Stocks rose sharply for the third straight session. It’s earnings season. Through yesterday, the results were basically in line with lowered expectations, but perhaps the biggest driver of higher stock prices was the reversals over the past several days in the value of the dollar and the yield on 10-year Treasuries.
Within a bear market that has lasted almost 10 months, any reversal of less than a week must be taken in context. Bear market rallies or reversals are common and can be short-lived, but the recent sharp escalations in the dollar and bond yields do have a ring that momentum may have moved both too far too fast. Not long ago, a dollar translated into more than 1.3 euros. Last week, a dollar was worth more than a euro. Comparisons against the yen are even more stark. As for the yield on 10-year Treasuries, only about three weeks ago, the yield was just a shade over 3.6%. Two weeks later, it was almost 4.3%. Normally a daily move of 5 basis points is huge. Over the past three weeks there have been sessions where the yield moved more than 20 basis points…in either direction. This morning, it sits at 4.06%. It has been above 4% for all of 10-days. 4%, within a basis point or two, had been the high for 2022 until the exaggerated moves of the past two weeks. I don’t think inflation expectations have gyrated that much over such a short period of time. Rather, the volatility is a signal of the illiquidity that currently exists in the bond market.
Stock prices have been jerked around by the sudden and extreme moves in bond yields, not only in the U.S., but around the world. For a time, the epicenter was London as Britain went through political turmoil enduring three Prime Ministers in less than 8 weeks. With that said, 10-year Treasury yields normally related to inflation expectations. While they are constantly moving, long-term expectations as measured in futures markets and TIPS spreads have only moved a few basis points over the past two weeks.
Investors are hoping the Federal Reserve can end its rapid push to elevate the Fed Funds rates toward 5% within the next few months. The rally was ignited Friday by a report that FOMC members at their early November meeting will discuss the possibility of beginning to temper the pace of rate increases at its December meeting. That doesn’t mean it is prepared to declare victory. It doesn’t mean the Fed Funds rate can’t reach 5% or higher next year. That will depend on the rate of inflation several months from now, but the persistent 75-basis point increases started in June may well be coming to an end. At least that’s the hope of the moment.
The value of the dollar and the trend in long-term rates is only part of the equity valuation equation. The other major component is earnings. As noted above, so far this earnings season, most companies matched or exceeded forecasts. That all changed last night. The disappointment came from the technology sector, the part of our economy that had been the catalyst for growth over the past decade.
Since the start of the 21st century, there have been multiple sea changes rooted in technology. Social media, streaming, cloud computing, Internet retailing, smartphones and electric cars are a half dozen examples. Leadership companies grew at breakneck speeds. These disruptive companies took over major market shares from heretofore conventional alternatives. Search results gave instant answers. Social media changed our lives. It also moved advertising from old media formats like newspapers and TV to the Internet. Cloud computing provided more efficiencies. You can fill in the other blanks yourselves.
But the sky is never the limit. Newspapers are disappearing. 4-section papers are now 16-pages. Few watch conventional TV anymore except for news, sports, and other live events. In a word, these industries are reaching some level of maturity. Add an economic slowdown to the mix, and you have ingredients for a sharp deceleration in growth. Last night we heard from Alphabet#, Microsoft#, and Texas Instruments# among others. It is the height of earnings season. Previously we heard from Tesla. Tonight, Meta Platforms# (formerly Facebook) reports. Tomorrow, it will be Apple# and Amazon#. The messages are identical. These companies no longer are in that early life cycle that allows them to grow through any economic slowdown. Market share gains still occur, but there is not much share left to take from disrupted economic segments. Alphabet reported that YouTube’s ad revenues declined over the past year. Facebook users are down. The disruptor is getting disrupted by TikTok. Whatever the metaverse may be, few are ready to embrace it yet.
Over the next quarter century, there will be new technological disruptions, but that isn’t where I am going today. The top of the S&P 500, well over a quarter of the value of the index, is concentrated in the companies I just mentioned that were the disruptors of the past quarter century. For many years, beating the S&P 500 could be done by simply owning Apple, Amazon, Google, Microsoft, and Tesla. Not any longer. This morning, Microsoft, Alphabet and Texas Instruments are all likely to open down 5% or more. The culprit in each case is expectations. How much of the reduction relates to a slower economy and how much relates to business maturity isn’t important. What’s important is that the leadership members of the S&P 500 are all maturing at once. Even Tesla is showing signs of growing pains just as the electric car business is starting to take off. While Tesla has well over 60% of the U.S. market, its share in China and Europe is closer to 12%. This week the company announced price cuts in China, obviously a sign that competition is taking its toll as markets become more competitive.
We have seen this tale play out before. After the Internet bubble burst, growth slowed for the likes of Intel, Cisco#, and Microsoft. More importantly, lofty P/E ratios never returned to former levels. Intel and Cisco stock prices today are a fraction of what they were more than two decades ago.
That doesn’t mean that all the big name stocks mentioned are sales or that their growth prospects have suddenly disappeared. As a group they have been market laggards all year long. Not all the business segments are suddenly mature. The movement to cloud computing and electric vehicles still has a long runway. Each company must be viewed separately. The evolution toward autonomous vehicles, the metaverse, and quantum computing will create vast new opportunities. But for now, the pain of maturity and a slowing economy are dominating. With that said, let me put this morning’s likely decline into perspective. The market value lost in overnight trading in Texas Instruments, Microsoft and Alphabet simply reverses less than two weeks of gains. Investors had been hoping for better news and a repeat of the sharp rally these stocks achieved in July when they beat reduced forecasts. But with that said, there is a message here that should ring loud and clear.
Successful investors look ahead, not back. They want to own companies that can grow faster than GDP consistently. They want companies likely to gain market share. They want innovators of tomorrow, not yesterday’s disruptors. It is rare for yesterday’s disruptors to disrupt again, but it does happen. Microsoft is a perfect example. Once a PC-centric company, it pivoted to an enterprise and cloud focus. Its growth reaccelerated. Alphabet didn’t just rely on Google search. It built YouTube. Its Waymo division promises to be a big factor once autonomous vehicles become reality, but often new disruptors knock off the old leaders. There are no more minicomputer companies. The PC makers destroyed them. Name me a restaurant chain that built a second successful chain from the ground up. I can’t.
All of today’s leaders still have growth opportunities. But for all their efforts to diversify, Intel is still a manufacturer of microprocessors, and Cisco is still dominated by routers and switches. Look ahead. Look for very large addressable market opportunities, a company that will touch all our daily lives. Don’t look back. The world doesn’t need another social network or another streaming service. That’s old news. We already own smartphones and PCs. Even if you pick the right industry, you still must identify the dominant leader. No one said it was easy, but the formula is always the same. Large market opportunities combined with best-in-class management.
For yesterday’s heroes, it is time to pivot. Some have. Microsoft and Apple now pay healthy dividends and buy back stock. Bull market times allowed these giants to spend indiscriminately on ventures. Some worked, a lot didn’t. When capital was cheap and debt cost nothing, there was little cost to failure. That isn’t so today. Meta, in particular, is being criticized, rightfully so in my opinion, for spending billions chasing an opportunity that may or may not materialize. Companies like Peloton and Beyond Meat are failing because they misread their opportunities. Everyone in the world doesn’t want a spinning bike or a pea-based burger. Companies need to size themselves to their opportunities. There is a limit to growth opportunities. Real estate developers who get in too late end up with empty buildings and no tenants. Tech companies chasing opportunities for which they aren’t equipped waste shareholder money. Just as Intel or General Electric or for that matter, Peloton.
I said investors should look ahead, not back. The same holds for corporate managements. As the size of future opportunities change, companies must adjust. When mobile phones burst onto the scene, Facebook adapted from PC-centric to a mobile platform, but it didn’t have to reinvent its product. The metaverse is a whole new world. Facebook may succeed but it has no substantive competitive advantage other than the fact that it is spending a lot of money trying. If it finds the pot of gold, there will be time for investors to jump on the bandwagon. In the meantime, its focus should be on building and maintaining the best social media platforms.
Today, Keith Urban is 55. Hilary Clinton turns 75 and Pat Sajak is 76.
