech, and Real Estate rounding out the top six. But looking around, with a few notable exceptions, earnings are surprising to the upside, not the downside. This is a signal for growth.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

We can expect summer volatility, but I am bullish on U.S. stocks. I like growth, particularly U.S. domestics that have less sensitivity to currency and trade war risk. Stay focused on the data, which should tell you to be bullish too. Growth is not dead, and the market is rewarding strength, which is abundant now.

About The Author

Jason Bodner

Jason Bodner writes Sector Spotlight in the weekly Marketmail publication and has authored several white papers for the company. He is also Co-Founder of Macro Analytics for Professionals which produces proprietary equity accumulation/distribution research for its clients. Previously, Mr. Bodner served as Director of European Equity Derivatives for Cantor Fitzgerald Europe in London, then moved to the role of Head of Equity Derivatives North America for the same company in New York. He also served as S.V.P. Equity Derivatives for Jefferies, LLC. He received a B.S. in business administration in 1996, with honors, from Skidmore College as a member of the Periclean Honors Society. *All content of “Sector Spotlight” represents the opinion of Jason Bodner*


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