The
big US stocks dominating markets and investors’ portfolios just
reported a truly-spectacular quarter. Their collective revenues
neared record levels, driving their highest earnings ever
witnessed. Yet despite all that, risks abound. The US stock
markets have never been more concentrated, relying on fewer and
fewer companies. Valuations remain deep into dangerous bubble
territory, and market fragility signs are mounting.
The
flagship US S&P 500 stock index has enjoyed a banner 2024, blasting
up 18.8% year-to-date in mid-July! Traders’ fascination with
mega-cap techs involved in artificial intelligence fueled fully 38
new record-high closes this year, over 1/4th of all trading days.
The resulting greed and euphoria have left the SPX chronically- and
extremely-overbought, mostly stretching far above its baseline
200-day moving average.
Since this latest mighty upleg started powering higher in late
October, there had been only one minor pullback until last month.
Over several weeks in April, the SPX retreated 5.5%. By mid-July,
the SPX had soared an impressive 37.6% higher in just 8.6 months!
At that latest record high, the S&P 500 had shot way up to 1.149x
its 200dma. Q2’24’s earnings season was getting underway and
looking fantastic.
Normally earnings beats stoke bullishness fueling nice rallies in
big US stocks. But the SPX ignored them to fall 4.7% into late
July. Then Japan’s extraordinary market chaos spooked world traders
last week, and the SPX plunged again deepening its pullback to
8.5% over several weeks. This selloff is threatening formal
correction territory down 10%+, which would spawn
increasingly-bearish sentiment among traders.
In
just three trading days, the SPX plunged 6.1% to Monday’s latest
pullback low. Inarguably that was Japan-driven. Those were the
same few days after the Bank of Japan hiked its rate from a
0.0%-to-0.1% range to “around 0.25 percent”, to attempt to reverse
its plummeting yen. That currency had collapsed 14.7% YTD by early
July, hitting its worst levels relative to the US dollar since
way back in December 1986!
That
weaker yen was stoking price inflation, forcing import prices higher
which Japan heavily depends on. But that mere 15-basis-point rate
hike started unwinding the enormous global yen carry trade. Traders
borrow yen for next to nothing, convert it into other currencies,
and buy higher-yielding assets including US mega-cap-tech stocks.
Unbelievably-heavy and brutal selling slammed Japanese stock
markets.
Astoundingly in those three trading days after the BoJ’s little hike
from almost zero, Japan’s benchmark Nikkei 225 stock index
crashed 19.5%! That included a shocking 12.4% plummeting on
Monday alone, the second-worst down day in Japanese stock-market
history after Black Monday in October 1987! Fear soared globally,
with the S&P 500’s VIX implied-volatility fear gauge skyrocketing to
65.7 that morning!
Though anything over 50 flags extreme unsustainable fear which is
always short-lived, the SPX still plunged 3.0% that day. While
Japan’s stock-market action was crazy, I can’t recall Japanese
stock-market fortunes ever mattering for American ones. That sure
looked like a fragility warning, highlighting the precariousness of
these lofty US stock markets. Their AI bubble may very well be
starting to burst.
For
28 quarters in a row now, I’ve painstakingly analyzed the latest
results just reported by the 25 biggest SPX components and US
companies. Almost all American investors are heavily deployed in
these behemoths due to fund managers crowding in. How big US stocks
are collectively faring fundamentally offers clues on what markets
are likely to do in coming months. This table includes key
SPX-top-25-component results.
Each
of these elite companies’ symbols are preceded by their SPX rankings
changes over this past year, and followed by their index weightings
exiting Q2’24. Next comes their quarter-end market capitalizations
and year-over-year changes, revealing how these stocks performed.
Looking at market caps instead of stock prices helps neutralize the
distorting effects of massive stock buybacks artificially boosting
prices.
Next
comes a bunch of hard accounting data directly from 10-Q reports
filed with the SEC. That includes each SPX-top-25 component’s
quarterly sales, earnings, stock buybacks, dividends, and operating
cash flows generated. Their quarter-end trailing-twelve-month
price-to-earnings ratios are also shown. YoY percentage changes are
included unless they’d be misleading, such as comparing positives
with negatives.
Overall the big US stocks’ Q2’24 results proved phenomenal,
confirming why these companies are the best. But despite their
continuing size-defying growth, troubling signs abound. These
include extreme concentration, extreme overvaluations, and the
overwhelming probability that these outsized growth rates aren’t
sustainable. That’s even riskier if the US economy slows down as
Americans struggle with inflation.
For
years US stock markets have been starkly bifurcated, with the
legendary Magnificent 7 mega-cap techs radically outperforming
everything else. Microsoft, Apple, NVIDIA, Alphabet, Amazon, Meta,
and Tesla are universally-loved, averaging mind-boggling $2,287b
market caps exiting Q2! These giants are now responsible for a
record 32.7% of the SPX’s entire weighting, exceedingly-risky
off-the-charts concentration!
That
catapulted the SPX top 25’s weighting to 50.2%, also the highest
ever witnessed. That’s effectively half the US stock markets,
with the Mag7 alone a third! Whenever some subset of these mega-cap
techs inevitably suffer heavy selling, they will drag down the
broader markets with them. This Monday’s Japanic was a great case
in point, with global fear peaking about an hour before US stock
markets opened.
At
worst soon after, the SPX was down 4.3% intraday. But the
comparable losses in MSFT, AAPL, NVDA, GOOGL, AMZN, META, and TSLA
were much worse at 5.6%, 10.9%, 15.5%, 7.0%, 9.7%, 7.6%, and 12.4%!
Mega-cap techs leading to the downside was even more pronounced
during recent weeks’ 8.5% SPX pullback. From their own recent-month
closing highs to latest lows, they also plunged way farther.
MSFT, AAPL, NVDA, GOOGL, AMZN, META, and TSLA suffered ugly outsized
15.5%, 11.7%, 26.7%, 17.2%, 19.5%, 16.0%, and 27.2% losses so far in
this pullback! And those will deepen if the SPX keeps rolling over
into a 10%+ correction or a deeper 20%+ new bear. Market-darling
stocks that leverage the SPX on the way up also amplify it on the
way down. All that recent selling came despite fantastic Q2
results.
Amazingly given their vast sizes, the Magnificent 7’s aggregate
revenues soared 15.3% YoY last quarter to $473.8b! That’s an
incredible achievement, which these great companies sure deserve
credit for. That trounced the next-18-largest US companies, the
rest of the SPX top 25. Their collective sales only edged up 1.6%
YoY to $754.6b. Adjusted for CPI inflation now running 3.0% YoY,
that’s actually real shrinkage.
But
like usual this comparison is skewed by composition changes near the
bottom of these elite ranks. Netflix blasted into the SPX top 25
over this past year, displacing oil super-major Chevron. While NFLX
did $9.6b in sales in Q2, CVX’s dwarfed that at $51.2b! So had
these last few big US stocks stayed stable, next-18-largest revenues
growth would’ve looked better yet still really lagged the
mega-cap-tech behemoths.
The
same was true on the earnings front, with the Mag7’s bottom-line
profits reported to the SEC under Generally Accepted Accounting
Principles rocketing up 42.4% YoY to $110.4b! That again
dwarfed the next 18 largest’s 11.8%-YoY increase to $112.1b.
Together the entire SPX top 25’s $222.5b was the highest on record,
exceeding Q4’23’s $218.1b! The biggest-and-best US companies are
earning tons of money.
Nevertheless these massive profits aren’t sustainable forever and
stock prices are way too high even given such colossal earnings.
This economy is tough for the great majority of Americans, who are
struggling with stagnant incomes yet greatly-inflated prices. Wall
Street loves to tout disinflation, the rate of increase moderating.
But general prices remain way higher than pre-pandemic levels, a
huge problem.
Everyone responsible for a household or business has lots of stories
about how expensive everything needed for existing has become. That
includes shelter, food, energy, insurance, medical, education,
repairs, and the list goes on. The US government’s leading CPI
inflation gauge claims general prices have only risen 22.3% since
late 2019. But that’s intentionally lowballed for political
reasons, reality is far worse.
Based on extensive reading of economics stories in the financial
media in recent years, actual inflation is double to triple that.
General price levels for necessities are up on the order of 50% to
75%, crushing increases that are difficult to bear! So roughly
9/10ths of Americans are having to make hard decisions on
budgeting. They are increasingly mostly buying things they have to,
leaving little money for things they want to.
Much-less discretionary income left after necessities is a serious
downside risk for sales and profits among most of these SPX-top-25
companies. Everyone loves new Apple iPhones, but with innovation
dwindling older models remain fast and useful for several years or
longer. If cash-strapped Americans stretch out their iPhone upgrade
cycles, AAPL’s revenues and earnings will fall forcing its valuation
even higher.
Tesla’s expensive battery cars are way-less-necessary than
smartphones, true luxuries. Even upper-middle-class Americans are
being pinched by inflated prices, leaving way less money to splurge
on new cars. Amazon faces waning-discretionary-spending risks too,
as some big fraction of AMZN’s sales are from things people want
rather than need. Slower consumer spending would really slam
corporate profits.
And
when Americans have less money to spend on non-essentials,
businesses increasingly face tough sledding. As their sales slow
and profits plunge, the easiest expenses for them to slash are
marketing. Alphabet and Meta are totally dependent on business
advertising, and Amazon and Microsoft also have some exposure on
that front. If business ad spends wane in harder economic times,
mega-cap tech is in trouble.
With
Americans forced to divert higher percentages of their incomes into
shelter, food, energy, insurance, and other essentials, most big US
companies are at risk of serious slowdowns in revenues and
earnings. After the mega-cap techs, the hottest giant company today
is Eli Lilly thanks to its GLP-1 weight-loss drugs. LLY sells two
variants of these, one for treating diabetes and another just for
vanity pound shedding.
In
Q2’24, their combined sales skyrocketed 342.4% YoY to $4.3b! That
rivals mighty NVIDIA’s 262.1% YoY revenues growth last quarter on
stellar demand for its graphics chips used in AI processing. These
GLP-1 drugs may be effective, but the jury is still out on
longer-term side effects. Yet at $1,000+ per month without
insurance, most Americans can’t afford them as inflated prices
consume their take-home pay.
They
may have to resort to eating less often and exercising more to
manage their weights. Out of all these SPX-top-25 stocks, only
Walmart and Costco are greatly benefitting from this budget-busting
price environment. As this leading discounter and wholesaler save
people money, their grocery market shares and sales are growing. I
shop at Costco every week to buy fresh food for my family, and it is
bursting at the seams!
My
kids are both tall-and-strong athletes deep into high-level
competitive basketball, along with other sports. I joke with my
wife that if it wasn’t for Costco we couldn’t afford to feed them!
Despite big price increases even at Costco in recent years,
everything from meat to cheese to fruit is way more affordable
there. COST operates at razor-thin margins, with membership fees
responsible for over 2/3rds of its profits.
Even
NVIDIA isn’t immune to an economic slowdown from cash-strapped
Americans. Its stratospheric sales and profits growth over the last
year was mostly fueled by other mega-cap techs buying its
GPUs for large-language-model AI use. But despite hundreds of
billions of dollars invested in AI infrastructure, it hasn’t yet
found any profitable uses. As revenues slow at NVDA’s customers, so
will their GPU purchases.
These lofty stock markets are priced for perfection, fully
betting for a US economy led by strong consumer-spending growth for
years to come. But with Americans forced to shunt high-and-rising
fractions of their incomes into buying necessities at inflated
prices, discretionary spending is increasingly dwindling. And
slumping revenues are directly leveraged by earnings, which fall
much faster. That’s an ominous portent.
The
big US stocks’ valuations remain deep into dangerous bubble
territory despite their fantastic quarterly results. Exiting
Q2, the SPX top 25 averaged 43.6x trailing-twelve-month
price-to-earnings ratios! Interestingly that’s the one place there
wasn’t a divergence between the Magnificent 7 and the next 18
largest, with average P/Es of 44.2x and 43.4x respectively. These
valuations are extreme by all historical standards.
Over
the last century-and-a-half or so, fair-value for US stock markets
averaged around 14x earnings. Twice that at 28x is where
formal stock-bubble territory starts. The longer stock markets
spend at bubble valuations, the greater the odds a major secular
bear market will awaken to maul prices back down to mean revert and
overshoot. Today’s 44x is crazy-high, virtually guaranteeing an
overdue bear is stalking!
While big US stocks are earning massive profits, their stock prices
are still far beyond levels justified by those. Traditionally major
bear markets run until SPX P/E ratios fall under 14x, sometimes as
low as half fair-value at 7x. But even if the inevitable bear
merely forces P/Es back to a still-very-overvalued 21x, that would
more than cut the SPX in half! The beloved Magnificent 7
would lead the way down, faring way worse.
While euphoric traders have forgotten about stock bears, they are
serious and not to be trifled with. From March 2000 to October 2002
after the last time the SPX was this overvalued, it plunged 49.1%
over 30.5 months! Later from October 2007 to March 2009, the SPX
plummeted 56.8% in 17.0 months! There is plenty of modern precedent
for bears gutting excessive stock prices, especially starting from
bubble toppings.
And
even milder minor bears are dangerous, with the last one clawing the
SPX down 25.4% from early January 2022 to mid-October that same
year. Before that bear, Wall Street asserted that
fundamentally-strong mega-cap techs were among the safest stocks.
Yet surrounding that SPX-bear span, the Mag7 market-darlings
averaged brutal 54.6% losses more than doubling the SPX’s!
Bubble stocks are never refuges.
As
if that wasn’t menacing enough, slowing discretionary consumer
spending will exacerbate bubble valuations giving any bear
more fodder. If a big US stock’s revenues slump 5%, its earnings
could easily drop 20%+. That means if it had a current average 44x
P/E, that could surge near 55x. That makes for proportionally more
downside as a bear does its gory work of realigning stock prices
with underlying earnings.
Corporate stock buybacks are another big risk along these lines.
Last quarter the SPX top 25’s collective buybacks soared 29.0% YoY
to $87.7b, still huge but well off Q4’21’s $107.3b record. These
buybacks aren’t only done to bid stock prices higher boosting
managements’ bonuses, but also to goose earnings per share.
Buybacks retire shares, and the fewer outstanding the higher the
earnings spread across the remainder.
Like
businesses slashing their advertising spending when times are tough,
cutting buybacks is the easiest way for big US stocks to preserve
cash in a weakening economy. And if these enormous buybacks keep
slowing, the earnings-per-share drops will more closely match
underlying profits. That too will leave bubble valuations higher
than they would’ve been with huge buybacks, exacerbating any
rebalancing bear.
Like
Americans can’t cut out food no matter how expensive it gets,
corporations are loath to reduce their dividends. The SPX top 25’s
surged 10.8% YoY to $45.5b in Q2. Many investors and funds rely on
these dividends to yield income, and stocks look way less attractive
without them. So if companies eventually have to significantly cut
dividends due to slowing consumer spending hurting sales, there’ll
be hell to pay.
Any
big dividend cuts will really intensify bear selling, as we just saw
with another big US stock. Once-revered chipmaker Intel isn’t an
SPX-top-25 stock, ranking as 73rd at the end of Q2. Just last week
in its latest quarterlies, INTC warned it was “suspending the
dividend starting in the fourth quarter”. Despite its stock already
being quite low, that day alone it plummeted another 26.1%!
Dividends are always sacrosanct.
Finally the big US stocks’ cash flows generated from operations last
quarter were also strong, surging 12.0% YoY to $239.5b. But again
all that growth came from the Mag7, which saw OCFs soar 26.5% YoY to
$156.3b! The next 18 largest’s operating cash flows excluding
money-center banks plunged 23.8% YoY to $82.2b. But that too was
skewed lower by Netflix forcing out Chevron from the SPX-top-25
ranks.
Make
no mistake, despite big US stocks just reporting spectacular Q2
results these bubble-valued stock markets remain dangerous.
Valuations are still extreme as American consumers have increasingly
less discretionary income to spend on wants. Unless general price
levels somehow magically retreat back to pre-pandemic ranges,
corporate profits are under serious threat. And huge disinflation
ain’t gonna happen.
Today’s inflation nightmare gutting Americans’ finances and about to
erode stock markets was caused by extreme Fed money printing and
out-of-control government spending. In just 25.5 months after March
2020’s pandemic-lockdown stock panic, the Fed recklessly ballooned
its balance sheet an absurd 115.6% or $4,807b higher. Despite
quantitative-tightening bond selling since, that remains up fully
72.6% or $3,020b!
With
top Fed officials itching to start cutting rates soon, they are also
tapering their QT bond selling which is the only meaningful way
to shrink the US money supply. And no matter who controls the
presidency or Congress after November’s elections, neither party
will slash government spending back down anywhere near 2019 levels.
These inflated general prices are here to stay, which will
increasingly weigh on stock markets.
American investors need to prudently diversify their risky
stock-heavy portfolios into gold and its miners’ stocks,
which thrive in inflationary times. With
gold powering up
to new nominal records this year on big Chinese-investor and
central-bank buying, gold stocks have lots of catch-up rallying to
do. They are
nearing their tipping point where traders turn bullish and rush
in, fueling a massive
mean-reversion-overshoot bull.
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The
bottom line is big US stocks just reported a spectacular quarter,
with near-record revenues and the strongest earnings ever
witnessed. Yet despite these great achievements, valuations remain
deep into dangerous bubble territory. Even these huge profits are
nowhere near fat enough to justify these lofty prevailing stock
prices. That portends a looming bear market to maul prices back
down in line with earnings.
Even
worse, these extreme valuations will likely head higher until that
bear really roars. Corporate sales and profits should come under
increasing pressure as cash-strapped Americans cut back on
discretionary purchases. Inflated necessities’ prices are consuming
more of their incomes. Declining revenues will be amplified by
earnings, leaving US stock markets even more bubbly. Traders need
to reallocate some into gold. |